Owner's spouse has wages but no hours.

[KateSmithPA]

Here's something I have not encountered before. I received the 2002 census from a plan for which our firm took over record-keeping services at the end of 2002. The owner's wife receives about $30,000 in compensation but has no hours of service. I spoke with the HR person and she told me that the owner pays his wife W-2 wages from the company but she never does any work for the company. Basically, according to this person, he pays her to be a wife and mother.

Now, I don't care whether or not this woman is paid for not doing anything. I suppose that happens all the time. However, this plan failed discrimination last year. Since the wife has no hours of service, she is not a plan participant. If she had been considered an employee last year, and if she did not defer into the plan, the plan would have passed discrimination.

I guess I am wondering, can she be credited with hours of service since she is paid W-2 wages, even if she doesn't work at the company?

[david rigby]

Does the plan require hours? If so, any reason to inhibit the plan being amended otherwise?

Alternatively, do you care? Normally, it is the plan sponsor who reports hours and comp. If you tell the sponsor, that the plan requires hours for participation/accrual, then either the sponsor can provide corrected hours data, or see above.

[QDROphile]

You should look in The Great Big Book of Everything under "F" for "fraud." The particular section you want to read carefully is how not to get involved with the fraud of another person in a way that could make you liable or subject to penalty. You are not responsible for someone else's fraud. Your responsibilities may or may not include the unfortunate opportunity to assist in perpetuating someone else's fraud and thus becoming liable in some way. Or your position may make you responsible for either correcting the fraud that you learn about or reporting it to someone else. So you need to figure out where you are in the scheme of things to know whether to be amused and carry on with proper technical execution or if your have some danger in touching this on the way by or have some obligation to take note and address the impropriety directly.

[KateSmithPA]

Well, that is actually my concern. I am not interested in committing fraud, or in turning a blind eye to somebody else's fraud. I guess I really just wondered how someone receives W-2 wages from a company if they don't actually work for that company.

[rcline46]

Consider a Domestic paid by the corp, reimbursed by the Domestic's employer (usually ower of corp!)

Not only is this legal, but since the person is not employed by the corp, the W-2 is irrelevant, and so are any hours.

Treat this as the same thing.

[mbozek]

There is no requirement that an employer must pay an employee a hourly wage or perform a specified number of hours of service. Employers are free to pay employees a flat salary or retainer pay,e.g., the employee agrees to perform services for the employer if the employer calls on the employee. The IRS has no jurisdicton over the terms or conditions of employment between the parties any more than it has jursidicton over the amount of money paid for the services. I also dont understand what is the fraud in the amount of the payments made between spouses. Since under IRC 2523 spouses can make unlimited transfers of assets as tax free gifts why can't they agree to pay a taxable salary which yields income to the IRS for some vague unspecified service?

[QDROphile]

For example, look under "Insurance" and find that some company owners put domestics and other persons on a payroll who perform no services for the company and are never expected to perform sevices for the company. They become "eligible" for group insurance benefits or cafeteria plan benefits as "employees" under the terms of the policies or plans.

The insurance companies have a copy of the The Great Big Book of Everything and have no problem denying a claim by a person who was not really an employee, as long as they can find the fraud. They have a nasty way of interpreting policy terms in the cold light of conventional reality.

mbozek raises a very good point. One must find the fraud. At one time, we found Commies everywhere and some lives were ruined for no good reason. An unorthodox arrangement is not necessarily fraud. But if one is in a sensitive position, one might have to worry about finding the fraud.

The IRS has a copy of the The Great Big Book of Everything and has even adopted for itself one of the doctrines in the Book called "form over substance.'' They trot out the doctrine only when they find it useful, such as in the case of fraud. Many retirement plan rules are expressly intended to be form over substance. Comply with the rule, everything is OK. An employment arrangement has many aspects, including many tax aspects. Can I employ my child with no substance to the employment in order to give the child the ability to have a ROTH IRA, even if I follow all the formal rules for reporting and witholding on wages? I think the IRS might object.

So what rules are you responsible for? And what rule is the taxpayer trying to beat?

[KateSmithPA]

I do appreciate all the answers, but please understand that, as far as I can tell, my client is not trying to foment fraud on the 401(k) plan. The spouse was not included in the discrimination test last year. I just wondered if she could be included due to the fact that she receives wages from the company.

[mbozek]

The regs define an employee as a person who performs services for an employer. If the employer is paying taxable wages to the spouse they must be for services, because otherwise it would be a nontaxable gift to the spouse.

[Guest Robin Vatalaro]

MBozek is right - this is from an accountant's perspective: a payment made by a business must be reaonsable and necessary in order to be deducted on the business (or sole proprietor's) tax return. Wages paid for "no services" are not deductible under the reasonable and necessary test. If there's no deduction for an "employee's" wages, then the "employee" is not actually an employee and thus should not be considered for plan participation.

[KateSmithPA]

So then, it sounds like I should continue to ignore the spouse with regard to the 401(k) plan. Whether or not she should be getting wages from the company for no services is an issue for their accountant and lawyer. Thank you all for your replies.