Secure Act 2.0 seemingly offers something for everyone, including increasing the income tax credit available to small businesses encouraging the establishment and operation of a new retirement plan. Secure 2.0 expands these credits, while also creating a new credit for those small businesses that make employer-matching or nonelective contributions. Furthermore, the Act also creates another new tax credit for small employers offering special benefits to military spouses. Those eligible small employers should be made aware of these potentially significant tax benefits.

Modification of Credit for Small Employer Pension Plan Start-Up Costs

Section 102 of the Secure Act 2.0 enhances the small employer tax credit (which reduces the amount of federal taxes owed on a dollar-for-dollar basis) by increasing the (retirement plan) start-up credit from 50% to 100% for qualified start-up costs, up to an annual cap of $5,000 per year for those employers with up to 50 employees.

Starting with tax years beginning after December 31, 2022 (i.e., 2023), an eligible employer can take advantage of this increased tax credit under the Act. The tax credit is a percentage of an eligible employer’s qualified start-up costs paid by the employer in establishing or administering a new retirement plan or employee education. For many small employers, this enhanced tax credit could  cover most, if not all, the costs of establishing and operating a retirement plan for its first three years.

To qualify for the start-up tax credit, the following conditions must be satisfied:

– An eligible employer must have no more than 100 eligible employees who received at least $5,000 of compensation (from the employer) during the tax year preceding the first credit year. The plan must also have at least one eligible, non-highly compensated employee.¹

– An employer with no more than 50 employees is eligible for a tax credit of 100% of qualified start-up costs—up to the maximum allowable credit. For those employers with 51 to 100 eligible employees, the tax credit is reduced to 50%.

– The minimum credit is $500, while the maximum is $5,000. Specifically, the credit is $250 per eligible employee who is not a highly compensated employee. In the case of an eligible employer with up to 20 employees, the credit would be $5000 ($250 x 20). For those otherwise eligible employers that have more than 20 eligible employees, the credit would be capped at $5,000.

– The plan (established by the employer) must be a 401(k), profit sharing, defined benefit plan, SEP, or SIMPLE IRA.

– The employer did not maintain a 401(k) plan, SEP, or SIMPLE IRA in the three immediately preceding taxable years that covered substantially the same employees.

– The credit only applies to covered expenses (“qualified start-up costs”) paid by the employer. Expenses paid by the plan are not eligible for the credit. The IRS defines qualified start-up costs as:

 “Expenses which are paid or incurred in connection with:

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

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

– Eligible employers use Part I of IRS Form 8881 “Credit for Small Employer Pension Plan Start-Up Costs, Auto-Enrollment, and Military Spouse Participation” to claim the credit for start-up costs incurred in establishing or administering a plan.

The Senate Finance Committee summarized the tax credit provision within Section 102 of Secure 2.0 as follows:

“Modification of credit for small employer pension plan start-up costs. The three-year small business start-up credit is currently 50% of administrative costs, up to an annual cap of $5,000. Section 102 [of the Act] makes changes to the credit by increasing the start-up credit from 50% to 100% 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% in the first and second years, 75% in the third year, 50% in the fourth year, 25% in the fifth year — and no credit for tax years thereafter. Section 102 is effective for taxable years beginning after December 31, 2022.”

Employer Contribution Tax Credit

Secure 2.0 also established a new tax credit for small businesses that make employer contributions to a new retirement plan. This credit is available for five years for those employers with 100 or few employees who make employer contributions—up to $1,000 per employee. Like the start-up tax credit, this (employer-contribution) credit is effective for tax years beginning after December 31, 2022 (i.e., 2023).

This credit will be a fixed percentage of the amount contributed by the employer as an employer contribution up to a per-employee cap of $1,000 for those employees with compensation of $100,000 or less.

The employer contribution’s credit is treated as a separate credit in addition to the start-up costs credit; therefore, an eligible employer may be eligible for both the start-up credit and the employer contribution’s credit.

To qualify for the employer contribution’s tax credit, the following conditions must be satisfied:

– Like the start-up credit, an employer must have no more than 100 eligible employees who received at least $5,000 of compensation from the employer in the preceding year. Importantly, for contribution purposes, it counts employees in the year for which contributions are made— while the start-up credit counts for the year before that credit is claimed.

– For an eligible employer with 50 or fewer employees, the credit is 100% of employer contributions (matching or nonelective) made for eligible employees with a maximum credit of $1,000 per non-highly compensated employee (i.e., employees earning less than $100,000). The credit, however, is phased out at a reduced rated for those employers that have between 51-100 employees.

– An eligible small employer can take advantage of this credit for employer plan contributions for the first five years during which the plan is maintained. The “applicable percentage” (amount of employer contribution made to the plan) is 100% for the year the plan is established and for the following year, and then decreases by 25% each year thereafter (i.e., 75% for the third year, 50% fourth year, 25% fifth year, and 0% thereafter. Notably, the applicable percentage is generally reduced by 2% for every employee over the 50-employee threshold.

– Like the start-up credit, the contribution credit is not available if the employer maintained a qualified plan, including a 401(k), SEP, or SIMPLE IRA, in the three immediately preceding taxable years that covered substantially the same employees. Notably, unlike the credit for start-up costs, this limit, due to an employer maintaining another retirement plan, applies only to the year the plan is established, and an otherwise eligible employer will still be eligible for a credit in the second through the fifth years.

– Employer contributions to a defined benefit plan cannot take advantage of the credit.

– An eligible employer also uses Part I of IRS Form 8881 to receive the credit for employer contributions.

Small Employer Auto-Enrollment Credit

In addition to credits for plan establishment, and administration and employer contribution costs, another tax credit is for a plan that adopts auto-enrollment.

– To be an eligible employer, you must have had no more than 100 employees, during the tax year preceding the first credit year, who received at least $5,000 of compensation from you (the employer) during that tax year. Unlike the start-up credit, there is no requirement that there be at least one eligible non-highly compensated employee.

– Eligible employers may receive a tax credit of $500 per year for three years starting in the year in which auto-enrollment provisions are effective—either as a new provision in an existing plan or in a newly adopted plan.

– An eligible employer uses Part II of IRS Form 8881 to receive credit for employer contributions.

Military Spouse Retirement Plan Eligibility Credit for Small Employers (Section 112)

Effective in 2023, Secure 2.0 offers another new tax credit for those eligible small employers that provide special retirement plan benefits to military spouses.

– An eligible employer must have had no more than 100 employees during the preceding tax year preceding the tax year for which the credit is claimed, who received at least $5,000 of compensation from the employer during that tax year.

– The tax credit applies to eligible employers that: 1) make military spouses immediately eligible for plan participation within two months of hire; (2) upon plan eligibility, make the military spouse eligible for any matching or nonelective contribution that they would have been eligible for otherwise—at two years of service; and (3) make the military spouse 100% immediately vested in all employer contributions.

– The tax credit equals (1) $200 per military spouse (that participates in the plan), plus (2) 100% of all employer contributions (up to $300) made on behalf of the military spouse, for a maximum tax credit of $500. This credit applies for three successive tax years (of the employer) beginning with the first tax year during which the employee began participating in the plan.

– A military spouse is an employee who is not highly compensated¹ and, as of the first date that they were employed by the employer, is married to a member of the uniformed services serving on active duty.

– An employer may rely on an employee’s certification that such employee’s spouse is a member of the uniformed services. The certification should provide the name, rank, and service branch of the spouse.

– An eligible employer uses Part III of IRS Form 8881 to receive the Military Spouse Participation credit.