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Does the government pay for your Glossary of Financial Clarity401(k)A retirement account through your job where money leaves your paycheck before you ever see it. If your employer matches, that match is about the closest thing to free money you'll get offered at work. It comes in traditional (tax later) and Roth (tax now) flavors.General education only. Not tax or investment advice. Read the full story?
That is close to how Ray asked it. Ray is made up, though we have some version of this call most weeks. He runs a commercial landscaping company, and he spent last month working out how to set up a plan. A provider's page told him he could claim $5,000 a year for three years. He put that against the quotes in front of him and figured the plan would cost him almost nothing.
That $5,000 is a ceiling. What Ray can claim is set by how many people work for him, and it comes to $3,250.
The three credits
| Credit | What it covers | What it is worth | How long it runs |
|---|---|---|---|
| Startup costs | Setting the plan up, administering it, and teaching employees about it | 100% of those costs at 50 or fewer employees, capped at $250 per eligible non-highly-compensated employee, no less than $500 and no more than $5,000 a year | The first year and the two after it |
| Employer contributions | Money the business puts in for employees, not counting what employees defer themselves | Up to $1,000 per employee, at 100%, 100%, 75%, 50% and 25% | Five years |
| Automatic enrollment | Including an automatic enrollment feature in the plan | $500 a year | The first year and the two after it |
Why Ray's startup credit is $3,250
The cap is $250 for every eligible employee who is not highly compensated, which for 2026 means everyone eligible for the plan except anyone owning more than 5% of the business and anyone it paid more than $160,000 last year. Ray is the owner, so thirteen of his people count. Thirteen times $250 is $3,250. Getting to the $5,000 in the headline takes twenty eligible employees.
A second limit sits on top of that one. The credit covers 100% of qualified startup costs, which the Glossary of Financial ClarityIRSThe IRS, or Internal Revenue Service, is the federal agency that collects taxes and enforces the tax code. It processes returns, sends refunds, and runs audits. Most of what feels like a tax rule in everyday life is the IRS turning the laws Congress writes into forms, deadlines, and instructions.General education only. Not tax or investment advice. Read the full story defines as the ordinary and necessary cost of establishing the plan, administering it, and educating employees about it. It reimburses what you spent and goes no further.
Ray's first year runs $1,500 to get the plan built and $2,500 to administer it. He claims $3,250 and deducts the $750 the credit did not reach. Over three years that is up to $9,750, as long as his costs stay above the cap.
The credit for what the business puts in
Ray landed on a safe harbor match worth 4% of pay. The money he puts in for his crew carries a credit of its own, up to $1,000 per employee per year.
Thirteen employees at $1,000 is $13,000 in a single year, against $3,250 from the startup credit on the same plan.
Two rules shape it. Employee deferrals do not count, only employer money. And it skips anyone whose wages pass $110,000 in 2026, a threshold that moves with inflation.
The percentage falls as the plan ages. The business counts 100% of those contributions in the first two years, then 75%, then 50%, then 25%, with nothing from the sixth year on. Because the $1,000 ceiling never moves, a smaller contribution stops reaching it sooner. Ray's match clears $1,000 a head through his fourth year and falls short in the fifth.
When the five-year clock starts
Ray's design lets people defer from their first day and waits a year before the company matches anything, a defensible call for a business whose crew turns over in the first season.
It also spends one of his two 100% years with nothing to claim, because the five-year schedule counts from the year the plan is established rather than the year the first employer dollar goes in.
Whether the wait is worth it is Ray's decision, and he can only make it with the number sitting next to it. We price both versions during the design conversation.
The $500 for automatic enrollment
A plan that includes an automatic enrollment feature earns $500 a year for three years. Ray collects it, and he was going to enroll people automatically regardless, because a 401(k) started today has to unless the business has 10 or fewer employees or is under three years old.
What has to be true to claim any of this
- No more than 100 employees took at least $5,000 in pay from the business last year. Past 50, the startup credit drops to 50% of costs and the contribution credit falls by two percentage points for every employee above 50.
- At least one person eligible for the plan is not highly compensated. An owner-only plan gets nothing from the startup credit for that reason.
- The business had no plan covering substantially the same employees in the three years before the credit starts. Closing a plan and opening another one to reset the clock does not work.
- The credits reduce tax the business owes and do not generate a refund. Anything unused carries back one year and forward up to twenty.
Austin Wolfe and Joe Anderson run Workplace Retirement at ClearMind Capital in Columbus, and set up and administer 401(k) plans for businesses across Ohio and nationwide. Book a call and we will run your census the way we ran Ray's, so you see your own cap and what each design decision is worth before you sign anything.
Common questions
Can a small business get $5,000 a year for starting a 401(k)?
Only with twenty or more eligible employees who are not highly compensated, since the cap is $250 for each of them. Below twenty the cap is lower, with a floor of $500, and the credit never exceeds what the plan cost the business that year.
Do the tax credits cover the employer match?
A separate credit does, worth up to $1,000 per employee a year for employer contributions other than employee deferrals. It runs five years at 100%, 100%, 75%, 50% and 25%, and it ignores employees paid more than $110,000 in 2026. Contributions to a defined benefit plan do not qualify.
What if my business does not owe federal tax this year?
These are nonrefundable general business credits, so they lower tax owed rather than producing a payment. An unused amount carries back one year and forward up to twenty, which matters for a company with an early loss year.
Can I claim the credit for the year before the plan starts?
Yes, by election. The first credit year is the tax year the plan becomes effective for the employer, or the year before that one if the employer elects it.
Does a solo 401(k) qualify for the startup credit?
No. Qualified startup costs only count when at least one eligible participant is not highly compensated, and an owner-only plan has none. Bringing on an employee who joins the plan changes that.
What do I file to claim these?
Form 8881, which carries into Form 3800 with the rest of the general business credit. Have the plan's invoices and your employer contribution records ready for your Glossary of Financial ClarityCPAA CPA, or certified public accountant, is an accountant who has passed a demanding licensing exam and met state experience requirements. Not everyone who does taxes holds the license, and it lets them do things an unlicensed preparer can't, like represent you in front of the IRS and sign off on audited financial statements.General education only. Not tax or investment advice. Read the full story, broken out by employee.
Written byAustin Wolfe & Joe AndersonClearMind Capital | Workplace RetirementView bio →
- Internal Revenue Code section 45E, on the credit for small employer pension plan startup costs: the dollar limitation of the greater of $500 or the lesser of $250 per eligible non-highly-compensated employee or $5,000, the increase to 100% of costs for employers that would qualify at a 50-employee threshold, the three-year prior-plan rule, the election to treat the preceding taxable year as the first credit year, the no-double-benefit rule, and at subsection (f) the additional credit for employer contributions, its $1,000 per employee limit, the 100/100/75/50/25 applicable percentage schedule, the two percentage point reduction for each employee above 50, and the $100,000 wage limit indexed after 2023.
- Internal Revenue Code section 45T, on the $500 a year automatic enrollment credit for three years and the eligible automatic contribution arrangement requirement.
- Internal Revenue Service, Instructions for Form 8881 (Rev. December 2025), on the 100% rate for employers with 1 to 50 employees and 50% for 51 to 100, the per-employee contribution amounts counted in each of the five years, and the eligible employer definition of no more than 100 employees who received at least $5,000 in compensation in the preceding year.
- Internal Revenue Service, Notice 2025-67, for the 2026 figures: the section 45E(f)(2)(C) wage limit rising from $105,000 to $110,000, and the section 414(q)(1)(B) highly compensated employee threshold remaining $160,000.
- Internal Revenue Code section 39, on the one-year carryback and twenty-year carryforward of unused general business credits.
- Internal Revenue Code section 414A, on the automatic enrollment requirement for plans established after December 29, 2022 and the exceptions for businesses with 10 or fewer employees and businesses under three years old.
- Ray, his headcount, his plan design and every dollar figure attributed to his business are a constructed hypothetical for illustration, not a client and not a quote.
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