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Instant Analysis: a Retroactive Deduction for Adopting a 401(k) Plan

Practice Management

Let’s say you are a plan advisor with experience advising on cash balance, age-weighted profit-sharing, or similarly designed retirement plans – and your client’s accountant calls in April with a problem. 

Your shared client (with just a 401(k) plan) had a banner year and they are getting clobbered with a giant tax bill. She asks you: “Is there anything you can do to help?” 

Pre-SECURE Act Status

Right now, your answer is “not much.” Perhaps if they had put in a retirement plan like a cash balance plan last year it would have helped. But that will not help with the current problem, although of course, you would be happy to discuss putting in a plan now to avoid future problems. Naturally, the accountant says she will get back to you on that – she has bigger issues to deal with right now. You put a note in your CRM to follow up with the accountant in a couple of months. 

Your experience tells you that the client might put in a new plan by the end of year, but more likely the client will be forced to suffer through another large tax bill before becoming convinced. More typically, it takes about 18 months to convince a client to adopt one of these more highly designed retirement plans.

Post-SECURE Act Solution

That situation is about to change, thanks to a provision in the SECURE Act that was developed by the American Retirement Association Government Affairs Committee. Section 201 of the Act provides that if an employer adopts a qualified retirement plan, such as a cash balance or profit-sharing plan, after the close of the taxable year but before the filing date (including extensions) for the employer’s tax return, the employer can elect to treat the plan as being adopted in the prior tax year. 

In other words, if the employer adopts the plan prior to the extended filing date for the employer’s tax return, they can retroactively  count the employer’s contribution to such plan as deduction on that return. In the case of a partnership or LLC, that would be Sept. 15. 

However – and importantly for C corporations – even though they technically have until Oct. 15 to file their extended return, they will actually need to adopt the plan by Sept. 15 in order for the plan contribution (due by Sept. 15) to count as a deduction for the prior year. This new provision is effective for plans adopted with respect to taxable years beginning after Dec. 31, 2019.

It should be noted here that the retroactive deduction for the adoption of a new plan only applies to the employer contributions to the plan. As such, a standalone 401(k) plan and the accompanying employee deferrals would not qualify. They continue to be only deductible in the year made.

Flash Forward

So let’s flash forward to April 2021. The accountant with a different shared client calls with the same problem – a giant unexpected tax bill. But this time your response is entirely different – you can help immediately – with the adoption of a new plan, like a cash balance or age-weighted profit-sharing plan, funded with employer contributions, that will retroactively reduce that tax bill. That is instant tax relief for your client.

Some consultants are suggesting that this could reduce the sales cycle for these plans from 18 months to as little as 18 days. And there are estimates that interest in these plans will rise by 20% because of the instant tax relief they can now provide. That’s good news for both the employer client and its employees, who will now benefit from a plan providing much higher contributions than a typical 401(k) plan. We call that a pension win-win!

Brian Graff is NAPA’s Executive Director and the CEO of the American Retirement Association.