Who's the Employer?

Answer: No. Of course, two sole proprietorships technically couldn't be a "controlled group" because that applies only to incorporated entities, but they could be a group of trades or businesses under common control pursuant to Code section 414(c), perhaps through the attribution rules.

Either way, the answer is the same. Both IRC 414(b) and 414(c) refer not only to the controlled group rules, but also to the SEP rules and the SIMPLE rules. Thus all employees of both X and Y are deemed to be employed by a single employer for purposes of SEPs, SIMPLEs, and qualified plans. Accordingly, when the SEP rules require that all employees meeting certain requirements be covered, that includes all employees at both proprietorships.

Now, I have a question for you: you knew it was too good to be true, didn't you?

For more information on the effect of controlled group or common control status, see Chapter 10 of my book, Who's the Employer?.

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