Team Management

Looking to Offer a 401(k)? Here Are the Tax Benefits and Credits You Can Bank On

Jeff Rosenberger COO, Guideline 401(k) 
401(k) tax benefits and credits

Offering a 401(k) plan is a great way to bridge the gap between your company’s two important objectives: attracting employees with a compelling benefits package, while keeping business costs low so that your company can thrive.

A 401(k) is an employer-sponsored retirement savings plan that helps employees invest money from their paychecks toward their retirement. In addition to being a meaningful employee benefit, a 401(k) can save you, as both an employer and an employee, money on taxes. This can offset some of the costs of offering a retirement benefit.

Gusto makes payroll, benefits, and HR actually easy.

What 401(k) tax advantages are available to employers?

There are three potential 401(k) tax benefits that employers can claim:

  1. Qualified employers may claim a tax credit of up to $500 a year for the first three years of the plan.
  2. Some administrative fees can be a tax-deductible business expense, and
  3. Employer contributions are exempt from federal, state, and payroll taxes, if they fall under 25 percent of the total compensation paid (or accrued) during the year to eligible employees participating in the plan.

We’ll go into more detail below.

Startup cost tax credits, explained

When you offer a 401(k) or other qualified retirement plan, your business may be eligible for a startup cost tax credit, which is officially called the Credit for Small Employer Pension Plan Startup Costs. The credit covers 50 percent of eligible costs to set up a qualified retirement plan—up to a maximum of $500 per year.

These startup costs include any necessary plan setup and administration fees (such as Form 5500 preparation and auditing), plus costs to educate your employees about the plan. The result is a business tax credit on a dollar-for-dollar basis.

Pretty cool, right?

According to the IRS, your company may be eligible for the credit if:

  • It had 100 or fewer employees who received at least $5,000 in compensation in the previous year.
  • It had at least one plan participant who was not considered a highly compensated employee.* 
  • No employees received benefits in another qualified retirement plan from your company in the last three years.

*The IRS considers a highly compensated employee to be an individual who:

  • Owned more than 5 percent of the business, or
  • Earned more than $120,000 (and, subject to plan rules, was in the top 20 percent of earners).

If your company meets the criteria, you can claim the credit for each of the first three years of the plan when your business files taxes (for more information, please visit the IRS site here). Similar to other general business credits, if you can’t use it in the current year, you can carry it backward or forward.

It’s important to note that if you’re claiming the credit for certain plan expenses, you can’t deduct those same expenses. For example, if you’re claiming a $500 credit for a $1,000 plan set-up fee, you can’t deduct that cost from your company’s income. However, you can take a tax deduction for the expenses in lieu of the credit, or deduct any additional expenses in excess of the credit. (Pro tip: taking the credit, when available, is almost always a better deal!)

Here’s an example of how this tax credit can work:

Cathy Carlson, the owner of Cathy’s Cat Caps Company, wants to start a 401(k) for her small business. She currently has eight employees and wants to help them save for retirement, but she also has to manage her company’s costs. Cathy chooses a Guideline 401(k), with no startup fee, $39/month base fee, and a plan participant fee of $8/month.

Guideline 401(k)Year 1Year 2Year 3
Base fee+$468+$468+$468
Plan participant fee*+ $768+ $768+ $768
Total cost per year$1236$1236$1236
Credit– $500– $384– $384
Actual cost$736$852$852

*$8 x 8 employees x 12 months

CCCC can take a credit of $500 for the first year of the plan and can also deduct $236 of additional plan administration expenses from company income (total cost of the plan minus the $1,000 used to calculate the credit). In years two and three, if CCCC continues to have eight employees, CCCC’s costs would be $1236 annually and would be offset by a $384 tax credit. Not bad, right?**

How employer matching and profit-sharing impact business taxes

You may also choose to offer 401(k) matching and profit-sharing as a generous way to give employees a bonus that grows over time.

Employers may contribute a specific amount to an employee’s accounts up to a combined total of $56,000 for 2019, taking into account employee contributions (not including employee catch-up contributions), and subject to other limitations. This can be done through matching, profit sharing, or a combination of both.

Here’s how employer contributions work:

If Winnie contributes…Winnie’s employer can contribute…
$0$56,000
$9,000$47,000
$18,000$38,000

Qualified employer contributions are exempt from federal, state, and payroll taxes, meaning matching and profit-sharing are a great way to give a bonus your employees for their hard work while still helping your business save some money.

This all sounds great! Do I have to offer a 401(k)?

Though employers are not required to offer a 401(k), several states have legislation pending to require employers to provide a retirement plan for employees, either independently or through a state-sponsored program. Stay updated on retirement initiatives by checking your state’s website.

What are some other benefits of a 401(k)?

Since business owners are also employees, you can take advantage of your company’s 401(k) plan yourself, with tax-advantaged contributions, tax-deferred growth, higher limits than IRAs, and creditor and bankruptcy protection.

What should I look for in a 401(k) provider?

Companies should consider choosing a 401(k) provider that streamlines plan management, maximizes employee savings, and makes life easier for both employers and employees.

Consider plans that include:

  • Payroll integration, which eliminates duplicate data entry and lessens the burden on HR and administrative teams.
  • Low fees, to help employees save more for retirement and keep them from being gouged by the high-fee financial industry.
  • Ease of use, to enable all-inclusive plan setup and employee enrollment.

Consider plan providers that are:

  • ERISA 3(16) plan administrators, who can handle the day-to-day 401(k) plan management and free up resources in your organization.
  • ERISA 3(38) investment managers focused on minimizing plan investment expenses.

IRS Deadlines to remember

DateKey deadline
December 1Deadline to notify participants about the addition or removal of Safe Harbor plan provision
January 1Effective date for Safe Harbor plans
March 15S Corp and Partnership tax returns are due
April 18C Corp, Individual and 5500 tax returns are due
July 31Deadline to file 5500 without extension
August 23Last day to establish a new Safe Harbor plan for 2019
September 130-day notice needs to be sent to Safe Harbor plan participants
September 15S Corp and Partnership tax returns extensions are due
October 15C Corp, Individual, and 5500 tax returns extensions are due

**The credit is part of the general business credit, and you may carry it back or forward to other tax years if you can’t use it in the current year.

Updated: August 13, 2019

Jeff Rosenberger
Jeff Rosenberger Jeff Rosenberger is the COO of Guideline, which launched in 2015 to make it easier for small businesses to offer retirement plans.

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