Key Takeaways

  • Safe Harbor Laws offer legal protections, preventing penalties when actions are taken in good faith.
  • Safe Harbor in 401(k) Plans allows businesses to bypass non-discrimination tests by meeting specific employer contribution and participant requirements.
  • Changes to Safe Harbor Law have benefited small businesses by increasing tax deduction limits for personal property and reducing the paperwork burden.
  • International Safe Harbor Frameworks support data transfer agreements between the U.S. and the European Union (though the EU-U.S. Safe Harbor was replaced by the Privacy Shield in 2017).

What Is a Safe Harbor Law?

A safe harbor law states that certain types of behavior are not considered violations as long as they fall under a given rule. Rule 10B-18 of the Securities Exchange Act of 1934 defines safe harbor laws. As such, safe harbor laws offer protection when people show "good faith" efforts.

For example, if the law makes property owners report their land dimensions, landowners can't receive fines if they use surveyors or a faulty measuring tool. The landowners act in good faith without knowing about inaccuracies with the measurements. Otherwise, state law can fine landowners up to $500 for each under-reported acre. The fine amount depends on the property owner's location.

Safe harbor laws can be used in many legal areas, including:

  • Environmental laws
  • Tax laws
  • Sex trafficking laws
  • Copyright laws (as stated under the Digital Millennium Copyright Act )
  • Securities laws
  • Healthcare (the Affordable Care Act includes a safe harbor designed to make employee healthcare coverage affordable)
  • Another safe harbor provision is the IRS Special Accounting Rule. This rule enables employers to treat noncash fringe benefits provided in November or December as being offered in the following tax year.

Changes in Safe Harbor Law

Safe harbor laws were recently changed to increase limits for small businesses taking tax deductions for personal property within a purchase year. This change has been helpful, as it allows small-business owners to receive greater expense deductions.

Previously, the safe harbor regulations required applicable financial statements to prove deductions. Since 2016, however, business owners can take up to $2,500 in deductions for property, including smartphones, tablets, equipment, and machinery.

Safe Harbor Laws in 401(k) Plans

Safe Harbor 401(k) plans are a specific application of safe harbor laws in retirement plan design. These plans are designed to help businesses avoid the IRS-required nondiscrimination testing, which ensures that contributions do not disproportionately favor highly compensated employees (HCEs).

By offering a Safe Harbor 401(k), businesses automatically comply with certain IRS requirements for employer contributions. There are two primary types of Safe Harbor contributions:

  • Basic Safe Harbor Match: Employers match employee contributions dollar-for-dollar up to 3%, and 50% on the next 2%.
  • Non-Elective Safe Harbor Contributions: Employers contribute a fixed 3% of each employee's compensation, regardless of the employee's contribution.

Safe Harbor 401(k)s are popular with small businesses looking to offer employees more robust retirement options without the burden of passing complex nondiscrimination tests .

Why Are Safe Harbor Laws Important?

Safe harbor laws protect people and businesses from being responsible for unforeseen mistakes. These laws give peace of mind to anyone acting in good faith who may otherwise be violating the law for reasons out of their control.

Safe harbor, by another definition, is also a shark repellent tactic used by businesses to avoid being purchased outright. Business owners can buy heavily regulated companies to make themselves look like less attractive options. The term can also refer to an accounting method which simplifies the process of figuring out tax issues.

The Safe Harbor Account Method Can Simplify Tax Returns

The Internal Revenue Service (IRS) requires business owners to treat renovations as capitalized improvements. The value of these improvements must be claimed over a time period. However, most retailers and restaurants need to be remodeled often to keep the facilities looking fresh. As such, the IRS allows certain business owners to claim remodeling expenses as repair costs under the safe harbor accounting method. This method allows all purchases to be deducted during the same year.

Since figuring out tax expenses could be confusing for businesses owners, the IRS created a safe harbor accounting method for qualifying businesses. Business owners no longer have to worry about making the wrong decisions when tax time arrives and later receiving penalties.

On the other hand, safe harbor accounting can help businesses get around tax regulations:

  • If a business loses money and can no longer claim an investment credit, that business can transfer the credit to a profitable company. When this transfer occurs, the business can claim credit. The profitable company then leases the asset back to the original company, passing on tax savings.

Safe Harbor Helps Meet Discrimination Requirements for 401(k) Plans

Safe harbor laws associated with 401(k) plans offer different methods for meeting discrimination requirements. Safe harbor 401(k) plans became created in 1996 under the Small Business Job Protection Act. These retirement accounts were needed because many companies were not setting up 401(k) accounts for employees.

The reason for this intentional oversight was because nondiscrimination policies were difficult to understand. Safe harbor 401(k) plans keep employers safe from compliance issues by giving them a simpler product to work with for their employees.

Benefits of Safe Harbor 401(k) Plans

Safe Harbor 401(k) plans are especially beneficial for small businesses that have difficulty passing the annual nondiscrimination tests. These tests ensure that benefits provided to HCEs are not disproportionately higher than those given to non-HCEs.

Benefits of Safe Harbor 401(k) plans include:

  • Avoidance of Nondiscrimination Testing: Employers can avoid the ADP/ACP tests that limit how much HCEs can contribute.
  • Employee Contribution Maximization: With Safe Harbor plans, employees can contribute the maximum allowed by the IRS without restrictions based on the contributions of other employees.
  • Simplified Administration: These plans reduce the complexity of managing employee retirement benefits, making them more accessible to small businesses.

Safe Harbor 401(k)s thus help businesses ensure compliance with tax regulations while providing valuable retirement benefits to their employees.

Reasons to Consider Using a Safe Harbor Law

Safe harbor laws protect people who may be unaware they are committing legal violations. As such, your attorney might refer to safe harbor law if you or your business has unintentionally made a mistake resulting in legal consequences. When you can claim protections under safe harbor law, you won't face costly fines.

International Safe Harbor Frameworks

With privacy law compliance, Safe Harbor Certification was often the first step for U.S.-based startups. These safe harbor arrangements were related to data transfer between the European Union and the United States.

  • Businesses that wanted to take advantage of safe harbor laws could join the United States-European Union (EU) Safe Harbor. However, the U.S. Department of Commerce stopped accepting applications for Safe Harbor Certification on Oct. 31, 2016. The reason stated was that the United States wasn't doing its part to protect the data of EU companies and citizens associated with U.S. companies. This case was one of the few examples where safe harbor became removed.

However, the Swiss-U.S. Privacy Shield Framework received approval on Jan. 12, 2017. It replaced the U.S.-Swiss Safe Harbor. The U.S. Department of Commerce will begin accepting applications for the Safe Harbor Privacy Shield on April 12, 2017.

A Safe Harbor program like this one allows companies to self-certify compliance within the Safe Harbor Framework. To join, your business or organization must abide by policies outlined by the Framework. Review the self-certification information and complete the online certification form.

Why Choose Safe Harbor 401(k) Plans

Safe Harbor 401(k) plans offer several advantages for businesses looking to simplify their retirement plan administration and ensure tax compliance. Reasons to consider using a Safe Harbor 401(k) include:

  • Eliminating Nondiscrimination Test Failures: Safe Harbor plans allow highly compensated employees (HCEs) to contribute the maximum amount to their 401(k) accounts without worrying about failing discrimination tests.
  • Enhanced Employee Satisfaction: Offering a Safe Harbor plan can increase employee participation in retirement savings programs, as the contributions are guaranteed and not contingent on their own contributions.
  • Attracting Talent: A well-designed Safe Harbor plan can be a competitive benefit that attracts and retains high-quality employees.
  • Simple Administration: Unlike traditional 401(k) plans, which require annual compliance testing, Safe Harbor 401(k)s are easier to manage and typically involve fewer penalties for mistakes.

Frequently Asked Questions

  1. What are the tax benefits of a Safe Harbor 401(k) plan?
    A Safe Harbor 401(k) plan allows businesses to make tax-deductible contributions, helping them avoid penalties and meet IRS contribution requirements for employees.
  2. Can a Safe Harbor plan be amended mid-year?
    Yes, Safe Harbor 401(k) plans can be amended mid-year to meet changing business conditions. Employers must notify employees within a specific time frame, depending on the contribution type.
  3. Are Safe Harbor plans required to comply with ADP/ACP tests?
    No, Safe Harbor 401(k) plans are exempt from the annual ADP/ACP nondiscrimination tests that limit contributions for highly compensated employees.
  4. How do Safe Harbor contributions compare to traditional 401(k) plans?
    Safe Harbor contributions are pre-determined and mandatory, providing immediate compliance with IRS rules, whereas traditional 401(k) plans require annual testing and might face penalties for non-compliance .
  5. What types of businesses benefit most from Safe Harbor laws?
    Small businesses with fewer employees or those struggling to pass IRS nondiscrimination tests benefit greatly from adopting Safe Harbor 401(k) plans.

If you need legal help with what is safe harbor, post your question on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies such as Google, Menlo Ventures, and Airbnb.