Retroactive 2021 Tax Planning; Overlooked Deductions and Credits
With 2021 behind us, many business owners are discovering that, despite COVID-related challenges, they had a good year from a business perspective. That means it would be great to have additional tax deductions and credits to help reduce the business’s overall tax liability.
Fortunately, certain retirement plan-related deductions and credits are still available for 2021 – that’s right—after the fact—for establishing and funding qualified retirement plans they set up in 2022 for 2021. Let’s explore how business owners can potentially reduce their business’s tax bill with qualified plan deductions and credits.
First, businesses may fully deduct amounts contributed to qualified plans and these contributions may be made up to the due date, plus extensions, of their 2021 tax return filing date. But what if the business hadn’t established a qualified plan by the end of 2021? What options do these business owners have?
Fortunately, the rules for establishing retirement plans have changed as a result of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. Under the SECURE Act, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year, to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline as illustrated below.
Tax Status | Filing Deadline | Extended Deadline |
S-Corporation (or LLC taxed as S-Corp) | March 15 | September 15 |
Partnership (or LLC taxed as a partnership) | March 15 | September 15 |
C-Corporation (or LLC taxed as C-Corp) | April 15 | October 15 |
Sole Proprietorship (or LLC taxed as sole prop) | April 15 | October 15 |
[Note: Simplified employee pension (SEP) plans have historically followed the above schedule; and special set-up rules apply for safe harbor 401(k) plans.]
Establishing a plan retroactively can be particularly appealing if the business owner establishes a defined benefit plan, such as a cash balance plan. Cash balance plans can allow qualifying business owners to contribute and deduct hundreds of thousand dollars to such an arrangement under the right circumstances. As noted previously, this can be done retroactively for the 2021 tax year. With the help of their tax advisor, business owners can determine if a cash balance plan is right for them.[Note: Simplified employee pension (SEP) plans have historically followed the above schedule; and special set-up rules apply for safe harbor 401(k) plans.]
In addition, small businesses (with fewer than 100 employees) may also be eligible for additional tax credits for setting-up retirement plans and/or adding an automatic enrollment feature. Let’s explore some of the incentives and the plan establishment process.
The “Startup Credit” for new plans is $5,000, available for the first three years the plan is in existence and offers real benefits by freeing up tax dollars for other important business purposes. The credit was greatly improved as part of the SECURE Act, effective January 1, 2020 (increasing the maximum credit from $500 to $5,000). It is intended to encourage business owners to establish retirement plans by helping make the plan more affordable during the startup process. In addition, the business receives full tax deductions for all contributions made to the plan.
On top of that, if a business owner elects to add an automatic enrollment feature to the plan, an additional $500 credit (for the first three years) is also available to the company. The automatic enrollment feature calls for newly eligible participants to be enrolled automatically in the plan with a specified default deferral rate. The IRS provides additional details about the startup and auto deferral credits here. Consider the following example.
| EXAMPLE: The Limited is an LLC taxed as a partnership. Its standard tax filing deadline is March 15th of the year following the tax year in question. For the 2021 tax year, The Limited timely files IRS Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns. Consequently, it has an extended tax filing deadline of September 15, 2022, for its 2021 tax year. The owners of The Limited may decide in August of 2022 they would like to set up a 401(k)/profit sharing plan for the business for 2021 and later years. The Limited has until September 15, 2022, to execute plan documents to set up the plan, effective for 2021. While The Limited would be able to make a profit sharing contribution on behalf of participants for 2021, participants can only make pre-tax employee salary deferrals and designated Roth contributions prospectively—meaning after they execute valid salary deferral elections for compensation yet to be received in 2022. |
Retirement plan availability and coverage has become a public policy concern in recent years. More people need to be saving additional amounts for retirement. Employer- sponsored retirement plans are effective in getting individuals to save for retirement. Thus, from a policy perspective, the goal is to help and encourage smaller employers to offer retirement plans to their employees.
Clearly, in addition to benefiting employees, retirement plan deductions and credits can be helpful in controlling overall tax liability and should be given serious consideration. The next step for a business owner who is contemplating starting a retirement plan is to discuss these issues with a certified public accountant (CPA) familiar with retirement plans and their complexities. When dealing with retirement plan issues, there is no “one size fits all” approach, and careful planning and execution is essential. That said, these deductions and credits often play an important role in limiting the tax liability for many business owners—and letting them keep more of what they earn.
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