3 Key Tax Benefits for Small Business Owners When Offering a 401(k)

Many business owners choose to offer their employees a 401(k) or other retirement plans.

And it makes sense, as there are many benefits to consider when offering a retirement plan, like attracting and retaining top talent and saving for your own work-free years. But, owners often overlook the additional tax benefits of providing a retirement plan, from saving for your own retirement plan pre-tax to deducting plan expenses from business income.

Here Are 3 Key Tax Benefits for Small Business Owners When Offering a 401(k)

1. You Can Save for Your Retirement Pre-Tax

First and foremost, by offering a defined contribution plan, business owners can take advantage of significant tax savings for themselves.

This is critical, as many owners with high incomes face high marginal tax rates of 30% and above. Fortunately, by offering a 401(k), owners can enroll and take advantage of pre-tax contributions of $20,500 per year in 2022 ($27,000 for age 50 and over) and any applicable company match. And, with the ability to add a profit-sharing plan, owners can contribute up to a staggering $61,000 per year ($67,500 including catch-up contributions) depending on their income and profit-sharing agreement.

This can create significant tax savings for owners, allowing them to contribute pre-tax, grow the money tax-free, and then pay taxes on the distribution during retirement.

But, some owners may choose to pay the tax now by contributing to a Roth 401(k). This can be an excellent fit for some, assuming they’ll be in a higher tax bracket during retirement. The way it works is that contributions are made with after-tax money (no tax deduction), they grow tax-free, and they are distributed 100% tax-free during retirement.

Additionally, Roth savings can be an excellent option for business owners who plan to leave an inheritance, as there are no taxes due on withdrawals for their heirs either.

2. All Plan Expenses Are Deductible

Next, while the costs of implementing a 401(k) plan have dropped drastically, there is still a cost to consider.

But fortunately, all plan expenses and employer matching contributions create a deduction, reducing your total taxable business income. This can greatly benefit business owners as they are essentially paying for their 401(k) plan expenses and matching contributions with pre-tax money.

Here are some of the common expenses that are tax deductible when offering a 401(k) plan:

• Initial set-up fees.

• Ongoing administration.

• Investment management fees.

• Employer matching contributions.

• Employer profit-sharing contributions.

This can help lower some of the cost burdens of offering a 401(k) or another retirement plan through essential tax savings.

3. There Are Credits Available to Offset Start-Up Costs

Lastly, several tax credits are available to help owners offset start-up costs.

At a high level, there are two you can benefit from:

• Start-up costs: “Eligible employers may be able to claim a credit of up to $5,000, for three years, (total $15,000) for the ordinary and necessary costs of starting a retirement plan,” according to the IRS.
• Auto-enrollment credit: “An eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for a 3-year taxable period beginning with the first taxable year the employer includes the auto-enrollment feature.” according to the IRS.

Notably, employers may either deduct their expenses or apply for credit, but they can’t do both. In addition, there are several eligibility requirements to claim the credits, which can be found on the IRS website.

There are also several proposed tax credits in the Secure Act 2.0, which Brad Campbell, former head of the Labor Department’s Employee Benefits Security Administration, believes has a 70% chance of passing this year.

The proposed credits include:

• Doubling the amount of credit-eligible expenses from 50% to 100% of qualifying expenses. (Cap remains at $5k per year over 3 years for a total of $15,000.)
• Expands the credit to include multiple employer plans.
• Adds a new tax credit for employer contributions: capped at $1,000 per employee.
• Maintains the credit for using auto-enrollment.

And though it remains to be seen whether the Secure Act 2.0 will pass, the tax credit changes could be significant for small business owners offering a 401(k) or another retirement plan.

TrueNorth Retirement Services Is Here to Help

If you’re interested in working with TrueNorth’s Retirement Team to help understand the benefits of establishing a retirement plan for your small business, then TrueNorth Retirement Services is here to help.

TrueNorth Retirement Services is among the top retirement planning firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Retirement, we focus on helping our business owner clients build long-term wealth while maximizing the benefits of their retirement plan, whether that’s a self-employed defined benefit plan, 401(k), or something else. Contact us to schedule a consultation.