I heard that there are tax credits that can offset plan costs. How does this work?

You may be eligible for a tax credit to offset your plan costs. Plans covered under this credit would be cash balance plans, defined benefit plans, and safe harbor 401(k)s. The credit is $250 for each qualifying employee. The minimum credit is $500 and the maximum credit is $5,000. The credit covers the set-up costs and annual administration. You can claim it for the first three years of the plan.

In addition, you can select to claim the credit in the tax year before the plan becomes effective if you choose. It is claimed on Form 8881 that is filed with your business tax return. You can find the form here: https://www.irs.gov/forms-pubs/about-form-8881

The credit applies if the following conditions are met:

1) You have 100 or less employees who have over $5,000 in compensation for the previous year;

2) You had at least one eligible participant who was not deemed a highly compensated employee; and

3) In the three years prior to the first year you claim the credit, your employees weren’t essentially the same employees who received retirement contributions under another plan you sponsored.

The bad news is that most solo plans don’t qualify because they don’t have any qualifying employees. The business owner is considered a highly compensated employee and is excluded.