The Noninvolved Spouse Exception to Attribution

[Oh so SIMPLE]

A new client is a sole practicing MD with 11 employees. He has a side business that provides some sort of medical assessment and referral services, but does not treat patients. He is by independent contact with the side business the 'medical consultant' that answers questions as they arise and reviews all notes generated by the two very young staffers (24 and 27). His wife manages the side business.

The MD would like to transfer all ownership in the side business to his wife, and then beginning the next year implement a DB plan for just the side business. If the medical practice employees come into play, the plan would not meet minimum coverage. That's the reason for transferring to her the ownership of the side business.

In looking over section 1563(e)(5) and regulation 1.414©-4(b)(5), one of the requirements for no spousal attribution is that neither spouse be 'a member of the board of directors, a fiduciary, or an employee' of the entity owned by the other, and not participate in the management of the entity owned by the other.

The client has an opinion letter from a noted ERISA attorney to the effect that she is unaware of any case law or IRS ruling that clarifies what is meant by management, and would not therefore opine on whether the medical consulting would be 'management' except to say that if tried, the medical consulting should be reduced to a written agreement and closely limit what specifically the MD is doing, avoiding any business management involvement or decisions.

My first question is whether anyone knows of any IRS or court pronouncements that defines or clarifies what is mean by "management" in this rule? Would it extend to this situation?

The other issue is whether the noninvolvement exception to the spouse being deemed an owner of the other spouse's busniness woul be possible in light of the fact that the MD and wife have a son who is just 16 years old. Derrin Watson has cautioned here (see ##3 and 4, and sentence after 4, in particular) that by single family attribution of the medical practice from the MD to his son, and single family attribution of the side business from the wife to her son, the son is deemed to own 100% of both the sole proprietorship and the side business and then the two would be a control group. The ERISA attorney's opinion letter cited Derrin's comments, noting in the opinion letter that Derrin is renowned as THE expert on this issue, but that the ERISA attorney could find no court or IRS ruling on point and that this seemingly thwarts the noninvolved spouse exception to attribution between spouses.

My second question is whether anyone knows of any IRS or court rulings that define or clarify whether the parent-to-child attribution could be done simultaneously from both the father to the under-age-21 child and the mother to the under-age-21 child where this would prevent the purpose of the noninvolved spouse exception?

[Guest Sieve]

I do not know of any cases or IRS pronouncements on either of the issues you raise (although I recall someone mentioning that the minor child attribution issue was addressed by the IRS at an ASPPA conference once, but I may be wrong).

But, I would raise 2 issues to consider:

• Have you addressed potential affiliiated service group issues?
  
• Will the wife have unlimited power to dispose of the stock in the side business, or will there be "conditions which substantially restrict or limit [her] ability to dispose of [the] stock and which run in favor of [husband or their child] . . ."? If the latter, then there still will be attribution to husband. (See IRC Section 1563(e)(5)(D).)
  

[PensionPro]

You should also consider the impact of state laws regarding community property in your analysis.

[Oh so SIMPLE]

I appreciate your inputs. The ERISA attorney's letter addresses the c/p issue, but the transfer contemplated to the wife will include a gift of the MD's c/p interest in the ownership of the side business to be wife's separate property. The wife will be gifting away her c/p interest to be the MD's separate property an amount of other assets equal to the value of the ownership of the side business that she will be receiving as her separate property. There will be no restrictions on the wife's ability to dispose of the ownership interest in the side business.

The ERISA attorney's letter also addresses the ASG issue but concludes it is not a factor because the side business and the medical practice have <1% of the same clientele, when measured from either direction, the type of services that the side business provides are not those typically provided by an MD's medical practice, and neither the medical practice nor the side business provides any services to the other.

The ERISA attorney's letter seems pretty comprehensive and even makes sense (!). She did identify the two vulnerabilities that I touched on in the OP, and I was hoping that there might be some case law or IRS having addressed these issues informally, such as reported in the Blue or Gray Books. Sieve mentioned maybe having heard the IRS address the child attribution issue at an ASPPA conference. Does anyone else having any sort of recollection or maybe know some details?

The ERISA attorney suggested in her letter that the client make an application for a private letter ruling on the two issues identified as vulnerabilities.

[PensionPro]

1999 IRS Q&A

Larry Starr and Criag Hoffman met with Mr. James E. Holland, Jr., Chief, Actuarial Branch 1, and Mr. Richard J. Wickersham, Chief, Projects Branch 3 of the Internal Revenue Service. The meeting took place in Arlington, VA on October 19, 1999.

The purpose of the meeting was to provide Mr. Holland and Mr. Wickersham with questions which were submitted by members of ASPPA. It is intended that the responses or deferrals to the questions provide the basis for discussion at the 1999 Pension Actuaries and Consultants Conference during the IRS Question and Answer session. The answers reflected in this presentation are Larry Starr's and Craig Hoffman's interpretation of Mr. Holland's and Mr. Wickersham's responses, and not direct quotes. They are intended to reflect as accurately as possible the statements made by the government representatives. This material does not represent the official position of the Internal Revenue Service, the Treasury Department, or any other government agency; nor has it been reviewed or approved by the Service or Treasury.

82. Man and woman each own a non-affiliated business and they have a child together. Does this mean that their non-controlled group is now controlled under 1563 (e) (6) and will be controlled until that child turns 18? - therefore never have children under 18?

That is correct - never have children under the age of 18!

[i thought it was supposed to be age 21 not 18, but this is the quote].