As a small business owner you’re always looking to hire and retain valuable, hard-working employees. Offering a 401(k) is a great way to attract high-caliber candidates, but you may be worried about the uncertainty of tax reform, how it will impact your small business, and your incentives for offering a 401(k) plan moving forward. Here’s what you need to know about small business 401(k)s under the Trump administration’s latest proposal for tax reform:
The ‘Upside Down Effect’
Most small businesses are taxed at a pass-through level. This means you pay taxes on your company’s profits at an individual rate rather than a corporate rate. Under the proposed tax plan, a 25% tax cap would apply to small businesses. This could result in your employer 401(k) contributions qualifying for the 25% tax deduction, but when the time comes for these funds to be withdrawn, they could be taxed at 35% or higher.
If the proposed tax plan is passed, the new tax rates would take some of the incentives that help drive small business retirement plans and turn them “upside down,” according to Paula Calimafde, chair of the Small Business Council of America.
This upside down effect is a technical glitch and “an unintended consequence of the tax reform plan,” said Craig Hoffman, general counsel for the American Retirement Association. This could lead you to think twice before offering retirement plans to your employees.
The Downside for the Business Owner
The House recently released their version of an official tax bill. The bill states that the 25% deduction will not be allowed to remain as a hard and fast rule because it could be used as a loophole for business owners. Depending on the type of business, business owners might need to recognize some income at their individual tax rates. However, employer contributions to employees’ 401(k) plans would still get the 25% tax deduction.
The Downside for the Employee
If the upside down effect isn’t fixed, you would benefit much more by taking the money you would have contributed to your employees’ 401(k)s and investing it on a capital gains basis. While you as a business owner may find other ways to save your own money for retirement, your employees will be missing out on your valuable contributions.
Since there are over 56 million employees in the U.S. working for small businesses, this change could have a massive impact on the financial future of small business employees. Small business advocacy groups have advised the Trump administration to ensure the money going into 401(k) plans is taxed at the same rate as the money eventually coming out before the final tax proposal is passed.