Form 8881 Small Employer Pension Plan Credit

The rule for claiming a credit on Form 8881 for pension plan contributions involves two separate credits available to eligible small employers:

Startup Costs Credit:

Eligible small employers can claim a credit for qualified startup costs paid or incurred during the tax year. The credit is 50% of qualified pension plan startup costs (or 100% for employers with 50 or fewer employees) and is generally limited to the greater of $500 or $250 for each non-highly-compensated employee eligible to participate in the plan, up to a $5,000 maximum limit. This credit is available for the first tax year and each of the following two tax years. Qualified startup costs include expenses paid or incurred in connection with establishing or administering an eligible employer plan or retirement-related education of employees, such as payroll system changes, investment setup fees, and consulting fees.

Employer Contributions Credit:

An additional credit is available for employer contributions (not employee elective deferrals) to an eligible employer plan. The credit is an applicable percentage of qualifying employer contributions, up to $1,000 per employee, for the first tax year the plan becomes effective and the succeeding four tax years [2]. The applicable percentage is 100% for the first and second years, 75% for the third year, 50% for the fourth year, and 25% for the fifth year. The credit phases out for employers with 51-100 employees, reducing by 2% for each employee over 50 [2].

Eligibility Requirements:

An eligible small employer must have had no more than 100 employees who received at least $5,000 of compensation during the tax year preceding the first credit year. The employer cannot have established or maintained a qualified employer plan for substantially the same employees during the three preceding tax years.

Important: Otherwise allowable deductions for startup costs must be reduced by the credit amount claimed [1].