Controlled group, two sole props; what's the 25% limit

[BG5150]

We have a controlled group of husband and wife with separate business, but with a minor child.

Husband has a PS plan.  Wife adopts it.

His income is $225,000.  Her income is $25,000.  They file jointly (if that matters)

What is the deduction limit?  Is it the overall plan limit of $62,500 (225k + 25k / 4)? Or is it limited to each company separately?

In other words, can she get a PS contribution of $15,000 and can he get the balance of $47,500?

Or does it have to be $55,000 (max 415) for him and $6,250 for her?

 

 

[Larry Starr]

Derrin Watson's book Who's The Employer deals with all these issues. 

From the book:

Q 10:21 How are the Code §404(a) limitations on deductibility applied to controlled groups?   

This answer applies only to controlled groups, but not necessarily to other related employers. See Q 12:7 for discussion of deductibility in common control situations. See Q 13:24 for a discussion of deduction limits for affiliated service groups.

If two controlled group members jointly maintain a qualified plan, the limitations of Code §404(a) relating to the deductibility of contributions are applied as though all controlled group members maintaining the plan were a single employer. [Code §414(b)]

This differs from the other applications of the controlled group rules discussed above. For purposes of Code §415, for example, all employers in the group are aggregated, whether or not they cosponsor a plan. But for two employers in a controlled group to be aggregated for deducting contributions to a plan, they must both sponsor that plan.

Example 10.21.1 Nina, Pinta, and Santa Maria are all members of a controlled group. Nina and Pinta jointly sponsor a profit-sharing plan covering their employees. Santa Maria does not participate in the plan. Chris works for all three corporations, and receives $40,000 compensation from each (total $120,000). He is the only participant in the plan. The Code §404(a) limit on deductible contributions is $20,000, which is 25% of $80,000, Chris’ compensation from Nina and Pinta. His compensation from Santa Maria is excluded because Santa Maria did not maintain the plan.

Example 10.21.2 Oscar Corp and Meyer Corp are in a controlled group. They jointly sponsor a defined benefit plan and a profit sharing plan. Col. Mustard works for both companies and participates in both plans. Since they jointly sponsor the plans, Code §404(a)(7) limits the deduction to the greater of 25% of compensation or the required defined benefit contribution.

Example 10.21.3 Assume the same facts as Example 10.21.2, except Oscar Corp sponsors a defined benefit plan for its employees and Meyer Corp sponsors a defined contribution plan for its employees. Since neither cosponsors the other’s plan, the two companies are separate under Code §404. Accordingly Code §404(a)(7) does not limit the deductions. This would also be true in a common control or an affiliated service group situation.

In theory, the Code §404 deduction limit is allocated to the employers according to regulations. However, in the more than 40 years since ERISA, the Treasury has yet to take pen to paper (or pixels to screen) to compose those regulations. Absent those regulations, there is a single Code §404 limit that each employer uses.

Q 10:22 Since there are no regulations on the allocation of the Code §404 deduction limit, can one corporation deduct contributions made for employees of another controlled group member?   

Generally, no, it cannot. While Code §404 does not specify who can deduct the contribution, we must still consider Code §162.

Code §404 allows deductions for contributions to qualified plans “only if they would otherwise be deductible” [Code §404(a)] Code §162determines if expenses are ordinarily deductible by a trade or business, and Code §212 performs the same function for other expenses associated with the production of income. They both limit deductions to expenses which are “ordinary and necessary.”

The IRS has ruled it is not generally an ordinary and necessary business expense for one corporation to provide retirement benefits for the employees of another corporation, even if the two corporations are in a controlled group. There may be exceptions, but they are rare. [Rev. Rul. 69-525; Rev. Rul. 70-316; Rev. Rul. 70-532; PLR 8032079]

One such exception is termination liability payments under Code §404(g). Such payments are deductible without regard to whether the corporation making the payment employed the participants benefiting therefrom. Any member of the controlled group (or group of trades or businesses under common control) can make and safely deduct such payments. [Code §404(g)(2)] The fact that Congress felt it necessary to draft a special exception to allow the deductibility of termination liability payments by controlled group members who did not employ the participants benefiting from those payments is evidence that Code §162 otherwise bars such deductions.

A safe rule to follow would be that each controlled group member should contribute its appropriate share of the employer contribution, based on its employees and their compensation. Each member can then deduct its own contribution.

Although the IRS rulings on this point discuss only controlled groups, there is no reason to suspect a different logic applies to groups under common control or to affiliated service groups.