The SECURE Act 2.0 was passed into law on December 29, 2022 as part of the Consolidated Appropriations Act. The SECURE Act 2.0 contains many tax changes affecting business and individual taxpayers. This article will provide updates concerning the changes made to the tax credits available for businesses for establishing a 401(k) plan. There are three credits available, two were in existence prior to the SECURE Act 2.0 and have received changes, while the Auto Enrollment Credit is a new result of this legislation.
Startup Tax Credit
There are three eligibility requirements businesses must meet in order to claim the Startup Tax Credit. To qualify, a business must:
- Have 100 or fewer employees who were paid $5,000 or more in compensation in the preceding year.
- Cover at least one non-highly compensated employee (defined below) through the plan.
- In the three preceding tax years prior to becoming eligible for the Startup Tax Credit, employees were not receiving contributions or accrued benefits in another retirement plan sponsored by the company, or an entity related to the company. This requirement prevents a company from adding a 401(k) feature to an existing profit sharing plan or adopting a new 401(k) just to receive the credit.
As mentioned above in point two, there is a test to determine which employees are considered highly compensated. That test is as follows:
- Any individual who owned 5% or more of the company at any time in the current or preceding year. Anyone who meets this test is an HCE regardless of compensation amount.
- Received more than $135,000 in 2021, or $150,000 in 2022, or was in the top 20% of employees when ranked by compensation.
Once eligibility is verified, a company must identify which costs are eligible to count towards determining the credit amount. Qualified startup costs include:
- Costs to establish the plan
- Costs to administer the plan
- Recordkeeping costs
- Investment advisory fees
- Costs to educate employees about the plan
Annual credit amounts and limitations are determined based on employee headcount. There are different calculations depending on employers with less than 20 employees, between 20 and 50, and between 51 and 100, as detailed below.
- An eligible employer with 50 or fewer employees is allowed a credit equal to 100% of qualified startup costs
- Eligible employers with between 51 and 100 employees may claim a credit equal to 50% of qualified startup costs
- Credit is maxed out at $5,000 per year, with a minimum of $500 per year
- Businesses with less than 20 employees are subject to a different credit calculation equal to $250 per each non-highly compensated employee, still subject to the $500 minimum
The credit is available for the first three years the plan is active, or, if the employer makes an election, it can be claimed the year prior to the plan establishment, and the succeeding two years. The Startup Tax Credit is claimed by filing Form 8881.
Employer Contribution Tax Credit
The SECURE Act 2.0 also aims to incentivize employer contributions to 401(k) plans by providing higher credit amounts for employer match contributions. Eligibility requirements for the Employer Contribution Tax Credit are the same as outlined above for the Startup Tax Credit, with the following additional restriction on employee earnings.
- Eligible employees are those earning less than $100,000 per year.
The annual credit amount is computed per employee, and is the lesser of $1,000 per year, or a percentage of their actual deferrals. The credit is available for a five-year period, with the percentage of contributions stepping down as follows between years one and five. Additionally, the percentages are affected by employee headcount, with differing percentages being applicable for businesses with 50 employees or fewer, and for those with between 51-100 employees.
- Credit percentage by year for employers with 50 or fewer employees:
- 100% of contributions, up to $1,000 maximum per employee, for the first two years
- 75% of contributions made in year 3, subject to $1,000 per employee maximum
- 50% of contributions made in year 4, subject to $1,000 per employee maximum
- 25% of contributions made in year 5, subject to $1,000 per employee maximum
- Credit percentage by year for employers with between 51 and 100 employees is the same schedule as employers with fewer than 50 employees, but the annual credit percentage is reduced by 2 percentage points for each employee over the 50 base headcount. For example, a business with 80 employees would be able to claim 40% of contributions as a credit in year one (100% minus (2 x 30), the number of employees exceeding 50).
Regardless of employee headcount, any contributions not eligible for a tax credit still result in deductible expenses for the employer.
Auto-Enrollment Tax Credit
The Auto-Enrollment Tax Credit is a new credit introduced by the SECURE Act 2.0. The goal of this credit is to increase employee participation in a retirement plan by making employees opt out, rather than opt in, at start of employment. The annual credit amount and eligibility features are as follows:
- The annual credit amount is $500
- To qualify, the auto-enrollment feature must meet Eligible Automatic Contribution Arrangement (EACA) requirements. Those requirements are beyond the scope of this article, please discuss further with your plan administrator.
- This credit is available to new 401(k) plans AND existing profit-sharing plans adding a 401(k) feature.
- The only employer eligibility requirement is to have 100 or fewer employees who were paid at least $5,000 in compensation in the preceding year.
- The $500 credit is available for the year the automatic enrollment feature is added, and the succeeding two years.
This credit is particularly relevant because of another change contained within the SECURE Act 2.0. The Act contains a mandate for all 401(k) plans to include an automatic enrollment feature beginning in 2025. Because of this pending requirement, employers not currently offering auto enrollment may want to adopt this feature early in order to minimize future disruption and claim the auto-enrollment credit at an earlier date.
The SECURE Act 2.0 changes have provided desirable enhancements to the existing Startup and Employer Contribution Tax Credits, while incentivizing automatic employee enrollment features via the new Auto Enrollment Credit. If your company has recently established a 401(k) plan, is looking to do so, or needs to add an automatic enrollment feature, let us know how we can help. You may qualify for a tax credit.
About the author
Matt McKinney is a tax manager in DHW’s Hickory office. Matt has been with the firm over 10 years and assists business owners in navigating the complex and ever-changing tax landscape. Matt can be reached by calling 828-322-2070 or via email at firstname.lastname@example.org.