Tax Credits for Starting a 401(k): What Small Business Owners Should Know

Many small business owners like the idea of offering a 401(k), but hesitate because it sounds expensive or complicated. What often gets missed is that the IRS actually provides tax credits to help small businesses start retirement plans, and those credits have become much more generous in recent years.

In some cases, these credits can cover a large portion of the cost of starting and maintaining a 401(k) during the early years.

What Is the 401(k) Startup Tax Credit?

The IRS offers a tax credit to encourage small businesses to set up retirement plans, including 401(k)s. A tax credit is different from a deduction: it reduces your tax bill dollar for dollar, which makes it especially valuable.

There are actually two separate credits to be aware of. The first helps cover the cost of setting up the plan. The second helps offset the cost of making employer contributions for employees.

1. The Credit for Starting a 401(k)

When a small business starts a new 401(k), there are usually setup and administrative costs involved. The IRS allows a tax credit to help cover these expenses.

To qualify, the business generally needs to have 100 or fewer employees and must not have offered a retirement plan in the last three years. The credit is meant for employers who are offering a plan to employees, not owner-only plans.

If the business qualifies, it can claim a credit of up to $5,000 per year for the first three years of the plan. These credits can be used to offset costs like plan setup, ongoing administration, and educating employees about how the plan works.

Over three years, that can add up to as much as $15,000 in tax credits.

More information: Retirement plans startup costs tax credit

2. A New Credit for Employer Contributions

In addition to the startup credit, a newer law called "The SECURE 2.0 Act" introduced another incentive that many business owners are not aware of.

This second credit applies when a business makes employer contributions to employees’ retirement accounts, such as matching contributions or profit sharing. For very small businesses, the credit can equal 100% of those employer contributions, up to $1,000 per employee per year.

This credit is available for up to five years, though it gradually phases down over time and is reduced for larger small businesses.



For employers who want to offer a competitive benefit but are concerned about the cost, this credit can make a meaningful difference in the early years of the plan.

More information: SECURE 2.0 Act of 2022

A Lesser-Known Credit for Automatic Enrollment

There’s also a smaller, often overlooked tax credit available if a 401(k) plan includes automatic enrollment. This is when employees are enrolled in the plan by default unless they choose to opt out.



To encourage this feature, the IRS offers an additional tax credit of up to $500 per year for three years. The credit applies whether the automatic enrollment feature is added to a new plan or an existing one. While it’s not as large as the other credits, it can still help offset administrative costs and, at the same time, increase employee participation in the plan.

More information: Retirement topics - Automatic enrollment

Why Planning Matters

These credits work best when they’re considered before the plan is set up. Small details — such as when the plan starts, how contributions are structured, and which employees are eligible — can affect how much credit a business can actually claim.

This is one example of why tax planning throughout the year can be just as important as filing the return itself.

A Few Important Limitations to Keep in Mind

While these credits are helpful, they don’t apply in every situation. For example, Solo 401(k) plans (where the owner is the only participant) generally don’t qualify. The credits are focused on helping employers offer retirement benefits to employees.

It’s also important to understand that the credits apply to employer costs and employer contributions, not the owner’s personal salary deferrals. And, like all retirement plans, the 401(k) must follow IRS eligibility and nondiscrimination rules.

More information: Retirement plans frequently asked questions (FAQs)

Final Thoughts

For many small businesses, starting a 401(k) is no longer just about offering a benefit, it can also be a smart tax move.

With the available credits, the IRS has made it much easier for small employers to take that first step, while reducing the financial impact during the early years.

If you’re thinking about starting a 401(k), or simply want to understand your options, we invite you to schedule a free consultation here.