The Small Business 401(k) Tax Advantage

A 401k plan can help set your small business apart in a crowded talent market. Here’s how to take advantage of the 401k small business tax credit.

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If you’re a small business owner, chances are, you recently completed your tax filing. So, how to save money on taxes next year is probably top of mind. Here’s something you may not know: offering your employees an employer-sponsored 401(k), if you haven’t already offered one, could save you a big chunk of change at tax time next year.

Before we get to the specifics, let’s review why offering your employees a 401(k) is a good idea even outside of tax advantages. Did you know that 90 percent of small businesses—those that employ between 0-99 people — don’t offer their employees a 401(k)? There are 42 million people who work at a business of that size in the U.S. and just 26 percent of them have access to an employer-sponsored retirement plan.

Offering a 401(k) sends a clear message to your employees that you care about—and are willing to literally invest in—their future. It doesn’t just alleviate retirement anxiety among your employees, it helps recruit and retain top talent in the first place. According to a Glassdoor Employment Confidence survey, a retirement plan is one of the most valued benefits an employer could provide their employees. But beyond participating in the plan yourself, what are the other benefits of offering one for the small business owner? Let’s break that down.

Small businesses often struggle to balance two important, yet competing objectives: attracting employees with a strong benefits package, and keeping business costs low. Fortunately, a low cost 401(k) plan can help bridge the gap between these two things.

As a small business owner, not only can you deduct employer contributions to employee retirement accounts from your taxable business earnings, you may qualify for a plan startup cost tax credit, which can offset some of the costs of launching a retirement benefit.

The Credit for Small Employer Retirement Plan Startup Costs covers 50 percent of ordinary and necessary costs companies incur to set up and administer a qualified retirement plan, up to a maximum of $500 per year. These startup costs include any necessary plan setup and administration fees, as well as any money spent on employee education. The result is a reduction in the amount of tax a business owes on a dollar-for-dollar basis.

Here’s a breakdown of what’s required for a business to qualify for the credit:

  • They had 100 or fewer employees who received at least $5,000 in compensation for the preceding year
  • They had at least one plan participant who was a non-highly compensated employee (did not own 5% or more of the company and received less than $120,000 in compensation, or was in the bottom 80% of compensation for employees)
  • No employees received benefits in another qualified retirement plan provided by the same employer or a related employer

If your company meets these qualifications, you can claim the credit for each of the first three years of the plan (so long as you continue to qualify). It’s part of the general business credit, and if you can’t use it in the current year, you can carry it backward or forward.

An important caveat to note is that if you’re claiming the credit for certain plan expenses, you can’t deduct those same expenses. For example, if you’re claiming a $500 credit for a $1,000 plan set-up fee, you can’t deduct that cost from your company’s income. You can take a tax deduction for the expenses in lieu of the credit, but taking the credit, when available, is almost always a better deal. You can, however, deduct any additional expenses in excess of the credit.

Disclaimer: This content is provided for informational purposes only and is not intended to be construed as tax advice. You should consult a tax professional to advise regarding tax credits or deductions your company may be eligible for.

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