Take Advantage of SECURE Act Changes Before it's too Late!
Good news for 2021 (that can be applied to 2020 taxes!): it’s not too late to reduce your 2020 tax liability and accelerate retirement savings. The SECURE Act made a number of changes that are favorable to employers and self-employed individuals who wish to establish a new retirement savings plan. Under the SECURE Act, a new profit sharing plan or cash balance plan doesn’t need to be adopted until the tax filing deadline (including extension, if applicable) for the plan’s initial year. For example, an S-Corp adopting a new cash balance plan for 2020 would have until its 3/15/21 tax filing deadline to adopt the plan retroactive to 1/1/20 (and if they file an extension they’d have until 9/15/21 to adopt the plan).
We’ve been getting a lot of questions about the new SECURE Act rules regarding 1) the deadline for adopting a new retirement plan, and 2) how to calculate the startup plan tax credit amount. Below is some information on each topic that I hope you find to be useful.
There are three immediate ways to take advantage of opportunities created by these changes for the 2020 tax year, and to mitigate the effect of potential tax hikes under the new administration:
1. Start a new Profit Sharing plan: Prior to 2020, only a SEP-IRA could be adopted after year-end up and up until the plan sponsor’s tax filing deadline. Because SEPs generally require that all eligible plan participants receive the same contribution as a percentage of pay, they can be cost-prohibitive for employers who have any eligible employees. However, Profit Sharing plans can make contributions on an age-weighted basis so these types of plans are typically much more attractive than a SEP-IRA for business owners with eligible employees who are younger than them.
Note: that a 401(k) salary deferral provision cannot be adopted retroactively, so if an employer were to adopt a new profit sharing plan retroactive to the first day of the 2020 plan year the 401(k) salary deferral provision could only be added to the plan as of a 2021.
2. Add a Cash Balance plan: Cash Balance contributions reduce both taxable income and adjusted gross income (AGI), helping avoid any new tax thresholds and minimizing the impact of new tax hikes. Cash Balance plans remain the gold standard to accomplish these goals.
3. Optimize the Tax Cuts and Jobs Act (199A Deduction): exclusions to the 2018 tax law change prevented certain firms from benefiting. Fortunately, Profit Sharing and Cash Balance plans offer a great advantage, allowing some owners to reduce AGI enough to qualify for up to an additional 20% tax deduction.
Startup Plan Tax Credit
Prior to 2020 the startup plan tax credit was capped at $500 per year for each of the plan’s first three years. Under the SECURE Act, the startup plan tax credit amount can be up to $5,000 for each of the plan’s first three years (although the calculation follows a very specific formula and the tax credit amount is generally limited by how many non-highly compensated employees (NHCEs) the employer has). The amount would be calculated for each of the plan’s first three years as follows:
A. # of NHCEs x $250 =
B. Lesser of A or $5,000 =
C. Greater of B or $500 =
D. 50% of start-up/admin costs * =
E. Lesser of C or D = the tax credit amount for the year
* Costs that are incurred by the employer to set up the plan and for annual plan administration (costs that are deducted from plan assets do not qualify)