The SECURE 2.0 Act of 2022, part of the giant budget law passed at the end of 2022, improves the credit for pension plans established by small employers (small employer plans) by:

1. Making the credit equal to the entire amount of creditable costs (qualified start-up costs) for employers with 50 or fewer employees (up to an annual cap), and
2. Allowing a credit amount for employer contributions to small employer plans, and (iii) fixing a technical glitch pertaining to small employers that join multiemployer plans.

Increased credit for start-up costs.

The Act increases the small employer pension plan start-up cost credit from 50% to 100% of qualified start-up costs for employers with up to 50 employees. Employers with 51 to 100 employees continue to be eligible for a SEP credit of 50% of qualified start-up costs. In either case, an annual cap based on the number of employees, with a maximum of $5,000, applies (unchanged from existing law). This portion of the credit is available for the first three tax years of the plan’s existence.

New credit for employer contributions.

The Act also provides a credit amount for all or a portion of employer contributions to small employer pension plans for the first five employer tax years beginning with the one that includes the plan’s start date. Specifically, the amount of the start-up credit discussed above is increased by the “applicable percentage” of employer contributions on behalf of employees, up to a per-employee cap of $1,000. The applicable percentage is 100% in the first and second tax years, 75% in the third year, 50% in the fourth year, and 25% in the fifth year. No credit is available in the sixth and subsequent years.

Caution: The applicable percentage is based on the date the plan was established, not when employees begin to participate in the plan.

The amount of credit allowed for employer contributions is reduced for employers with 51 to 100 employees. The reduction is equal to 2% multiplied by the number of employees in excess of 50 multiplied by the amount of the credit.

Example

A, an employer with 70 employees, establishes a small employer pension plan and contributes $1,000 per employee to the plan in the first year. The amount of its credit for employer contributions is determined as follows: First, multiply its total contributions ($70,000) by the applicable percentage (100%) for a result of $70,000. Next, determine the reduction by multiplying 2% by the number of A’s employees greater than 50 (70-50=20) for a result of 40%. So, the $70,000 figure in the first step will have to be reduced by 40% ($70,000 x 40%), or $28,000. Thus, A can take a SEP credit of $42,000 ($70,000-$28,000). (Of course, once A determined the 40% reduction percentage, it could have obtained the same result by simply multiplying $70,000 by 60%.)

No credit is allowed for employer contributions if the employer has more than 100 employees.

In addition, no credit is allowed for employer contributions on behalf of an employee who makes more than $100,000. The $100,000 figure will be adjusted for inflation in multiples of $5,000 in tax years beginning after 2023.

The credit amount for employer contributions is not available either for elective deferrals under Code Sec. 402(g)(3), or for contributions to a defined benefit plan under Code Sec. 414(j).

Observation

The Act changes the credit so it now has two portions, calculated separately: a qualified start-up cost portion available for the first three years of the plan’s existence and an employer-contribution portion, available for its first five years.

The above rules apply to tax years beginning after December 31, 2022.

Multiemployer plans.

The Act also allows employers joining a multiple employer plan (MEP, which includes pooled employer plans) to take a portion of the small employer pension credit for qualified start-up costs for the first three years after they join an MEP, regardless of how long the MEP has been in existence.

Under prior law, the credit was available for only the first three years the MEP itself was in existence. For example, if the MEP had been in existence for one year when the employer joined, the employer would only get to claim the SEP credit for two years. If the MEP had been in existence for three or more years, the employer would get no credit. The Act fixes this technical glitch. This change is effective retroactively for tax years beginning after December 31, 2019.

Small employers that joined a preexisting MEP in 2020 or 2021 should contact us about filing amended returns to claim the small employer pension credit for any creditable start-up costs barred under prior law.