Tax Relief for Small Employer Retirement Plans

To avoid the expense of establishing a retirement plan, many small employers have left their employees on their own when it comes to saving for retirement. However, the small pension plan startup costs credit under Sec. 45E alleviates some of the burden by allowing a credit for establishing a qualifying retirement plan; although in some circumstances, taxpayers might find it more beneficial to take a deduction instead. Under Sec. 45E, a qualifying small may take a general business credit of 50% of up to $1,000 of qualified startup costs paid or incurred in the first credit year and each of the immediately following two tax years. Even though the credit is nonrefundable, assuming the meets the general business credit requirements of Sec. 38, it may carry the credit back one year or forward 20 years (Sec. 39(a)(1)). Any deduction pertaining to pension startup costs must be reduced by the credit amount. The credit is generally claimed by filing Form 8881, Credit for Small Employer Pension Plan Startup Costs. However, taxpayers whose only source of this credit is from a partnership or S corporation, and who are not themselves a partnership or S corporation, are not required to complete or file this form. Those taxpayers can claim the credit directly on Form 3800, General Business Credit (see Form 8881 instructions). Qualified startup costs include any ordinary and necessary expenses paid or incurred by an eligible in connection with the establishment or administration of an eligible plan or the retirement-related education of employees with respect to the plan (Sec. 45E(d)(l)(A)). An eligible plan must have at least one participant who is not a highly compensated employee. The first credit year is the tax year the plan becomes effective. However, an may elect to take the credit in the year preceding the tax year the retirement plan became effective. An might prefer to elect the preceding year if the paid or incurred $1,000 or more of startup costs in the prior year or, going forward, the company doesn't expect the startup costs to last three years from the plan's adoption. The election is made by filing Form 8881 for the preceding tax year. employer has the same meaning as in Sec. 408(p)(2)(C)(i), which describes SIMPLE IRA plans. Therefore, to qualify for the credit, an must have 100 or fewer employees who received at least $5,000 of compensation from the in the preceding year (or be covered by a two-year grace period under Sec. 408(p)(2)(C)(i)(II)). If an is a member of a controlled group, the credit is allocated based on each member's proportionate share of the qualified startup costs. However, if the or any member of the same controlled group maintained a predecessor plan during the three years preceding the implementation of the plan for substantially the same employees, the is barred from taking the credit (Sec. 45E(c)(2)). Eligible plans are any qualified plan under Sec. 4972(d), such as a Sec. 401(k) plan, SIMPLE plan, or simplified employee pension (SEP). WHETHER TO TAKE THE CREDIT OR A DEDUCTION The following example compares the tax benefit of the credit or a deduction. Example. Business A has eight employees, each earning more than $5,000 a year, and decides to offer a pension plan. …