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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

Trustees as Managers

(Posted August 15, 2001)

Question 119: Individual A is the income beneficiary of a trust ("Trust") and his adult daughters ("B", "C" and "D") are the remainder beneficiaries. A, B, C and D each have established 100%-owned corporations, which are designated as trustees for the Trust. Each corporation then annually receives trustee fees and employs the owner as its only employee. A, B, C and D are required to perform trusteee functions such as attendence at trustee meetings, etc. The corporations do not have any other functions than as stated above. The trust makes investments and has employees. The trust is under common control with Corp A. Are the trust and the four corporations an affiliated service group? Are the corps service organizations? Capital is not a material income producing factor for them. How about the trust? It would seem ridiculous if it was considered a service organization.

Answer: It is true the corporations are service organizations. Capital is not a material income producing factor. Although I don't know what business the trust runs, from its investments and activities it appears that capital is a material income producing factor for the trust. Let's assume so, and we'll assume the trust is not practicing in the fields of health, law, accounting, consulting, insurance, actuarial science, performing arts or engineering (which would automatically make it a service organization).

If capital is a material income producing factor for the trust but it is not in one of those fields, then it is not a service organization. As such, it cannot be a FSO or an A-Org. It could be a B-Org. But the trust does not provide employee services to the corporations, and so it is not a B-Org. Accordingly, the trust is not in an ASG with the corporations.

Are you out of the woods? Not by a long shot.

Let's start by asking whether the trustee fee that is being paid is reasonable. If not, then it looks a lot more like a gift from the father to the daughters. In any event, it would not be deductible by the trust. Moreover, it would call into question the reasonableness of the salary paid to the daughters, which would affect both the deductibility of their salary and the plan contribution. All of this is based on the amounts involved and the work actually done. Paying $1,000 to attend a meeting or two won't raise any eyebrows. But paying $50,000 would be highly suspect.

More to the point, what are the corporations doing? They are providing trustee services to the trust. And what does a trustee of a trust do? The trustee manages the trust. Hence each corporation appears to have, as its sole business purpose, the provision of management functions to the trust, and arguably is part of a 414(m)(5) management function kind of affiliated service group along with the trust. Though it's possible the IRS might accept that they are like outside directors (not really managing), the point is far from certain. I would not even consider establishing a plan for the daughters' corporations without receiving a determination letter from the IRS regarding ASG status.

These issues are discussed in more detail in Chapter 13 of my book, Who's the Employer?.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.