The retirement plan startup credit

How it works

An employer with 100 or fewer employees who earned above a pay line the IRS sets, with at least one such employee who is not a highly compensated employee, can claim a credit for plan startup costs for each of the first three years. For employers with 50 or fewer employees the credit is 100 percent of eligible costs, and for 51 to 100 it is 50 percent, in both cases capped at this year's official plan startup credit cap (not yet verified here; see the official source below) a year, with a floor of $500. A second credit covers employer contributions, up to $1,000 per employee, at 100 percent in the first two years and phasing down over the next three, for employers with 50 or fewer employees and reduced for larger ones. The credits are claimed on Form 8881, and costs used for the credit cannot also be deducted.

What it gives

A plan that costs a few thousand dollars to set up and run can cost nearly nothing after the credit for three years.

The contribution credit returns much of what the employer puts in for workers in the early years.

The automatic enrollment credit stacks on top of the others.

What it costs, or where the catch is

A business whose only workers are the owner and a spouse does not qualify.

The contribution credit excludes contributions for owners and high earners.

Costs claimed for the credit lose their deduction, so the net benefit is the credit minus the lost deduction.

A worked example

Rosalind owns a cafe with six employees and starts a 401(k) with automatic enrollment. Setup and the first year's administration cost $2,400, all of which comes back as a 100 percent credit. She contributes $800 for each of five eligible workers, $4,000 total, and the contribution credit returns $4,000 in year one. With the $500 automatic enrollment credit, her first year credits total $2,400 plus $4,000 plus $500, which is $6,900.

Where it goes wrong

The common miss is a solo owner with no employees expecting the credit, or an employer who both deducts the startup fees and claims the credit on the same dollars.

Who confirms it for you

For your own numbers, a CPA or enrolled agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

IRS: Retirement plans startup costs tax credit. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.