DB (Schedule C income) and DC plan participation

[Guest MTransue]

I have a client (husband and wife) who owns 100% of a company. They currently have a SEP plan, but considering a profit sharing plan.

As employees of this company, the husband and wife receive salaries, and would be eligible for the profit sharing plan.

Independent of the company and unrelated services, the wife receives $50K during 2004, and it will be included on her Schedule C income tax return.

Can the wife participate in BOTH the company's profit sharing plan AND in a DB plan associated with her Schedule C income?

[Blinky the 3-eyed Fish]

Yes, but the 404(a)(7) deduction limits will come into play, as the company and the wife's sole proprietorship are part of a controlled group.

[SoCalActuary]

If the wife was not an employee of the company, not an officer, not a director, and the state was not community property, maybe you could have independent plans.

This also requires that her business is her sole and separate property. Did her business get started with any community assets? If so, it probably is joint property also.

That said, the separate DB might still be valuable as a way to use up part of the 25% limit. However, you have to test both plans together for discrimination, including the 40% coverage rule for the controlled group. Instead, I would recommend a combination of profit sharing and a cash balance DB plan covering both entities.

[Blinky the 3-eyed Fish]

Why cash balance?

[SoCalActuary]

Consider a PS contrib of 5% plus CB contrib of 2.5% for all NHCEs. The look for the max CB benefit that passes the general test for the two owners. This meets TH mins, looks like a 7.5% PS to employees, allows 40% + coverage percentages for a26, and gives maximum discrimination.

It is harder to control ee costs in a traditional DB.

[JAY21]

Yeah, but can you get a IRS determination letter on the cash-balance plan in any sort of reasonable time frame, if at all these days ? I like the idea, but I don't believe there are any cash-balance Volume Submitter/Prototype plans out there (to my knowledge) so I'd definitely want an IRS determination letter, but wouldn't know what to tell the client on the approval wait at this point.

[SoCalActuary]

New CB plans without the conversion issue are able to get FDLs. Accudraft has CB as a modification of their VS doc, with easy use. However, it is still individually drafted, with the higher costs.

I tell clients that it is worth the extra cost.

[WDIK]

Are there employees other than the husband and wife in either entity?

[JAY21]

SoCalActuary, what is the turnaround times you have been seeing on getting a FDLR on cash balance plans (with no conversion issues) ?

[SoCalActuary]

No recent experience. My last one was approved in the normal 5-8 months of other plans.

[Blinky the 3-eyed Fish]

I too have had no longer time getting a determination letter for a new cash balance plan that any other plan. But I think we are getting off the beaten path here, because in this case the higher costs aren't worth it because there are no other employees that I can see from the original post. If there were other employees, then there would be no cost for the determination letter as the plan would meet an exemption from the user fees.

To further off the path, be careful to meet the gateway requirements SoCal. 5% in the DC and 2.5% in the DB will not meet the 7.5% minimum for all employees.

[Guest MTransue]

The $50K income is from an unrelated company which she has no ownership. It was income from financial consulting.

The company she received the $50K and the company owned by her and her husband are not related.

With that said, can she participate in the (assumed) profit sharing plan AND a DB plan associated with your $50K income?

[Blinky the 3-eyed Fish]

Sure the $50K is paid from an unrelated company, but it is being recognized as income to her sole proprietorship. The sole proprietorship IS a related entity with the one owned by her and the husband.

Now if she were an employee of the unrelated company and earned the $50K as an employee (which you already said she wasn't), then the unrelated company could have a pension plan that would not be considered with the husband and wife's plan.

[Lame Duck]

If she is an employee with the company that paid her the $50,000 and the company sponsors a DB plan, she would be able to participate to the full extent. There would be no controlled group issues arising. However, your original post referred to her reporting this income on her Schedule C, which is the income tax filing form for a sole proprietor. She would own 100% of the sole proprietorship and would have 100% ownership of the other business through attribution. (See 1.414©-4(b)(5)) Since both businesses are owned 100% by the same person, they constitute a controlled group and benefits must be aggregated under the plans. The deductibility rules for combined DC and DB plans under 404(a)(7) would be applicable. As SoCalActuary points out, if she was not an employee of her husband's business, she might qualify for the spousal exception. That doesn't appear to be the case, since you specified that the wife is an employee of the business.

[SoCalActuary]

The jointly owned company has at least two employees (him & her), but who else? A good design has to pass discrimination testing, but only if there are NHCE's to test. Are there any?

[Guest MTransue]

The husband and wife's company has a half dozen employees. I don't know how many employees the other company has that the wife performed consulting services.

If she has Schedule C income how does that make her a 100% owner of the company that she performed consulting services? (Lame Duck reply)

[Blinky the 3-eyed Fish]

If she has Schedule C income how does that make her a 100% owner of the company that she performed consulting services?

It doesn't (you misunderstood Lame Duck's reply, as he wasn't saying that at all). Is she an employee of the company that paid the consulting fee or not? Like I said before, you already said that the wife will have the $50K she earned flow into her sole proprietorship. That means that she is being paid as an independent contractor. Thus, in effect she works for the sole proprietorship. The sole proprietorship is the "store" and the company that paid the $50K is the customer. The business that is sponsoring the proposed retirement plan is the sole proprietorship. She is 100% owner of the sole proprietorship.

Now SoCal's comments have much more relevance in that you need a good plan design. Adding a DB plan is going to have costs to the staff employees of the jointly owned business.