Most taxpayers would say they want to take every legally permissible step to lower their tax bill. Yet each year taxpayers fail to claim tax credits they are fully eligible to receive. These credits are often attached to behavior or practices that taxpayers are already engaged in. The missing piece is simply an understanding of what benefits are currently available and how to take advantage of them.
Taxpayers may be understandably overwhelmed by how often tax laws change or appear and disappear. This is where providing guidance as a tax professional can alleviate anxiety—and refocus that energy onto creating a proactive tax plan. Currently, there are over 1200 different tax credits available, many of which were created to incentivize specific behavior among corporations. Business owners may have unrealized potential savings waiting for them next tax season. Below we’ll explore two primary examples: the retirement plans startup costs tax credit and the employer provided childcare tax credit.
Retirement Plans Startup Costs Tax Credit
The retirement plan startup costs tax credits were introduced by the Secure Act 2.0. This bill provides incentive for employers and individuals to save for retirement, to offset the lack of funding currently set aside in Social Security benefits. Small business owners who have not explored this option may be amazed to find that the credit can cover 50% of eligible startup costs for small employer pension plans, capped at $5,000.
Eligible plans include SEPs, SIMPLEs, 403(b) profit sharing plans, and money purchase pension plans. Only small businesses qualify, which in this case means they must have no more than 100 employees. Lastly, the company’s employees must have received a total of at least $5,000 in compensation during that tax year.
Businesses that meet the qualifications above can determine how much they are eligible for by referencing the breakdown below. Their maximum credit will equal the greater of these two options:
- $500, or
- The lesser of these options:
- $250 per non-highly compensated employee, or
Part of a strategic tax plan may involve setting up an employer-provided retirement plan for the first time. Some plans may be more affordable than a new entrepreneur may realize. For example, with a simplified employee pension (SEP) plan, the employer is not required to match employee contributions. So if a business owner sets up a SEP, even if they are the only retirement plan holder, they may qualify for a $500 tax credit.
Once the retirement plan is in place, a simple way to further increase tax savings is to add an auto-enrollment feature. This bumps up the total tax credit by $500 each year for up to three years (assuming the small business continues to qualify). Research shows that plans with an auto-enrollment feature have a 92% opt-in rate, compared to a less than 50% opt-in rate if auto-enrollment is not in place.
Lastly, the employer contribution cost factors into this credit. This element was introduced in 2023 and can cover up to $1,000 per employee for the first two years after the plan is established. In year three, the credit can cover 75% of employer costs, and that drops down to 50% in year four and 25% in year five. The credit could potentially cover all of the employer match.
We’ll take a look at a case study to see how this would play out. Let’s say a business has 10 employees, three of which are highly compensated and do not qualify under the tax credit. All employees participate in the retirement plan. The cost for the plan is $49 plus $8 per participant, totaling $1,548 per year. Since this business has seven non-highly compensated employees, the business is eligible for a tax credit of $1750, which covers the full cost of the plan! Now the business can offer a great employee benefit at no cost, attract high quality employees, and increase their employee loyalty by managing costs and vesting schedules well.
Employer Provided Childcare Credit
The second valuable tax credit to discuss with your clients focuses on employer-provided daycare. Depending on their office setup and the number of parents working there, small businesses may not have the capacity to set up a childcare area in their office building and hire personnel to provide childcare during the work day. However, this credit is also available to companies who contract with a childcare facility to provide services for their employees.
Small businesses can receive up to $150,000 per year in the form of a tax bill reduction. If the employer provides their own onsite daycare, their credit can cover up to 25% of qualified expenditures. This can include wages for childcare workers, meals, furnishings, toys, and even electricity and other facilities needs for that daycare space. If the employer hires an outside childcare facility, the credit can cover up to 10% of their expenditures. This can also apply to backup services that you can call to care for a sick child while you are working.
To qualify for this credit, the employer must offer childcare to all employees throughout the tax year. This is to prevent businesses from only offering the benefit to highly compensated employees or introducing the benefit at the very end of the year to get a tax break, secretly hoping no one will take it.
The most recent data the IRS has on this credit is from 2016. In that year, the IRS estimated that between 169 to 278 corporations claimed this credit. However, more than half of parents polled said that childcare responsibilities had impacted their ability to work over the last month. The report concluded that businesses that can offer assistance with childcare are likely to see increased employee retention, loyalty, and productivity in the workplace. The conversation may have started with seeking out tax credits, but the end result is a much farther-reaching positive impact on your client’s business.
Tax credits like those for employer-provided retirement plans and childcare were instituted to encourage businesses to provide more support for their employees. Companies that are already investing in employee benefits may be surprised to find that they can qualify for a sizable tax reduction with little to no changes to their current setup.
The first step toward tax savings for most business owners is simply knowing their options. This is where you can be an invaluable resource as a tax professional who makes it your business to keep up on the latest tax credits and other important changes to tax law. To increase your knowledge base and receive training on how to incorporate specific tax credits into your practice, sign up to become a Certified Tax Planner today.