401(k) plans offer important tax advantages for small businesses and their employees. If you are a business owner, you should understand these benefits when deciding whether or not to offer a 401(k) plan to your employees. Too many businesses focus on “what is this going to cost me,” rather than, “what are the benefits?”
While we strongly recommend always speaking with your accountant on the topic of taxes, here is a high-level summary of the tax benefits possible by offering a 401(k) plan.
You Mean I Get A Tax Break Just For Starting A 401(k)?
Do you have 100 or less employees? Did you pay each of them at least $5,000 last year? Was there at least one “non-highly compensated employee”, an employee who made less than $120,000 in the preceding year? If you’ve answered yes to these questions, you are likely eligible for a 50% credit on your start-up costs up to a $500 max/year! Click here for details regarding eligibility.
Now you’re probably thinking, “What qualifies as a start-up cost?” Start-up costs can include fees for the set-up required to administer your plan as well as the cost to educate your employees about the benefits of your new 401(k).
You can claim this credit for the first three years of the plan. The IRS will also allow you to start claiming the credit for the tax year before the tax year in which the plan becomes effective. To claim your credit, you’ll need to file Form 8881, Credit for Small Employer Pension Plan Startup Costs.
Ongoing Employer Benefits
Are you considering employer contributions? Employer matching or profit sharing contributions can help you defer more income personally, while helping your business attract and retain the talented employee it needs. And the best part? These contributions are tax deductible!
How does it work? The deduction cannot be greater than 25% of total compensation paid during the year to participants in the plan. Total compensation includes elective deferrals, but deferrals are not counted against the limit. For 2016, the maximum compensation that can be taken into account for each employee is $265,000. You can read more about deductions here.
401k Participants Can Benefit Too?
Are you concerned that you’ll have a low rate of participation in your new 401(k) plan? Entice them with their tax advantages!
Participants who make pre-tax 401(k) deferrals lower their taxable income. Also, participants who are over 18, not claimed as a dependent on another person’s tax return and not enrolled as a full-time student could be eligible for a tax credit of up to 50% of their 401(k) plan contributions, to a maximum of $2,000. Married? Couples filing a joint return can claim up to $4,000. The IRS rules and limits can be found here.
It’s Time To Start Saving!
Now that you know your tax advantages, it’s time to start saving. The sooner you start your plan, the greater tax relief you will see next tax season.