Little Known Tax Credit for Small Businesses

Did you know that you can claim a tax credit for setting up a qualified retirement plan, such as a 401(k) plan, for your business?  The credit is 50% of eligible costs for starting a plan, for a top credit of $500.

The credit can be claimed each year for the first three years in which the plan is in effect. Or, instead of claiming the credit for the first year, you can opt to claim it for expenses incurred in the year prior to the effective date of the plan.

Eligible costs include administrative fees and costs for educating employees about the plan and participation in it. Since only the first $1,000 of expenses is taken into account in figuring the credit, any expenses in excess of $1,000 can be deducted as an ordinary and necessary business expense.

The credit applies only to small businesses (no more than 100 employees who received at least $5,000 in compensation in the prior year).

Catch:  The plan must cover at least one employee who is not a “highly-compensated employee” (including an owner). Thus, a self-employed person with no employees who sets up solo 401(k) plan can’t claim the credit.

 

Details of the credit can be found in the instructions to Form 8881.

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