For starters, I want to clarify that I am not a certified public accountant, and I am certainly not an attorney. Therefore, what you are about to read should not be considered tax or legal advice. However, as a CFP® professional who works closely with 401(k) plans, I believe I can speak for those in the retirement industry when I say that navigating SECURE Act 2.0 is making many of us feel like we need to be CPAs or lawyers ourselves.
There are a number of SECURE Act 2.0 provisions that are still in need of “guidance” from the appropriate government agencies. Other provisions have been extended, and at least one provision currently in place (ROTH matching) has proved difficult to implement. So, it is likely that we have not hit peek confusion just yet.
The provision that others and I are currently wrestling with is Section 102, Modification of credit for small employer pension plan startup costs. Specifically, what seems to be in question is the amount of tax credit allowed, or should I say disallowed, for companies transitioning from SIMPLE and SEP plans to start a new 401(k).
Here is what I think I think about Section 102. In my opinion, employers who transition from SEPs and SIMPLE plans to 401(k) plans cannot receive the tax credit for qualified startup costs but can receive the additional tax credits for employer contributions beginning in the 2nd year of the 401(k) plan.
Again, no tax credits for startup costs, but yes to the additional tax credits for employer contributions, just not in the 1st year of the plan.
Stay with me, I will explain.
To fully understand the “modification” of the tax credits you must remember that before SECURE Act 2.0 there was SECURE Act 1.0 which was passed in December of 2019, just three months before any of us had a clue the world was about to experience the greatest public health crisis in a hundred years.
The original SECURE Act introduced the increased tax credit for plan startup costs from $500 to $5,000. “Eligible employers” could have no more than 100 employees, and the credit was only available for up to 50% of the qualified startup costs.
Also, and this is the important part, the credit could not be received if the employer had a previously sponsored qualified plan (which according to 26 U.S. Code § 4972(d) includes SEP and SIMPLE retirement plans).
More specifically, the tax code states in Title 26-subtitleA-chap1-subchapA-partIV-subpartD-sec45E(c)(2):
Such term [eligible employer] shall not include an employer if, during the 3-taxable year period immediately preceding the 1st taxable year for which the credit under this section is otherwise allowable for a qualified employer plan of the employer, the employer or any member of any controlled group including the employer (or any predecessor of either) established or maintained a qualified employer plan with respect to which contributions were made, or benefits were accrued, for substantially the same employees as are in the qualified employer plan.
In plain English, sponsors do not qualify for the tax credit if they had another qualified plan in the last 3 years. (There is more to it than that, but you get the idea).
Ok, if you are still with me on this treasure hunt, put a pin in paragraph (2) of section 45E because it is the key to why I think the tax credits for employer contributions should be available to the sponsors in question.
Fast forward now to SECURE Act 2.0, Section 102. Two very important changes happened.
1. The previous tax credit for qualified startup costs was increased to 100% for employers with no more than 50 employees. (I believe the tax credit for up to 50% of the qualified startup costs is still available for employers with no more than 100 employees).
2. An additional credit was added for employer contributions by certain eligible employers. The credit is available for five years. The percentage of the contribution allowed is 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, and 25 percent in the fifth year. Note: There is a somewhat complicated calculation for determining the amount of the credit but for our purposes, it could be as much as $1,000 per eligible employee.
Whatever you think about SECURE Act 2.0 with all its multiple confusing provisions, Section 102 quite possibly makes now the greatest time ever for a small business to start a 401(k) plan.
I encourage you to read all of Section 102 within the Act, not just the section-by-section summary. There are many important details regarding these tax credits, and it was deep within the “Consolidated Appropriations Act, 2023” (Division T is actually where SECURE Act 2.0 is located) that I discovered what I believe to be a legitimate reason former sponsors of SIMPLE and SEP plans should be allowed to receive the employer contribution credit.
There is no question that sponsors with less than 100 employees who start brand new 401(k) plans are going to benefit from all the applicable tax credits.
However, remember that pesky 45E, paragraph (2)? At first glance, it appears to have thwarted the hopes of tax credits for sponsors with current SIMPLE and SEP plans, and it appears that it does regarding the administrative startup costs. But, what about the newly added employer contribution credits?
Near the bottom of Section 102, in the modified language added to 45E, it says:
(4) Determination of eligible employer; number of employees –
For purposes of this subsection [subsection related to employer credits], whether an employer is an eligible employer and the number of employees of an employer shall be determined under the rules of subsection (c), except that paragraph (2) thereof shall only apply to the taxable year during which the eligible employer plan to which this section applies is established with respect to the eligible employer.
Did you read that? Paragraph (2) only applies to the taxable year the plan is established. I read that to mean the credits are available then for the remaining 4 years. If that is true, then it is great news for sponsors of SIMPLE and SEP plans wanting to transition to a 401(k).
So, there you have it, my very amateur analysis of Section 102.
Lastly, it is a critical time for the retirement plan service community as we continue to strive to provide the most accurate and relevant information to sponsors and participants. To that end, please offer any thoughts and interpretations you have that could help.
The opinions and commentary of the author are provided for general and educational purposes only and are not intended to provide legal, tax, or investment advice.
Information is as of the date published and may not contain updates or changes to the topics covered.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types; advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services.
Wyatt Moerdyk is the CCO, and Managing Member of Evidence Advisors, LLC, a registered investment advisory firm
