Is a Deferred Comp plan that only covers LLC members covered by ERISA?

[Guest FAQ]

DOL Opinion Ltr 76-111 (and probably other cases or rulings since then) indicates that ERISA does not apply to a plan under which the sole owner of a trade or business is the only participant, since such a plan does not cover any "employees," citing Labor Reg. 2510.3-3©(1).

2510.3-3©(2) states that a partner is not an employee with respect to a partnership, for purposes of the definition of "employee benefit plan" under ERISA.

Facts: A startup company is an LLC taxed as a partnership and is owned primarily by a venture capital firm, but several executives own between 1% and 5% of the LLC.

Question: If one or more of the executives who own LLC interests enter into an agreement that provides for deferral of a portion of their compensation, would such an arrangement not be deemed to be an ERISA plan because it does not cover an "employee"? (Based on the regulation noted above.)

ERISA is an issue because the executives make up most of the workforce. Covering them all would pose a problem under the "select group" requirement for top hat plans. However, if anyone has seen a case or ruling that allows most of the employee population to be covered by a top hat plan (such as where everyone is management or highly compensated), I would love to see it. The highest percentage of covered employees that I have seen sanctioned is about 15% (the Demery case, I believe). Barring such a case, they need to implement a plan that would not be considered an ERISA plan, and I am hoping that a plan covering only LLC members (i.e. partners) would be such a plan.

Thanks in advance for any thoughts.

[Ron Snyder]

Members of an LLC are self-employed and are not employees. They may be covered under a Top Hat plan not subject to ERISA. Such a plan need not cover all Keys or HCEs.

[Guest FAQ]

Thanks for the reply, vebaguru.

Good point regarding the LLC members not being employees. Even though the members involved with managing the business only own between 1-5% of the company, they do have management authority and would likely be viewed as partners rather than employees (a discussion in BNA's tax mgt portfolio on LLCs indicates that individuals who own fractional interests in LLCs who do not have management powers might be treated as employees for some purposes).

The original problem was that the company WANTS to cover almost all of its managers, but since this would be most of the "employees," this would be too broad of a group under the top hat rules (assuming again that this was an "employee" rather than a "partner" setting).

BNA notes that partners can defer guaranteed payments (e.g. payments for services) via a nonqualified plan, which would allow the desired tax result while avoiding ERISA issues, as noted by vebaguru (as long as no "employees" participate in the arrangement).

This leads to the next question -- has anyone ever seen an arrangement that enabled deferral of guaranteed payments? Any thoughts on whether the LLC's operating agreement would have to address such deferrals? Whatever its form, clearly it would have to comply with the new deferred comp rules.

Thanks.

[mbozek]

The TH exemption applies to an unfunded plan established primarily for a select group of management or HCEs. Since there are no regs or binding guidance from the DOL there is no is no prohibition on covering a large portion of the highly compensated work force. The worst case scenario is that if the plan is determined to be subject to ERISA then it must be funded and terminated. The participants would be taxed on the amounts that are deferred in the trust. Any employee who elects to participate would be required to acknowledge that he understands that the plan's benefits could be paid prior to the time elected under the plan and the ee would be liable for income tax.