Key Takeaways
- A business is eligible for the credit if they had no more than 100 employees who were paid at least $5,000 in the year before it set up the plan.
- Most retirement plans commonly offered by employers qualify as "pension plans" under the rules for the Form 8881 tax credit.
- A business can claim the credit for expenses it incurred to set up a qualified plan, including administrative costs and money spent to educate employees about their benefits and options under the plan.
- Unlike a tax deduction, a tax credit reduces your income tax liability dollar for dollar.
Qualifying as a small employer
As the name makes clear, the tax credit on Form 8881 is available only to certain “small” employers. A business is eligible for the credit if:
- They had no more than 100 employees who were paid at least $5,000 in the year before it set up the plan. Employees who were paid less than $5,000 don’t count toward the total.
- A business did not previously have a retirement plan in place in the prior 3 years covering substantially the same employees as the plan being set up.
Note that the definition of a small employer for this credit may differ from definitions used elsewhere in the tax code, such as with the Affordable Care Act, where the cutoff is 50 full-time employees. So a business that’s considered a “large” employer under the ACA or other provisions may still qualify for this credit.
TurboTax Tip:
In some cases a company may save more money by simply deducting their pension plan startup costs as regular business expenses rather than claiming the credit.
Qualifying your plan
Most retirement plans commonly offered by employers qualify as "pension plans" under the rules for the Form 8881 tax credit. These include:
- traditional pension plans, in which employees are guaranteed a specific benefit when they retire
- 401(k) and 403(b) plans
- profit-sharing plans
- money purchase pension plans
- SEP IRAs and SIMPLE IRAs
A business can claim the credit for expenses it incurred to set up a qualified plan. This includes:
- administrative costs
- money spent to educate employees about their benefits and options under the plan
Using the tax credit
Unlike a tax deduction, a tax credit reduces your income tax liability dollar for dollar. For example, if you have a $1,000 tax deduction, that reduces the amount of income subject to tax by $1,000, producing a tax savings of, at most, a few hundred dollars. A $1,000 tax credit, on the other hand, cuts your taxes by the full $1,000.
However, in some cases a company may save more money by simply deducting their pension plan startup costs as regular business expenses rather than claiming the credit. You can’t do both for the same expenses. Run the numbers both ways and go with whichever saves the most money.
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