Historically, if a company wanted to set up a retirement plan to take advantage of the tax deductions, the plan had to be in place by the last day of the tax year. This either led to a mad dash during the last two weeks of December or a realization of the missed opportunity come tax time.
The SECURE Act, which was signed into law in late 2019, changed that. Starting in 2020, companies now have until the extended due date of their tax returns to set up a plan! That means there is still time for companies, including owner-only businesses, to set up a profit sharing and/or cash balance plan and make tax deductible contributions for the 2020 tax year.
Here are a couple of examples.
Profit Sharing Plan
A profit sharing plan allows a business owner to make (and deduct) a contribution of up to $57,000 for him or herself. The plan could also be designed to add a 401(k) feature that would be effective prospectively.
Cash Balance Plan
A cash balance plan allows for much larger deductible contributions if the business owner is willing to commit to making those contributions, generally for at least 5 years. A 55-year-old with eligible pay of at least $285,000 could make a deductible cash balance contribution of more than $200,000. For someone in a combined 40% federal and state tax bracket, that contribution translates to immediate tax savings of more than $80,000!
Any employees who have worked for the company for at least a year (as of July 1, 2020) would need to receive a minimum level of contribution, which is also deductible. Depending on demographics, that contribution is generally around 5% to 7% of their pay.
As an added bonus, certain expenses related to setting up and running the plan may be eligible for tax credits for the first three years.
Timing is Everything
If you are facing significant tax liabilities for 2020 and filed an extension for your 2020 company return, you still have time to explore whether setting up one of these plans is right for you. If you did not extend your 2020 return, now is still a great time to start thinking about setting up a plan for 2021 and beyond.
Trusts as Owners
We are available to work with you to review the various plan options and prepare a customized illustration of the contributions levels that are available based on specific demographics. We have also provided several helpful resources on our website:
- Plan Design Quick Comparison Chart
- Plan Implementation Deadline Calculator
- Summary of New Plan Tax Credits
- New Plan Tax Credit Calculator
There are a couple comments we should note.
- As noted above, it is possible to include a 401(k) feature with a profit sharing plan that is setup under this new rule; however, the employee contribution part of the overall plan can only be effective prospectively.
- If you had a SIMPLE plan at any time during 2020, you would not be eligible to take advantage of this extended deadline. The reason is that a company is not permitted to have any other plans during any year that it has a SIMPLE in place.
Setting us a retroactive retirement plan is a great way to realize immediate tax savings, and DWC is here to help. If you have any questions about whether or how you can take advantage of this opportunity, please do not hesitate to contact us. We can talk through the options and work with you to obtain the necessary information for us to prepare customized plan design illustrations that show the contributions that are available.