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Consequences of Separate Status for Partnerships; Owner-Employee Rules
(Posted March 16, 2002)
Question 141: Mr. X owns 50% of each of two partnerships. The other 50% of partnership 1 is owned by Ms. Y, while Mr. Z owns the other 50% of partnership 2. Are the partnerships under common control? If not, and both companies have a profit sharing plan, does Mr. X have a separate annual addition limit in each plan? Or are the plans aggregated relative to annual additions under the "owner-employee" rules?
Answer: No. Yes. No. But perhaps I should elaborate.
For two businesses to be members of a brother-sister common control group (or two corporations to be in a brother-sister controlled group), the same 5 or fewer individuals, estates or trusts must have a "controlling interest" and "effective control." A controlling interest is ownership of at least 80 percent of each business (disregarding persons who don't own an interest in both businesses). Effective control is ownership of more than 50% of each business when considering each person's ownership where it's least.
The last sentence can be illustrated by your fact pattern. Mr. X owns 50% for effective control purposes, because he owns at least 50% in each business. Ms. Y, however, owns 0% for effective control purposes (the lesser of 0% or 50%). Similarly, Mr. Z owns 0% for effective control purposes. Add the three together, and they still only have Mr. X's 50%. Because you have effective control if you have more than 50%, effective control does not exist here; the businesses are not under common control. A controlling interest also does not exist because X, the only person owning stock in both businesses, owns less than 80% of each.
Does X have a separate annual addition in each for 415 purposes? Absolutely, yes. Let me put it another way. Suppose I work for General Motors, Ford, and Chyrsler, and each company pays me $200,000/year. Each also covers me under a profit sharing plan with an allocation of $40,000/year. That is perfectly valid and there is nothing at all in the Internal Revenue Code to stop it. (Note to GM, Ford, Chrysler -- Are you listening? I'm available!) IRC 415 adds together annual additions from a single employer, or from businesses treated as a single employer because they are part of a controlled group of corporations (after considering Section 415(h)), a group of trades or businesses under common control, or an affiliated service group. It does not add together allocations from plans maintained by unrelated employers. And that's what you have here.
I'm not sure what you mean by the "owner-employee rules." IRC 401(d) used to have some rules aggregating plans covering owner-employees. Those were repealed years ago as an anachronistic dinosaur that didn't fit into the modern 414 scheme. Also, there was a proposed regulation under IRC 415(o) that would have added together annual additions for 5% owners, but that proposal was withdrawn in 1993 and was never in effect in the first place. At present, there are no special rules for owner-employees that would bear on this situation.
The controlled group rules are discussed in more detail in Chapters 6 through 11 of my book, Who's the Employer?. The old 414(o) regulations are discussed in chapter 15.
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