Section 45E After SECURE 2.0: How Small Employers Recoup 100% of Pension Plan Startup Costs on Form 8881

A bookkeeper at a 22-person dental practice runs the numbers for the owner. The 401(k) plan the staff has been asking about will cost roughly $4,000 to set up in year one, another $4,000 for years two and three, and the owner is willing to put in $1,000 per employee in matching contributions. Total three-year out-of-pocket: about $54,000 in administration plus a chunk of matching dollars.

Then the bookkeeper applies Section 45E and the SECURE 2.0 employer contribution credit. Federal tax credits absorb roughly $36,000 of that bill. The plan effectively costs a fraction of what the owner was bracing for.

Most small employers never run this calculation. They hear "401(k)" and assume it is too expensive, too complex, or only for big companies. Since the SECURE 2.0 Act of 2022 was enacted, that assumption is dramatically out of date. For employers with 50 or fewer employees, Internal Revenue Code Section 45E now refunds 100 percent of qualified plan startup costs — up to $5,000 per year for three years — and stacks a separate, per-employee contribution credit on top of it.

Here is exactly how the credits work, who qualifies, where the traps are, and how to claim them on Form 8881.

The Three Credits Hiding in One Form

When people talk about "the small employer retirement plan credit," they usually mean a single number. In reality, Form 8881 packages three separate credits introduced or expanded by SECURE 2.0:

1. The startup cost credit under Section 45E — pays up to 100% of plan administration costs for three years.
2. The employer contribution credit under Section 45E(f) — pays up to $1,000 per non-highly-compensated employee for five years.
3. The auto-enrollment credit under Section 45T — pays a flat $500 for three years for adding an automatic enrollment feature.

A small employer can claim all three at once. Each has its own eligibility rules, its own cap, and its own phase-out schedule. Treating them as a single bucket is the most common reason a CPA leaves money on the table.

Credit #1: Section 45E Startup Cost Credit

This is the headline credit, and it is the one SECURE 2.0 supercharged.

What it pays

For tax years beginning after December 31, 2022, eligible employers with 1–50 employees receive a credit equal to 100% of qualified startup costs. Employers with 51–100 employees receive 50% — the original pre-SECURE 2.0 rate. Both groups are subject to the same annual cap.

The annual cap is the greater of $500, or the lesser of:

• $250 multiplied by the number of non-highly-compensated employees (NHCEs) eligible to participate, or
• $5,000.

The credit runs for the first credit year and the two following tax years — so a maximum of three years of credits. Over three years, the absolute ceiling is $15,000.

What counts as "qualified startup costs"

The statute defines qualified startup costs as ordinary and necessary expenses paid to establish or administer the plan, plus the costs of employee education about the plan. That covers:

• Plan document drafting and IRS submissions
• Third-party administrator (TPA) and recordkeeping fees
• Plan installation and conversion fees
• Investment platform setup costs
• Employee onboarding sessions, enrollment meetings, and educational materials

It does not cover employer matching or non-elective contributions — those are handled by Credit #2 below.

A concrete example

A landscaping company with 18 employees, 14 of whom are NHCEs, sets up a 401(k). Year one startup costs are $4,200.

• $250 × 14 NHCEs = $3,500
• Lesser of $3,500 or $5,000 = $3,500
• Actual costs were $4,200, but the credit is capped at $3,500.

Because the company has fewer than 50 employees, the credit percentage is 100%. Credit for year one: $3,500. If costs in years two and three remain at or above $3,500 per year, the credit ceiling holds, producing a three-year total of $10,500.

Who qualifies

To be an "eligible employer" under Section 45E, the business must satisfy three tests:

1. Size test. The business must have had no more than 100 employees who received at least $5,000 in compensation in the preceding year. Owner-employees count.
2. NHCE test. At least one eligible plan participant must be a non-highly-compensated employee. ("Highly compensated" under Section 414(q) generally means owners or anyone earning over $160,000 in 2026.) A solo-owner plan does not qualify.
3. Three-year non-overlap test. The same employees cannot have participated in another retirement plan sponsored by the same employer (or a related employer) during the three preceding tax years. This stops employers from terminating and restarting plans to harvest fresh credits.

Plan types eligible

The credit applies to any plan described in Section 4972(d) — meaning 401(k) plans, profit-sharing plans, SEP IRAs, SIMPLE IRAs, money purchase pension plans, and defined benefit plans. Roth and traditional features are both fine.

Credit #2: SECURE 2.0 Employer Contribution Credit

This is the credit small employers most often miss, because it requires a separate line on Form 8881 and a separate eligibility analysis.

What it pays

For each non-highly-compensated employee earning under $100,000 (indexed for inflation), the employer can claim a credit equal to a percentage of the employer contribution made on that employee's behalf, capped at $1,000 per employee per year.

The percentage depends on the year of the plan and the size of the employer:

For a business with 51–100 employees, the base percentage starts at 100% and drops by two percentage points for each employee over 50, then phases through the same year-over-year reduction. A 75-employee employer in year one receives 50% (100% − 2% × 25 = 50%).

A concrete example

A 12-person bakery sets up a SIMPLE IRA in 2026 and contributes the SIMPLE-mandated 2% non-elective contribution. Eight of the 12 employees are NHCEs earning under $100,000. Average annual compensation is $42,000, so the contribution per NHCE is $840.

• Credit per NHCE in year one: 100% × $840 = $840 (well under the $1,000 cap)
• Total contribution credit in year one: $840 × 8 = $6,720
• Same math in year two: another $6,720
• Year three: 75% × $6,720 = $5,040
• Year four: 50% × $6,720 = $3,360
• Year five: 25% × $6,720 = $1,680

Five-year contribution credit total: $23,520 — on top of any startup cost credits already claimed.

Important nuance

The contribution credit is reduced by the startup cost credit when both apply to the same dollar of expense, but in practice they cover different costs (administration versus matching), so double-dipping is rare. The credit also cannot exceed the actual contribution made; you cannot claim a credit for a contribution you did not write a check for.

Credit #3: Section 45T Auto-Enrollment Credit

The smallest of the three credits, but the simplest: a flat $500 per year for three years when an employer adds an "eligible automatic contribution arrangement" (EACA) to the plan.

An EACA enrolls eligible employees automatically at a default deferral rate unless they opt out. SECURE 2.0 made auto-enrollment mandatory for most new 401(k) and 403(b) plans established after December 29, 2022 — so for new plans, the $500 credit is essentially free money for compliance the employer was already required to do.

The credit does not require the employer to do any contribution matching. It is purely tied to the auto-enrollment feature. Claim it on Part II of Form 8881.

Stacking the Credits: A Realistic Three-Year Picture

Combine the three credits and the savings get meaningful fast. Consider a 25-employee marketing agency that:

• Sets up a 401(k) with auto-enrollment in 2026
• Has 20 NHCEs eligible to participate
• Pays $4,800 per year in plan administration costs
• Contributes $800 per NHCE per year in matching contributions ($16,000 total)

That is $72,500 in federal tax credits over five years for a plan whose total employer outlay (admin + matching) was about $94,400. The credits absorb roughly 77 percent of the employer's cost.

For an owner who has been hesitant to start a plan because of cost, this changes the conversation entirely.

Common Mistakes That Cost Real Money

Even employers who know the credits exist often misclaim them. The five most common errors:

1. Missing the three-year non-overlap rule

If the same employees were covered by another retirement plan from the same controlled group during any of the three preceding tax years, the startup credit is disallowed. Companies that paused a SIMPLE IRA, switched to a 401(k), or merged with a business that had a plan often trip this wire. Confirm plan history with a benefits advisor before claiming.

2. Counting highly compensated employees toward the $250 cap

The startup credit ceiling is $250 multiplied by NHCEs only. A 10-employee firm with 9 owners and 1 NHCE has a year-one cap of $500 (the statutory floor), not $2,500. Misreading this line on Form 8881 produces an inflated credit that will be reversed on audit.

3. Confusing the credit with a deduction

The Section 45E credit reduces your federal tax liability dollar for dollar. But Section 45E(e) requires that you reduce the deductible plan expense by the credit claimed. You cannot deduct $5,000 of startup costs and also claim a $5,000 credit on the same expense — you choose one or the other on each dollar. Most payroll-tax software handles this automatically; manual filers frequently miss it.

4. Forgetting the employee compensation cap on contribution credits

The $1,000-per-employee contribution credit only applies to NHCEs earning less than $100,000 (indexed). A high-earning sales rep who is technically an NHCE but earns $115,000 still generates no contribution credit. Run the payroll filter before computing the credit.

5. Skipping the carryback option

If the credit exceeds your tax liability in the year of the plan startup, the general business credit rules allow you to carry the unused credit back one year and forward 20 years. Many small businesses file Form 8881 without amending the prior-year return for the carryback, leaving cash with the IRS.

How to Claim: Form 8881 in Practice

Form 8881 (revised December 2025) has three parts that mirror the three credits above:

• Part I — Credit for small employer pension plan startup costs. Enter qualified startup costs, compute the $250-per-NHCE cap and the $5,000 ceiling, and apply the 100% or 50% percentage.
• Part II — Credit for small employer auto-enrollment. Enter $500 flat if you added an EACA in the current year (or in either of the two preceding tax years).
• Part III — Employer contribution credit. Enter employer contributions per eligible NHCE earning under the compensation threshold, apply the year-of-plan percentage, and cap at $1,000 per employee.

The form flows to Form 3800 (General Business Credit), which is then attached to the business return (Form 1120, 1120-S, 1065, or Schedule C for sole proprietors). Pass-through entities flow the credit to partners or shareholders on Schedule K-1.

Accurate bookkeeping is the prerequisite

Claiming these credits accurately requires clean payroll and plan-expense records. You need:

• Per-employee compensation totals to identify NHCEs and the $100,000 ceiling
• A breakdown of plan expenses into setup, ongoing administration, and employee education
• A separate ledger account for employer matching contributions, broken out by employee
• Evidence that an EACA was adopted (plan document, summary plan description)

If your books commingle plan administration with general HR expenses, or lump employer matching into a single "benefits" account, you will end up estimating the credit instead of substantiating it. Tracking these as distinct accounts from day one prevents both under-claiming and audit headaches.

Timing and Filing Strategy

Three practical timing rules to keep in mind:

1. The first credit year is the tax year in which the plan becomes effective, or at the employer's election, the year before. Choosing the prior year can be useful if startup costs were prepaid.
2. The contribution credit follows the actual contribution year, regardless of when the credit-year clock started. A plan effective January 2026 produces year-one startup credits for 2026 and year-one contribution credits for the year contributions are first made.
3. State conformity varies. Some states do not conform to Section 45E or the SECURE 2.0 expansions. Verify your state's treatment before assuming the federal credit doubles up at the state level.

The Strategic Picture: Why This Matters Beyond the Tax Savings

Federal policy has decided that closing the small business retirement plan gap is a national priority. Section 45E in its post-SECURE 2.0 form is one of the most generous small business tax credits Congress has ever enacted — outright cash for setting up a benefit that helps you recruit, retain, and lock in tax-advantaged growth for the owner's own retirement account.

For an owner who plans to take advantage of the plan personally (and most do), the tax math becomes even better: a 401(k) lets the owner defer up to $23,500 in 2026 (plus $7,500 catch-up if 50+), and the credits effectively pay for the infrastructure that makes those deferrals possible.

The window matters. The 100% startup-cost rate is a SECURE 2.0 enhancement, not a permanent feature of the code. Plans established in the next several years lock in the most generous tier of credits available.

Keep Your Retirement Plan Accounting Clean from Day One

A retirement plan brings real recordkeeping obligations — separating contributions from administration, tracking per-employee matching, documenting eligibility tests, and tying it all back to Form 8881. The credits only work if your books can prove the numbers.

Beancount.io provides plain-text accounting that gives you complete transparency and version control over every plan-related entry — perfect for the kind of audit trail Form 8881 substantiation requires. Get started for free and see why small employers are choosing transparent, AI-ready accounting for their benefit plan tracking and beyond.