Question 106: At the beginning of plan year 2000, Corporations X and Y are 100% owned by Individual A. In June of 2000, 50% of Corporation X is transferred to Individual B. Both corporations will continue to cosponsor that plan. Must X and Y be treated and tested as a controlled group for plan purposes for the entire 2000 plan year, or only for the portion of the year when the common ownership interest was high enough? For example, on a 401(k) plan, will the ADP/ACP testing be performed on a combined basis for 1/1 through 6/30 only?
Answer: Good question. I'm not sure. We have zero guidance. Let me describe to you the possibilities I'm aware of and what few things we do know.
We know that for qualified plan purposes, controlled group testing is done on a day by day basis. For income tax purposes it is different. You are a component member of a controlled group for an entire year, or you are not. If you are in the group for more than half the year, then generally you are a component member for the entire year. However, the component member rules do not apply to qualified plans, and so controlled group status can theoretically change several times during the course of a year.
Treasury and Labor regulations are remarkably sparse in dealing with what happens when a controlled group is formed, and provide even less detail when it is terminated. What we do know is discussed in more detail in Chapters 10 and 11 of my book, Who's the Employer?.
Some practitioners misinterpret IRC 410(b)(6)(C) as saying that when there is a change in controlled group status, you have a free pass of nondiscrimination testing for the current year and the following year. However, that section only applies to coverage and participation testing, not to testing discriminatory benefits under section 401(a)(4) or the ADP test.
Other practitioners argue that IRC 410(b)(6)(C) allows the testing of a plan on a combined basis for participation purposes, and therefore it can be tested on a combined basis for nondiscrimination. I'd like that to be a correct answer, but I don't think it is. The whole point of section 410(b)(6)(C) is that it doesn't require a test for participation. In fact, if coverage changed materially for one of the two employers (other than as a result of the change) my reading of section 410(b)(6)(C) is that the employer with the change could no longer use its benefits while the others would still be protected. In other words, section 410(b)(6)(C) doesn't take two currently unrelated employers and make them a single employer. It says that a plan continues to satisfy the coverage tests if the requirements of that section are met.
My thought is that you had a single employer plan until June 30, and after that point you had a multiple employer plan, requiring the filing of two Schedule T's with form 5500. On each Schedule T, you would note that section 410(b)(6)(C) lets you pass section 410(b). How would you run the ADP test? I see four possibilities:
Personally, I like answer 4, because I think it is most consistent with the statute. I would imagine that if you pass after running the three tests of level 1, no auditor would challenge you. But without doubt this is an area where we need guidance. As with all such areas where we don't have guidance, your best move is to make a reasonable effort to interpret the law and to act in good faith in a consistent manner.
- Test on a combined basis for the entire year, and on a separate basis for the entire year.
- Test on a separate basis for the entire year.
- Test on a combined basis for the period from 1/1 - 6/30 and on a separate basis after the shift.
- Test on a separate basis for the entire year. However, for the first six months, each company counts the contributions, compensation, employees, etc. of both companies, since prior to that date they were a single company.