Single member plan excludes employees in the controlled group

[katieinny]

A single member LLC set up a DB plan about 7 years ago. He owned other businesses, but his investment advisor told him that since those businesses weren't related to his LLC, he did not have to include the employees of those businesses in the plan. Fast forward seven years, and the employer discovers that there is indeed a problem. Financially, it makes more sense for us to do a VCP application under the premise that the plan was never qualified from day one. There would be 1041s filed for the taxable trust, and amended personal tax returns for the client. The plan document does not automatically bring in employees of a related business. It says "Furthermore, with respect to a Non-Standardized Adoption Agreement, Employees of an Affiliated Employer will not be treated as "Eligible Employees" prior to the date the Affiliated Employer adopts the Plan as a Participating Employer."

My question is should we be concerned that the IRS might refuse to allow the plan to be disqualified, and instead force the employer to go back and cover those employees from the beginning? Since there's nothing new under the sun, perhaps someone has run into a similar scenario?

[jpod]

If documentation is in order, and employees of even 414(b), © and (m) entities are excluded, neither IRS, DOL nor anybody else can force you to cover them.

No need to bother with VCP if client wishes to fall on its sword tax-wise, in fact I don't know what IRS would do with such a submission, other than reject it I suppose.

[KJohnson]

I had this once but caught it within period to actually seek the original determination letter asking for the plan to be considered disqualfiied. With the remedial amendment period for pre-approved plans like it is I don't know if you might be able to still qualifiy for that even at this late date. Most documents have language mirroring Rev. Rul. 91-4 allowing return of contributions upon receipt of an initial adverse determination. Without such a determination the fear might be the excise tax on a DB reversion.

[katieinny]

jpod -- you were right -- it was rejected.

[kerry]

katieinny,  I hate to resurrect such an old topic, but I'm curious of what the outcome was.  I'm not seeing too much information online about excluding employees by setting up a single member llc.

[My 2 cents]

It is my understanding that if they don't pass the separate line of business testing requirements, coverage, participation, etc. must be passed on a controlled group basis.  If a person owns and LLC and one or more other corporations, that makes it a controlled group, and just providing benefits under the LLC is probably going to fail.

[kerry]

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Thank you for the reply.  I'm wondering if there are any resources pertaining to this topic.  I'm specifically looking for a documented case where an employer set up an LLC in someone else's name, then funded a cash balance plan and excluded employees from the already established business. 

[Mike Preston]

Are you looking for proof that it doesn't work such as a documented case where somebody got caught and went to jail for fraud?

[kerry]

I didn't think the penalties would be that harsh, but sure.  I'm looking for a documented case(s) where an employer thought he could simply get a tax break by setting up a separate LLC in someone else's name so he would not have to run the cash balance plan through his main business.

 

[Mike Preston]

Yes, the penalties would be that harsh.  I've never seen a documented case as you describe.  I'd like to think that nobody is stupid enough to try it.

[kerry]

We are trying to discourage this from happening, but there are other advisors saying there should be no problem with this. 

In the meantime, I'm reading about codes 414b, c, m that are in place to "prevent employers from setting up multiple entities to avoid paying certain employees benefits they normally would have to pay"