IRS Provides Guidance on SECURE 2.0 Act Retirement Plan Changes

(Parker Tax Publishing January 2024)

The IRS provided guidance in the form of questions and answers with respect to certain provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0 Act) (Pub. L. 117-328). Among other provisions, the guidance addresses Section 102 of the SECURE 2.0 Act, which modified and increased the credit for small employer pension plan startup costs under Code Sec. 45E. Notice 2024-2.

Background

In Notice 2024-2, the IRS provided guidance in the form of questions and answers with respect to certain provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0 Act) (Pub. L. 117-328). Specifically, the notice addresses issues under the following sections of the SECURE 2.0 Act:

(1) Section 101 (expanding automatic enrollment in retirement plans)

(2) Section 102 (modification of credit for small employer pension plan startup costs)

(3) Section 112 (military spouse retirement plan eligibility credit for small employers)

(4) Section 113 (small immediate financial incentives for contributing to a plan)

(5) Section 117 (contribution limit for SIMPLE plans)

(6) Section 326 (exception to the additional tax on early distributions from qualified plans for individuals with a terminal illness)

(7) Section 332 (employers allowed to replace SIMPLE retirement accounts with safe harbor 401(k) plans during a year)

(8) Section 348 (cash balance)

(9) Section 350 (safe harbor for correction of employee elective deferral failures)

(10) Section 501 (provisions relating to plan amendments)

(11) Section 601 (SIMPLE and SEP Roth IRAs), and

(12) Section 604 (optional treatment of employer contributions or nonelective contributions as Roth contributions).

Notice 2024-2 is not intended to provide comprehensive guidance as to the specific provisions of the SECURE 2.0 Act, but rather is intended to provide guidance on discreet issues to assist in commencing implementation of these provisions. The IRS stated that it continues to analyze the various provisions of the SECURE 2.0 Act and anticipates issuing further guidance, including regulations, as appropriate.

SECURE 2.0 Act Changes to the Credit for Small Employer Pension Plan Startup Costs

As noted above, Notice 2024-2 addresses the changes made by the SECURE 2.0 Act to the credit for small employer pension plan startup costs under Code Sec. 45E. Section 102 of the SECURE 2.0 Act amended Code Sec. 45E to provide (1) an increased credit for qualifying small employers with no more than 50 employees; (2) a new credit based on matching and nonelective contributions made by qualifying small employers with no more than 100 employees; and (3) revised rules for the disallowance of deductions for certain small employer plan startup costs and matching and nonelective contributions to take into account the new credit based on matching and nonelective contributions.

The SECURE 2.0 Act added Code Sec. 45E(e)(4) to provide for an increase in the small employer pension plan startup cost credit provided under Code Sec. 45E(a) (startup costs credit), so that the credit for an eligible employer with no more than 50 employees is increased from 50 percent to 100 percent of the qualified startup costs paid or incurred by the eligible employer (increased startup costs credit). A startup costs credit (including the increased startup costs credit) is available to an eligible employer for a first credit year and each of the two tax years immediately following the first credit year (together, a 3-year startup costs credit period), as described in Code Sec. 45E(b) and (d)(3) and is subject to a dollar limitation set forth in Code Sec. 45E(b). Under Code Sec. 45E(d)(3), the first credit year is (1) the tax year that includes the date that the eligible employer plan to which such costs relate becomes effective with respect to the eligible employer, or (2) at the election of the eligible employer, the tax year preceding the tax year that the plan becomes effective.

The SECURE 2.0 Act also added new Code Sec. 45E(f), which provides for an additional amount of credit under Code Sec. 45E based on employer matching and nonelective contributions to an eligible employer plan other than a defined benefit plan (employer contributions credit). Under Code Sec. 45E(f)(1), an eligible employer is entitled to a credit for a tax year equal to a specified applicable percentage of aggregate employer contributions (other than any elective deferrals) made by the employer during the tax year to an eligible employer plan. Code Sec. 45E(f)(2)(A) provides that the credit is limited to no more than $1,000 with respect to any employee. Under Code Sec. 45E(f)(2)(C), contributions with respect to any employee who receives wages as defined under Code Sec. 3121(a) (that is, wages for purposes of the Federal Insurance Contributions Act (FICA)) from the employer for the tax year in excess of $100,000 (indexed for inflation) are excluded from the credit amount calculation for the tax year. Further, under Code Sec. 45E(f)(2)(B), the credit amount is reduced through a credit phase-in formula by 2 percent for each employee of the employer for the preceding tax year in excess of 50 employees. Code Sec. 45E(f)(3) provides that the applicable percentage is 100 percent for the first tax year during which the eligible employer plan is established with respect to the eligible employer (the first employer contributions credit tax year), 100 percent for the second employer contributions credit tax year, 75 percent for the third employer contributions credit tax year, 50 percent for the fourth employer contributions credit tax year, and 25 percent for the fifth employer contributions credit tax year (together, a 5-year employer contributions credit period).

The SECURE 2.0 Act amended Code Sec. 45E(e)(2) with respect to the disallowance of deductions for certain small employer plan startup costs and matching and nonelective contributions to take into account the new credit under Code Sec. 45E(f), by providing that no deduction is allowed (1) for that portion of the qualified startup costs paid or incurred for the tax year that is equal to so much of the portion of the credit determined under Code Sec. 45E(a) as is properly allocable to such costs, and (2) for that portion of the employer contributions by the employer for the tax year that is equal to so much of the credit increase determined under Code Sec. 45E(f) as is properly allocable to such contributions.

The amendments to Code Sec. 45E made by the SECURE 2.0 Act apply to tax years beginning after December 31, 2022.

Guidance Relating to the Credit for Small Employer Pension Plan Startup Costs

In Notice 2024-2, the IRS was asked whether the employer contributions credit under Code Sec. 45E(f) is treated as a separate credit that is in addition to the startup costs credit under Code Sec. 45E(a). The IRS responded yes. For example, an eligible employer might be eligible both for a startup costs credit calculated under Code Sec. 45E(a) (as limited by the dollar limitation in Code Sec. 45E(b)), and an additional employer contributions credit calculated under Code Sec. 45E(f)(1) (as limited by the dollar, wage, and credit phase-in limitations in Code Sec. 45E(f)(2), but not the dollar limitation in Code Sec. 45E(b)).

Next, the IRS was asked when an eligible employer plan is treated as being established for purposes of determining the first (and subsequent) employer contributions credit tax years during the 5-year employer contributions credit period. The IRS responded that an eligible employer plan is treated as being established on the date the plan becomes effective with respect to the eligible employer. The determination of the first employer contributions credit tax year during the 5-year employer contributions credit period is similar to the determination of the tax year that is the first credit year during the 3-year startup costs credit period under Code Sec. 45E(a), except that an employer may elect, under Code Sec. 45E(d)(3)(B), for the first startup costs credit year to be the tax year preceding the tax year in which the plan becomes effective with respect to the eligible employer. Thus, an eligible employer may be able to claim both the startup costs credit and the employer contributions credit beginning with the tax year in which the plan becomes effective with respect to the eligible employer. If an eligible employer elects, for purposes of the startup costs credit, for the tax year preceding the tax year in which the plan becomes effective with respect to the eligible employer to be the first startup costs credit year, then the 5-year employer contributions credit period begins with the second tax year of the 3-year startup costs credit period.

Asked how a change in an employer's status as an eligible employer under Code Sec. 408(p)(2)(C)(i) due to a change in the number of the employer's employees who received at least $5,000 of compensation from the employer for the preceding tax year affects the employer's eligibility for the Code Sec. 45E(f) employer contributions credit, the IRS explained that an employer is eligible for the employer contributions credit for a tax year during the employer's 5-year employer contributions credit period only if two requirements are met. First, the employer must be an eligible employer under Code Sec. 408(p)(2)(C)(i)(I) for the first employer contributions credit tax year during the employer's 5-year employer contributions credit period. Second, the employer must be an eligible employer under Code Sec. 408(p)(2)(C)(i) for the tax year with respect to which the employer contributions credit is claimed. Accordingly, if an employer had more than 100 employees for the tax year preceding the first employer contributions credit tax year during the employer's 5-year employer contributions credit period, the employer will not become eligible for the employer contributions credit for the first time in a subsequent tax year, even if the number of employees who received at least $5,000 of compensation from the employer drops to 100 or fewer for a tax year following the tax year preceding the first tax year in the employer's 5-year employer contributions credit period.

The IRS was asked how a change in an employer's status as an eligible employer under Code Sec. 408(p)(2)(C)(i) due to a change in the number of the employer's employees who received at least $5,000 of compensation from the employer for a tax year that precedes a particular tax year during the employer's 3-year startup costs credit period affect the employer's eligibility for (1) the startup costs credit under Code Sec. 45E(a) for that particular tax year or (2) the increased startup costs credit under Code Sec. 45E(e)(4) for that particular tax year. The IRS responded:

(1) An employer is eligible for the startup costs credit under Code Sec. 45E(a) (disregarding the increased startup costs credit under Code Sec. 45E(e)(4)) for a tax year during the employer's 3-year startup costs credit period only if (i) the employer was an eligible employer under Code Sec. 408(p)(2)(C)(i)(I) for the first tax year during the employer's 3-year startup costs credit period, and (ii) the employer is an eligible employer under Code Sec. 408(p)(2)(C)(i) for the tax year with respect to which the startup costs credit is claimed. Accordingly, if an employer had more than 100 employees for the tax year preceding the first tax year during the employer's 3-year startup costs credit period, the employer will not become eligible for the employer contributions credit for the first time in a subsequent tax year, even if the number of employees who received at least $5,000 of compensation from the employer drops to 100 or fewer for a tax year following the tax year preceding the first tax year during the employer's 3-year startup costs credit period.

(2) An employer is eligible for the increased startup costs credit under Code Sec. 45E(e)(4) for a tax year during the employer's 3-year startup costs credit period only if (i) the employer was an eligible employer under Code Sec. 408(p)(2)(C)(i)(I), applied by substituting "50 employees" for "100 employees," for the first tax year during the employer's 3-year startup costs credit period, and (ii) the employer is an eligible employer under Code Sec. 408(p)(2)(C)(i), applied by substituting "50 employees" for "100 employees," for the tax year with respect to which the startup costs credit is claimed. Accordingly, if an employer had more than 50 employees for the tax year immediately preceding the first tax year during the employer's 3-year startup costs credit period, the employer will not become eligible for the increased startup costs credit under Code Sec. 45E(e)(4) for the first time in a subsequent tax year, even if the number of employees who received at least $5,000 of compensation from the employer drops to 50 or fewer for a tax year following the tax year preceding the first tax year during the employer's 3-year startup costs credit period.

Asked whether it is possible for an employer that was eligible for the startup costs credit under Code Sec. 45E(a) for a tax year that began on or before December 31, 2022, to be eligible for the increased startup costs credit under Code Sec. 45E(e)(4) or the employer contributions credit under Code Sec. 45E(f) for a tax year that begins after December 31, 2022, the IRS answered yes. However, an employer that was eligible for the startup costs credit under Code Sec. 45E(a) for a tax year that began on or before December 31, 2022, can be eligible for the increased startup costs credit under Code Sec. 45E(e)(4) or the employer contributions credit under Code Sec. 45E(f) for a tax year that begins after December 31, 2022, only if there is a tax year during the employer's applicable 3-year or 5-year credit period that begins after December 31, 2022. For example, for an eligible employer with a calendar year tax year that maintains a plan that became effective on January 1, 2021: (1) the 5-year employer contributions credit period began with the eligible employer's 2021 tax year and ends with the employer's 2025 tax year; and (2) for the three employer contributions credit tax years in the 5-year employer contributions credit period that begin after December 31, 2022, it is possible, if the employer otherwise meets the eligibility requirements, for the employer to be eligible for an employer contributions credit equal to the applicable percentage of aggregate employer contributions set forth in Code Sec. 45E(f)(1) (75 percent for the 2023 tax year, 50 percent for the 2024 tax year, and 25 percent for the 2025 tax year).

On the question of whether an eligible employer is permitted to take into account, for purposes of determining the employer contributions credit under Code Sec. 45E(f) for a tax year, contributions to an individual who does not have wages as defined in Code Sec. 3121(a) in excess of the $100,000 (indexed for inflation) wage limitation set forth in Code Sec. 45E(f)(2)(C) for the tax year, even if the individual has earned income that is not wages as defined in Code Sec. 3121(a) for the tax year in excess of the $100,000 amount, the IRS responded yes. The $100,000 (indexed for inflation) wage limitation set forth in Code Sec. 45E(f)(2)(C), under which no contributions with respect to any individual who receives wages from the employer for a tax year in excess of $100,000 (indexed for inflation) may be taken into account for purposes of determining employer contributions credits for the tax year, only applies with respect to an individual who has wages as defined in Code Sec. 3121(a) that are in excess of the wage limitation for the tax year. Accordingly, contributions with respect to an individual who does not have any wages as defined in Code Sec. 3121(a) for a tax year because the individual is self-employed (including a partner) or because the individual is a state or local government employee whose services are excluded from employment under Code Sec. 3121(b)(7) (and, thus, does not have wages as defined in Code Sec. 3121(a)) may be taken into account for purposes of determining employer contributions credits for the tax year, even if the individual has earned income or remuneration from a state or local government in excess of the $100,000 wage limitation.

On the question of which tax year of an eligible employer a matching or nonelective contribution made by the employer to an eligible employer plan is taken into account for purposes of the employer contributions credit under Code Sec. 45E(f), the IRS responded that such a contribution is taken into account for purposes of the employer contributions credit for the same tax year that a deduction under Code Sec. 404(a) would apply with respect to the contribution. Thus, an employer is deemed to have made a matching or nonelective contribution on the last day of the preceding tax year if the contribution is on account of that tax year and is not made later than the time prescribed by law for filing the return for that tax year (including extensions thereof).

For a discussion of the small employer pension plan startup costs credit, see Parker Tax ¶106,300.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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