The Improved §45E New Retirement Plan Credit

Already established retirement plans may qualify for a new tax credit

Existing §45E was a tax credit for employers establishing a retirement plan for their workers. The SECURE 2.0 Act of 2022 significantly enhanced this credit for tax years ending after December 31, 2022.

§45E now has two sub-credits: one for startup expenses and one for employer contributions. Both are claimed on Form 8881, Credit for Small Employer Pension Plan Startup Costs, Auto-Enrollment, and Military Spouse Participation.

§45E(c)(1) limits the §45E credit to an employer with no more than 100 employees who received at least $5,000 of compensation in the preceding tax year.

An eligible retirement plan for the §45E credit is defined in §45E(d)(1)(B) as a §401(k) plan, a §403(b) plan, a SEP, and a SIMPLE plan.

Startup Expenses Credit

The startup expenses credit is 50% of the qualified startup costs paid or incurred by the taxpayer during the tax year. Qualified startup costs are defined in §45E(d)(1)(A) as the ordinary and necessary expenses for either the establishment or administration of an employer plan or the retirement-related education of employees.

Under new §45E(e)(4), for tax years beginning after December 31, 2022, if the employer had no more than 50 employees who received at least $5,000 of compensation in the preceding year, the startup expenses credit rate is 100%.

The credit limit under §45E(b) is the lesser of $250 for each employee eligible to participate in the plan who is not a highly compensated employee, or $5,000; however, the credit limit cannot go below $500.

The credit is available in the tax year in which the plan becomes effective and the subsequent two tax years for three total tax years, according to §45E(d)(3). The employer can also elect to start the three-year period in the tax year before the one in which they began the plan.

Qualified startup expenses are limited by §45E(d)(2) to expenses related to a plan with at least one eligible employee who is not a highly compensated employee. Under §414(q), a highly compensated employee is an employee who was either a 5% owner at any time during the current or preceding year or had compensation exceeding $150,000 in 2023 for the 2024 plan year (adjusted each year for inflation).

Employer Contribution Credit

The SECURE 2.0 Act created this new sub-credit for employer matching and nonelective contributions to an eligible retirement plan for tax years beginning after December 31, 2022.

§45E(f)(3) sets the credit percentage at 100% for the first tax year during which the eligible retirement plan is established, 100% for the second employer contributions credit tax year, 75% for the third employer contributions credit tax year, 50% for the fourth employer contributions credit tax year, and 25% for the fifth employer contributions credit tax year; however, §45E(f)(2)(A) limits the employer contribution credit to $1,000 per employee per tax year.

§45E(f)(2)(B) reduces the total employer contribution credit by 2% for each employee exceeding 50 employees; employers with more than 100 employees are ineligible.

If an employee has wages exceeding $100,000 (inflation-indexed), §45E(f)(2)(C) denies an employer contribution credit with respect to that employee.

Existing Businesses Also Benefit

Notice 2024-2 Q&A B-5 held that an employer who established a retirement plan in a tax year before the effective date of the SECURE 2.0 Act §45E changes can use the enhanced provisions if the employer is still within the three-year period (for startup expenses) or the five-year period (for employer contributions).

As an example, if an employer with less than 51 employees established a new retirement plan in tax year 2021, they are eligible in tax year 2023 for both the 100% startup expenses credit and the 75% employer contribution credit (since the plan is in the third year of existence).

Any employer who established a retirement plan for tax year 2019 or later may be eligible for the employer contribution credit for tax year 2023. Tax professionals should review client lists now to identify potential opportunities to claim this credit.

No Double Benefit

Under §45E(e)(2)(A), the business must reduce its deductible startup and employer contribution expenses by the amount of the credit claimed.

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