The SECURE Act 2.0: The Most Impactful Provisions #6 – Tax Credits for Administrative and Contribution Costs for New Plans for Small Employers (Part 1)

Key Takeaways

  • The SECURE Act 2.0 provides significant tax credits for startup plan costs—for both administration and contribution costs.
  • The credits are fully available for employers with 50 or fewer employees and partially available up to 100 employees.
  • This provision is effective now, that is, it is effective for tax years beginning after December 31, 2022 (in 2023 for calendar year taxpayers).

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some that won’t be effective for years to come. One difference between the SECURE Act 2.0 and previous retirement plan laws is that so many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can if they decide that the change will help their plans and participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.

This article and the next one discusses the “optional” provisions that provide significant tax credits for startup plans for small employers. The Senate Finance Committee’s summary of the provision explains:

Section 102, Modification of credit for small employer pension plan startup costs. The 3-year small business startup credit is currently 50 percent of administrative costs, up to an annual cap of $5,000. Section 102 [of the Act] makes changes to the credit by increasing the startup credit from 50 percent to 100 percent for employers with up to 50 employees. Except in the case of defined benefit plans, an additional credit is provided. The amount of the additional credit generally will be a percentage of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000. This full additional credit is limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees. The applicable percentage is 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, 25 percent in the fifth year – and no credit for tax years thereafter. Section 102 is effective for taxable years beginning after December 31, 2022.

This post covers the tax credit for administrative costs; the next will cover the tax credit for contributions.

To the extent that a “small” employer pays the administrative costs for setting up and operating a plan, there are tax credits for those payments for the first 3 years of the plan.

A small employer is defined as one that has up to 100 eligible employees. For employers with 1 to 50 eligible employees, the tax credit is 100% of the administrative costs, up to $5,000. For employers with 51 to 100 eligible employees, the tax credit percent is reduced to 50%. All employees who received at least $5,000 of compensation from the employer in the preceding year are counted for this purpose.

In addition, to be eligible for the administrative credit, the employer must have at least one non-highly compensated eligible participant.

Finally, an employer is not “eligible” is it has covered substantially the same employees in a qualified plan, SEP IRA, or SIMPLE IRA in the 3 preceding taxable years.

The $5,000 limit is a little more complicated than it appears. More technically, the limit is calculated as follows:

  • Minimum: $500
  • Maximum: $5,000
  • Method: $250 for each eligible employee who is not highly compensated. Thus, up to 20 such employees the credit would be less than $5,000, but for 20 or more, it would be the $5,000 upper limit.

The credit only applies to covered expenses (called “qualified startup costs”)  paid by the employer. That means that any expenses paid by the plan will not be eligible for the credit. The Code defines qualified startup costs as:

The term “qualified startup costs” means any ordinary and necessary expenses of an eligible employer which are paid or incurred in connection with—

(i) the establishment or administration of an eligible employer plan, or

(ii) the retirement-related education of employees with respect to such plan.

Based on that definition, the eligible costs include payments for services for plan administration, recordkeeping, and employee education. Unfortunately, it’s not clear if other expenses are also covered by the credit. For example, that is the case for advisory services regarding a plan’s investments. However, if a reasonable interpretation of “ordinary and necessary expenses” would include a particular service, then it is plausible that the expense would be eligible for the credit.

Concluding Thoughts

SECURE 2.0 amended an existing tax credit for administrative expenses by doubling its value for employers with 50 or fewer employees. The Congressional intent was to encourage the formation of new plans by small employers. That is because the most significant lack of retirement plan coverage is with small employers. This enhancement, together with the new credit for plan contributions for newly established plans, should accomplish that goal. The combined tax credits can make a new plan almost free for the first 3 years and, even after that, a plan sponsor will receive partial credits for contributions for another two years.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.