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Excluding Controlled Group Members from SEP


Guest Frasier Ives
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Guest Frasier Ives

Notwithstanding the cross-references in section 414(B), ©, (m), and (n) back to section 408(k), is it possible to use an individually designed SEP to limit the participation in a SEP to less than all of the employers within a controlled group? While this seems to fly in the face of a literal reading of the participation requirements in section 408(k)(2), why are the instructions on Form 5305-SEP worded the way they are in item 5 of the "When Not to Use Form 5305-SEP" section?

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No. It is written the way it is because it is the way it is written and is correct. Simply stated, if a controlled group,the form is not available "unless" all employees of the CG are eligible to participate (subect to the age and service requirments and union exclusions, and so on). Am I missing something?

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Guest Frasier Ives

I agree with you that the instructions simply provide that the IRS form cannot be used by a controlled group unless all members of the controlled group participate in the SEP. However, does it follow that an employer can use an individually designed SEP to specifically exclude certain controlled group members from a SEP without violating the statutory participation requirements? In other words, can you use the way the instructions are worded to take a position that an individually designed SEP can be drafted that limits participation in the SEP to just one member of the controlled group?

[This message has been edited by Frasier Ives (edited 07-27-99).]

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  • 3 weeks later...
Guest Paul McDonald

I do not believe that the IRS would approve an individually designed SEP that allowed for the exclusion of a member of the controlled group. To automatically satisfy the requirement that the plan may not discriminate in favor of the highly compensated, all members of the controlled group need to be included. Otherwise you could have another "SEP abuser" by structuring your controlled group in such a way as to only cover the HCEs.

SEP prototypes are required to define the employer to include all members of the controlled group, etc. Again, I can't see how you could argue that the ability to exclude one or more members of a controlled group could satisfy the requirements of Sec. 408(k)(3).

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Guest Frasier Ives

I also think it probably would not fly. If you could do it, then it would simply be too easy to manipulate corporate structures to skew benefits towards HCEs (i.e., put all the HCEs in one entity covered by a SEP, and put everyone else in another entity without a retirement plan), since there are no 410(B)-type coverage rules applicable to SEPs.

Nevertheless, I still don't understand why the IRS worded the Form 5305-SEP instructions the way they did. In particular, the instructions state: "Do not use this form if you . . . [a]re a member of . . . a controlled group of corporations (described in section 414(B)) . . . ,unless all eligible employees of all the members of such groups, trades, or businesses, participate in the SEP." If you cannot establish a SEP that limits participation to a single member of a controlled group, then the sentence in the instructions does not make a lot of sense (i.e., not only can you not use Form 5305-SEP if less than all employees of all controlled group members participate in the SEP, you simply cannot maintain such a limited SEP regardless of how you document the plan).

In contrast, however, it is clearly contemplated that individually designed SEPs (or prototypes) can be used to handle several of other situations listed in the Form 5305-SEP instructions in which the IRS form cannot be used.

Perhaps I am just trying to make a mountain out of a mole hill, but it is curious. In any event, the fact that an IRS form is poorly worded should not surprise anyone.

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Consider a situation in which a SEP is created for the unionizd employees of a component member of a controlled group. The IRS might rule favorably since there were no highly compensated employees in the group. Consider a plan that appears to violate the uniform allocation rule by the contribution of a specified amount per "hourly-paid" employee (none are HCE and all hourly paid employees only work for the adopting component). Thus, HCEs (ONLY) cd arguably be excluded by classification. But why?

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