Small Business - Retirement plan for sole employee?

[Guest aarondc]

Hi,

I am the managing partner of a small real estate development firm. I am hiring my first employee. He told me that he got a retirement contribution equivalent to 10% of his salary at his last job. I would like to match it.

I am technically a consultant to my company. I get a fee for my services paid yearly. I then have to pay all my self-employment taxes and I'm doing a SEP-IRA. An attorney friend cautioned me that I may have some kind of liability to my new employee as far as some kind of non-discriminatory pension plan arrangement. He suggested that my new employee's pension had to be equal to mine, or something like that.

Before I make this offer, I want to make sure I'm not going to get myself into trouble. Is there some kind of regulation that I must comply with? If so, what's the best route for me to take?

Thanks.

Aaron

Washington, DC

[QDROphile]

What are the other partners doing? For retirement plan purposes, partners are treated as employees under section 401© of the Internal Revenue Code. You could already have a big mess, cowboy.

[Guest aarondc]

The other partners are silent investors. If you wouldn't mind, please tell me what big mess you think I have.

[jquazza]

There is a very prevalent misconception with partners of LPs or LLCs who think because they file a schedule C, they are self-employed and can set up a separate plan for themselves (usually a SEP-IRA or similar plan.) Since they are partners (exclude passive investors partners,) they are actually considered employees of the partnership for pension purposes and the only plan they could participate in should be established by the partnership and be subject to the coverage and nondiscrimination rules that apply to qualified retirement plans.

Now, if you're an independent contractor and get your income reported on a 1099 instead of a K-1, you may actually be self-employed and set up a plan for yourself.

As far as your employee is concerned, what kind of income does he get (w-2 more than likely) and who reports it. The entity that reports his income is the entity that can cover him for pension.

[Guest aarondc]

Well, the current plan is to give him a W-2, which we would report ourselves.

Is there a better way for a two person business to be doing what we're doing?

Thanks.

Aaron

[QDROphile]

Silly me. I would not have expected a real estate development firm to be able to conduct business without the efforts of the partners or employees. If you are the only person providing services to the firm, you don't have a big mess. You may have questions concerning who is the correct sponser of the SEP.

Once another person gets into the picture, the correct characterization of your relationship with the firm and what you are paid from the firm gets more sensitive. Your consulting efforts may be treated for retirement plan purposes such that you and the firm's employees are treated as working for a single employer. Whether or not that happens or can be avoided depends on the particular circumstances and application of the rules is not simple. You need to know your status before you can design the optimal retirement arrangement or arrangements.

[david rigby]

You need to know your status before you can design the optimal retirement arrangement or arrangements.

No doubt, this is where an attorney can help you. Some relevant issues might be here:

http://employerbook.hypermart.net/QATopic.html

[GBurns]

QDROphile,

He is the managing partner and until this new employee starts, is the only person providing service. Would he not be an employee?

But, he also stated that he is a consultant. This would make him not an employee.

Since he can't be both, is there not a mess?

Since he most likely is an employee, is there not a mess?

[QDROphile]

I observed that the issue of who sponsored the SEP (LLP or the individual "consultant") could be a problem, but that is nothing compared to the mess if anyone provided services to the LLC other than the single individual.

[Bird]

Aaron, I think you need to back up and give specific info on how you receive your compensation.

You say you're the managing partner, which implies that you receive a K-1 from a partnership, but then you say that technically you're a consultant and pay your own self-employment taxes, which makes me (and others) wonder if you get a 1099 at the end of the year.

A SEP-IRA is a nice easy plan, but there are indeed eligibility rules and non-discrimination issues that need to be addressed. You can't, for instance, give him 10% and yourself 20%...nor can you give him 10% and yourself 5% with this type of plan.

I'm also curious about where the SEP money is (financial institution).

[Guest aarondc]

I get a K-1 from the partnership reflecting X profits. I also pay myself on a 1099 a fee of Y each year. Y is much less than X.

I haven't invested in the SEP yet. I'll go down to my local T Rowe Price or whatever to do that.

Hope this helps and thanks for all the advice.

Aaron

[GBurns]

aarondc,

"I also pay myself on a 1099 a fee of Y each year". Do you pay yourself or does the partnership pay you?

Also, investing in the SEP is a separate issue from sponsoring a SEP.

[mbozek]

A-it appears that you have two streams of income- profits from your investment in the p'ship which is reported on the K-1 and compensation for services which is reported on the 1099 (as managing partner) which is paid to independent contractors. The 1099 income is the amount which is used to determine the amount of the retirement contribution which can be contributed on your behalf by the p'ship. Instead of trying to get answers on this board you should download IRS publication 560 available at www.IRS.gov. or contact your pship's tax advisor who will be aware your specific employment situation.

[Bird]

Mbozek, I think the 1099 income is the amount which will be used to determine the amount of the retirement contribution which can be contributed...by himself, no (not the partnership). (If the payment arrangements are legitimate.)

Aaron, I'm going to pass on further discussion. You need to discuss this with your tax advisor (the one who decided to pay you on both a K-1 and a 1099). I'm guessing this was done to try to separate the "passive" and "active" components. It may or may not be OK, and in fact it probably doesn't matter much from a tax standpoint, but when you start talking about retirement plans and who is the sponsor of the plan(s) it gets ugly.

[mbozek]

I dont know if a partner can also be paid as an independent contractor from the same employer. I know that the IRS doesnt like for employees to be paid as partners for the same period.

[Bird]

  I dont know if a partner can also be paid as an independent contractor from the same employer. I know that the IRS doesnt like for employees to be paid as partners for the same period.

Exactly. I don't know the whole story, but it appears that the payment arrangements are better handled without a 1099 and instead with different K-1 numbers for the active partner, perhaps representing guaranteed payments. I'm not saying it's a huge problem, but I wind up with more questions than answers.