With taxes on everyone’s mind now, here’s something to talk about with a prospective client who is thinking about starting a retirement plan. It’s the tax credit for starting a new retirement plan.

Here’s how it works in broad brush strokes in a Q&A format:

What is it?

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) added a tax credit of up to 50% of the first $1,000 in retirement plan startup expenses for the first three years of a plan. Thus, the credit cannot exceed $500 during each of the first three years of the plan.

Who is an eligible employer?

An employer is an eligible employer if, during the preceding year, there were 100 or fewer employees who received at least $5,000 of compensation.

Can the plan cover only Highly Compensated Employees?

No. The plan must cover at least one Non-Highly Compensated Employee.

Does the plan have to be new?

Yes. The employer must not have established or maintained any employer plan during the three tax-year period immediately preceding the first tax year in which the new plan is effective.

What types of plans are eligible for the Tax Credit?

Eligible plans include qualified plans such as 401(k) plans, profit sharing plans, traditional pension plans, cash balance pension plans, and employee stock ownership plans. In addition, SEP IRAs and SIMPLE IRAs could qualify.

What expenses are eligible?

Expenses include those incurred to establish the plan, administrative fees and costs incurred to educate employees about the plan.

Is a “double tax benefit” available?

No. Qualified costs are not deductible to the extent they are effectively offset by the Tax Credit.

How does the employer claim the Tax Credit?

To claim the credit, an employer must file IRS Form 8881 - Credit for Small Employer Pension Plan Startup Costs.

This article is for general information purposes only and should not be considered tax or legal advice. An employer should always check with a qualified tax advisor for the application of the tax laws to its specific situation.

Jerry Kalish is President of National Benefit Services, Inc., a Chicago-based third party administrator. He also publishes The Retirement Plan Blog. He can be reached at jerry@nationalbenefit.com.


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