Credit amount – 50% ofadministrative and retirement-education expenses for a new plan.

Maximum Credit - 2023 and subsequent years employers with 50 or fewer employees, $1,000 first year, then 75%, 50% and 25% in next 3 years

Eligible Employer – Employs 100 or fewer employees who received in excess of $5,000 in compensation in prior year.

Three Year Look Back – No plans established

Non-Highly Compensated Employee – At least one

General Business Credit – Credit is part of the General Business Credit. Thus, unused credit can be carried back one year and any excess then carried forward 20 years.

*An individual whose only source of this credit is from a partnership or S corporation is not required to complete Form 8881. Instead, the credit is reported directly on Form 3800.

Sec 45E provides for a nonrefundable income tax credit for 50% of the administrative and retirement-education expenses for any small business that adopts a new qualified defined benefit or defined contribution plan (including a Code Sec. 401(k) plan), SIMPLE plan, or simplified employee pension ("SEP")).

The Appropriations Act of 2023 (SECURE 2.0 Act, Sec 102) has subsequently altered the credit for years after 2022.

You qualify to claim this credit if:

The plan established by the employer must be a 401(k), profit sharing, defined benefit plan, SEP, or SIMPLE IRA.

For purposes of the credit, qualified start-up costs mean any ordinary and necessary expenses of an eligible employer which are paid or incurred in connection with: (Code Sec. 45E(d)(1)(A))

Examples of eligible expenses include consulting fees, set-up fees for the investments into which the plan’s funds are deposited, and costs to modify payroll systems.

An employer won't be eligible for the credit if, during the three-tax year period immediately preceding the first tax year for which the small employer pension plan start-up costs credit 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 that are in the qualified employer plan. (Code Sec. 45E(c)(2))

Qualified start-up costs won't include any expense in connection with a plan that doesn't have at least one employee eligible to participate who is not a highly compensated employee. The code does not define a highly compensated employee, but presumably refers to the definition included in the anti-discrimination rules of IRC § 414(q) which states:

414(q)(1) In general - The term “highly-compensated employee” means any employee who: 

(A) Was a 5-percent owner at any time during the year or the preceding year, or

(B) For the preceding year:

      (i) Had compensation from the employer more than $80,000*, and

     (ii) If the employer elects the application of this clause for such preceding year, was in the top-paid group of employees for such preceding year.

* The $80,000 amount is the original amount from when this code section was amended in 1996 and is inflation indexed. For 2024 it is $155,000.

Also, if the credit is for the cost of a payroll deduction IRA arrangement, the arrangement must be made available to all employees of the employer who have worked with the employer for at least three months.

2023 and subsequent years 

For purposes of the dollar limitation, the "first credit year" is:

No deduction will be allowed for the portion of the qualified start-up costs paid or incurred for the tax year which is equal to the small employer pension plan start-up cost credit.  (Code Sec. 45E(e)(2))

The credit will not apply to a taxpayer for any tax year if the taxpayer elects to have the credit not apply for that tax year. (Code Sec. 45E(e)(3)) The election out of the credit is done simply by not filing Form 8881 with the employer’s return.

In most cases, it will be advantageous for employers to claim the credit (rather than electing out of the credit). But a taxpayer subject to the alternative minimum tax (AMT) might reduce his overall tax liability by electing out of the credit, because the credit will be part of the general business credit and can't be used against the AMT.

Under pre-SECURE 2.0 Act law, the start-up tax credit only applies for the first 3 years that a plan is in existence. For example, if a small business joins a MEP (multiple employer plan) that has already been in existence for 3 years, the startup credit is not available. If, for example, the MEP has been existence for 1 or 2 years when a small business joins, the small business may be able to claim the credit for 2 or 1 years, respectively. While the 3-year credit eligibility period still applies, the SECURE 2.0 Act Section 111 clarifies that employers joining a MEP (which includes PEPs, pooled employer plans) are eligible for the credit the first 3 years of being in the MEP, regardless of how long the MEP has been in existence.

Effective Date: Retroactively for taxable years beginning after December 31, 2019.

In the case of an eligible employer (as defined above), the small employer pension plan start-up costs credit will be part of and subject to the general business credit rules, including a one-year carry back and 20-year carry forward of unused credit when tax liability is less than the credit amount.