The 550 Tax Credit for Small Employer Pension Plans

While there is no federal benefit officially called the “550 tax credit,” the term is often used to refer to the Credit for Small Employer Pension Plan Startup Costs. This confusion may arise from the use of Form 5500, a required annual report for most retirement plans. This tax incentive helps small businesses offset the costs of establishing a new retirement plan. Recent legislation, including the SECURE 2.0 Act, has expanded this credit.

Employer and Plan Eligibility

To qualify for the credit, a business must have 100 or fewer employees who received at least $5,000 in compensation during the preceding year. The employer also cannot have sponsored another qualified retirement plan for substantially the same employees in the three tax years before the new plan is established.

The plan itself must also satisfy certain conditions. It must cover at least one employee who is not considered a “highly compensated employee” (HCE). For a given year, an HCE is someone who either owned more than 5% of the business in the current or preceding year or earned over a certain amount in the preceding year. An employee who does not meet this definition is a non-highly compensated employee (NHCE). Qualifying plans include 401(k)s, SIMPLE IRAs, SEP IRAs, and profit-sharing plans.

Calculating the Credit Amount

The credit is composed of two parts. The first relates to startup and administration costs. For employers with 50 or fewer employees, the credit covers 100% of these costs, and for businesses with 51 to 100 employees, the credit is 50%. The maximum credit is the greater of $500 or an amount equal to the lesser of $250 for each eligible NHCE or $5,000. Qualifying costs include setting up the plan, administering it, and employee education.

A separate credit is available for employer contributions made to the plan. This is calculated as a percentage of contributions for employees earning $100,000 or less in FICA wages. The credit is capped at $1,000 per employee and is available for up to five years. For the first two years, the credit is 100% of the contributions, then phases down to 75% in the third year, 50% in the fourth, and 25% in the fifth. For employers with 51 to 100 employees, this credit is reduced by 2 percentage points for each employee over 50.

How to Claim the Credit

The credit is calculated and reported using Form 8881, Credit for Small Employer Pension Plan Startup Costs. This form must be attached to the employer’s main income tax return, such as a Form 1120 for a corporation or a Schedule C for a sole proprietor. Part I of the form is used for qualified startup and administration costs, while Part II is for the employer contribution credit. The totals from Form 8881 are then carried to the business’s primary tax return to reduce the overall tax liability.