Tax Credit for Small Employer Pension Plan Startup Costs and Auto-Enrollment (Form 8881): A Guide

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There are 32.5 million small businesses across the US. These businesses account for 99.9% of businesses in the US and of course, are significant employers too.

Interestingly, 52% of businesses said finding and keeping quality employees is their biggest challenge. 

Establishing a new employer pension plan is a great idea for new businesses and expanding businesses that wish to improve employee benefits.

However, employer pension plan start-up costs can be quite substantial. The good news is that a tax credit is often available to offset these costs when a small business starts one for its employees. 

Form 8881 tax credit is available and can increase employee satisfaction levels through the advantages of an employer-based plan.

Read on to learn more about Form 8881 and how it can give your small business some good tax credits. 

Setting Every Community Up for Retirement Act (SECURE Act)

In 2019, Congress passed the Setting Every Community Up for Retirement Act. This act was intended to incentivize a small business to start up a retirement plan for employees. 

In return for starting the plan and offsetting the cost of doing this, the small business will get a tax credit.

In 2020, Congress passed the Consolidated Appropriations Act (CAA). This act increased the tax credit a business would receive when establishing a retirement plan.

New credit also was added to the previous bill with the 2020 legislation. This allows for an additional tax credit when the small business makes an auto-enrollment option part of their plan.

 The acts define the employees and businesses eligible by saying there can’t be more than 100 employees, and they can’t fall into the highly compensated category. 

What Is IRS Form 8881?

A tax credit from the IRS for anyone, individual or business, because it reduces the taxable income dollar for dollar. A business can enter its income and use deductions.

Yet, a tax credit will reduce the actual amount owed in taxes. 

When a business opens a small employer pension plan, it can use the tax credit to offset the costs of starting the plan. To get credit for the plan costs, the small business needs to inform the IRS they have created a pension plan and what it costs. 

The business would use Form 8881 as part of its tax filing to claim this tax credit. 

How to Qualify as a Small Employer

It’s important to note these are defined as small employer pensions, meaning a business must fit the qualifying criteria to be eligible for the tax credit. 

A business can have more than 100 employees with an income of at least $5,000 in the year before the plan was established. Employees at the small business who made less than the $5,000 benchmark are not counted.  

A business can also only qualify if it didn’t have a retirement plan for the three years prior that would cover the same employees now being covered. 

It’s also worth noting that while the Affordable Care Act defines a small business as 50 full-time employees, the size of the business is defined differently for this tax credit qualification.

How to Qualify Your Small Employer Pension Plan

In addition to your small business qualifying, you also need to meet certain criteria with your small employer pension plan.

The term pension plan is more widely applied than just an old-school traditional pension plan paid into by employees. 

There are a number of options that qualify for the Form 8881 tax credit. Some of the plans: 

  • 401(k) and 403(b) plans
  • Money purchased pension plans
  • Profit-sharing plans
  • SEP IRAs and SIMPLE IRAs
  • Traditional pension plans

The small business can claim administrative costs and costs to educate employees about the benefits and options as part of the tax credit.

How to Figure the Small Employer Pension Plan Startup Costs

The IRS has specific rules for tax credits and how much you get for the credit. 

A small business is eligible for 50% of the qualified start-up costs paid during the tax year. The credit will range between the greater of $500 or the lesser of $250 for each qualified employee.

Depending on how those numbers add up, the small business might be eligible for $5,000 for the first tax year and each of the next two tax years.

As you consider applying for the tax credit, there are several steps to consider.

  • Do you meet the criteria as an eligible employer?
  • What start-up costs did the start-ups incur?
  • Did you start an eligible plan?

It’s important to note that when you’re working through Form 8881, the business must reduce your deduction for start-up costs by the credit amount on line 5.

How to Figure Small Employer Auto-Enrollment Tax Credit

Remember, additional credits were made available in IRS rules in 2020 for auto-enrollment.

The small employer auto-enrollment credit is available for application in section 45T and as a part of the general business credit.

The employer is eligible for $500 per eligible employee; for each employee, that’s part of the eligible automatic contribution arrangement. The business can also qualify for the next two years for $500 per employee auto-enrolled as long as the plan remains in place.

What’s New from the IRS for Form 8881

In addition to increasing the credit limit for a small employer in the  Further Consolidated Appropriations Act, remember that this new legislation offers a new credit for small businesses that provide auto-enrollment for the retirement savings plan.

There were also changes made to the IRS form. The title changed to Credit for Small Employer Pension Plan Startup Costs and Auto-Enrollment.

The form transitioned into two parts. The first part is used to claim the actual credit for the start-up costs associated with the plan. Part II of Form 8881 claims the credit for the auto-enrollment part of the tax credits.

Take Advantage of Credit for Small Employer Pension Plan Startup Costs

Any business, especially a small business, can really benefit from tax credits. Not only does Form 8881 provide valuable small business tax credits, but the pension plans are a smart move to attract quality and committed employees. 

To learn more about tax credits from Form 8881 or other possible tax credits that could benefit your business, visit our blog for more information.

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