One of the primary
objectives of the qualified plan rules is to make the tax advantages
contingent upon covering a significant number of the nonhighly
compensated employees. As this goal could be thwarted by creating
separate legal entities for the highly compensated and nonhighly
compensated employees, a complex set of rules has evolved concerning
the aggregation of related employers for purposes of the minimum
coverage rules and other qualified plan requirements.
Unnoticed, these aggregation rules can cause serious negative
ramifications. Let's look at an example: Jean the pension consultant
goes to visit her client Exterminator, Inc. that sponsors a profit
sharing plan. When she arrives, she also sees the name of Bug
Analysis, Inc. on the door. Immediately she becomes concerned, since
she knows that the plan only covers employees of Exterminator, Inc.
She discovers that both companies are wholly owned by the same
two individuals. Since this is a situation in which the employees
must be aggregated, the profit sharing plan could be disqualified if
it cannot satisfy minimum coverage after counting the excluded
employees of Bug, Inc.
As failure to identify required aggregation can result in plan
disqualification, employers need a basic understanding of these
There are several aggregation rules. The controlled group rules
require aggregation of employers that have a sufficient amount of
common ownership, and the affiliated service group rules apply to
other situations in which related businesses work together to
provide goods or services to the public.
When either rule applies, aggregated employers are treated as one
entity for most qualified plan rules. Specifically, such
organizations must be combined for purposes of the coverage
requirements, nondiscrimination provisions, vesting requirements,
maximum limitations on benefits and contributions, compensation
limitations and top heavy requirements. Both rules apply to
corporations and "trades and businesses," including partnerships,
proprietorships, estates and trusts.
A third type of affiliation relates to situations in which
individuals are "leased" on a long-term, full-time basis. An
individual who meets the definition of "leased employee" is treated
as working for the recipient for purposes of the qualified plan
requirements. Each of these rules is covered more fully below.
Controlled Group Rules
There are three types of controlled groups: brother-sister,
parent-subsidiary and combined groups.
Brother-Sister Controlled Group
A brother-sister controlled group exists whenever the same five
(or fewer) owners of two or more entities own 80% or more of each
entity, and more than 50% of each entity when counting only
identical ownership. Let's look at an example:
In this case the 80% ownership test has been met, because the
three individuals (Joe, Sally and Ralph) who have ownership in each
entity own 100% of both businesses. However, the 50% identical
ownership interest test has not been satisfied. Identical ownership
is determined first by determining the common ownership interest for
each individual. For example, Joe's identical interest is 12%. The
second step is to add up the identical ownership interests of Joe,
Sally and Ralph. Since these only add up to 46%, this group does not
constitute a controlled group.
When performing the 80% test, only shareholders owning interests
in each potential member of the group are counted--any shareholder
who does not own stock in all of the companies being considered is
Another key consideration is the stock attribution rule that
applies to stock owned by certain family members. A spouse is
generally deemed to own an interest owned directly or indirectly by
or for his or her spouse. However, attribution is not required if
the spouses are separated or divorced or in situations in which an
individual has no direct ownership interests in the entity owned by
his or her spouse and is not an employee, director or otherwise
involved in the management of the company.
An individual is considered to own an interest owned by the
individual's children who are under age 21. Also, children under age
21 are attributed ownership interests of parents. Because of this
attribution rule, if a husband and wife each own 100% of their own
businesses and they have a child under age 21, the child is deemed
to own both businesses. Therefore, a controlled group will exist
even if the spousal exception would otherwise apply.
In addition, when a person owns more than 50% of an entity, he or
she is deemed to own any interest owned in that entity by his or her
adult children, grandchildren, parents and grandparents.
Parent-Subsidiary Controlled Group
A parent-subsidiary controlled group exists whenever one entity
(referred to as the parent company) owns at least 80% (measured by
vote or value) of another entity. Additional entities may be brought
into the group if a chain of common ownership exists.
Example: Corporation A owns 80% of Corporations B and C, and
Corporations B and C each own 40% of Corporation D. Because
Corporation D is 80% owned by entities within the group, Corporation
D is part of the parent-subsidiary controlled group that includes
all four corporations.
The last type of controlled group is the combined group under
common control. A combined group exists if an entity is both a
common parent in a parent-subsidiary group and a member of a
brother-sister group. If this is the case, the two related
controlled groups are treated as one controlled group.
Affiliated Service Group Rules
Congress first enacted the affiliated service group rules to
address the concern that small corporations had managed to divide
management and the rank-and-file into separate entities and avoid
the controlled group rules. The rules have been expanded several
times over the years to address new avoidance schemes. Today, the
law is quite complex. There are several threshold issues that help
to identify when affiliation may exist. Except for management
services affiliation (discussed below), affiliated groups exist only
when all three of the following elements are present:
- When two or more business entities work together to provide
one service or product to the public;
- When at least one of the entities is a service organization;
- When at least some common ownership exists between the two
A service organization is an organization for which capital is
not a material income-producing factor. Generally, capital is to be
deemed a material income-producing factor if a substantial portion
of gross income is attributable to substantial investments in such
things as plant and inventory. Organizations in the fields of
health, law, engineering, actuarial science, consulting and
insurance are automatically deemed service organizations.
These affiliation rules come into play regularly in the medical
world, where there are partnerships between doctors and hospitals
that provide services in outpatient clinics, MRI testing centers and
other cooperative medical centers. In these cases, there must be
careful analysis to see if the MRI testing center, for example, is
affiliated with the doctor's medical practice or with the hospital.
Management services affiliation is defined by a much broader
rule, which essentially prohibits an executive of any size company
from separating himself from the company for the purpose of
establishing his or her own retirement plan.
Leasing of Employees
Instead of hiring employees directly, a business may lease
employees from a third party for a number of legitimate reasons.
Unfortunately, at one time, leasing of employees was also used as a
way to circumvent the minimum coverage requirements. The employer
would lease rank-and-file employees and then exclude them from plan
eligibility. Code Section 414(n) was enacted to eliminate such
practices by requiring that individuals leased on a full-time,
ongoing basis would be treated as employees for purposes of the
A leased employee is a person who provides services to the
recipient and meets all three of the following requirements:
- The services are provided pursuant to an agreement between
the recipient and a leasing organization;
- The services are provided on a substantially full-time basis
for a period of at least one year; and
- The individual's services are performed under the primary
direction or control of the service recipient.
Even if an individual is a leased employee under the above
conditions, he or she will not be treated as an employee of the
recipient if leased employees constitute no more than 20% of the
recipient's nonhighly compensated workforce and the leasing entity
maintains a safe harbor plan.
Note that leased employees do not necessarily have to be covered
under the plan, they simply have to be counted for purposes of the
The affiliation rules are quite complex. It's helpful to remember
that they were, for the most part, enacted to eliminate perceived
abuses, and any situation in which employees are artificially
separated to avoid coverage is probably prohibited. Unfortunately,
the rules can also extend beyond situations that were not originally
foreseen. With the potential adverse affects of failing to miss
these situations, it's crucial for everyone involved in the plan to
keep an eye out for hidden aggregation problems.
IRS and Social Security Annual Limitations
Each year the U.S. government adjusts the limits for qualified
plans and social security to reflect cost of living adjustments and
changes in the law. Many of these limits are based on the "plan
year." The elective deferral and catch-up limits are always based on
the calendar year. Here are the 2009 limits as well as the three
prior years for comparative purposes:
|Maximum compensation limit
|Defined contribution plan maximum
|Defined benefit plan maximum benefit
|401(k), 403(b) and 457 plan maximum elective
|SIMPLE plan maximum elective deferrals
|IRA maximum contributions
|Highly compensated employee threshold
|Key employee (officer) threshold
|Social security taxable wage base
*Available to participants who are or will be age 50 or older by
the end of the calendar year.
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