Who's the Employer?

Answer: Well, you had better become sure because a lot rests on that issue. Let's run through basic principles:

1. HCE attribution is based on IRC 318, the same system used to determine affiliated service group ownership.

2. Under IRC 318, Mary is deemed to own whatever John owns and vice versa.

3. Under IRC 318, John's parents are deemed to own whatever John owns and vice versa.

4. Under any of the attribution systems, double family attribution is prohibited. Hence, stock ownership cannot be attributed from Mary to John to John's parents.

5. An employee is a highly compensated employee (HCE) if that individual owns or is deemed to own more than 5% of the company.

6. If an asset is community property, then each spouse owns half of the asset, regardless of how the title of the asset appears. (Of course, the title may indicate that it is the separate property of one party, but that is not necessarily determinative.)

So, with these principles, let's see what happens if the stock is John's separate property. John owns more than 5% of the company and is an HCE (rule 5). By rule 2 above, Mary also is an HCE. By rule 3 above, John's parents also are HCEs. This is straightforward.

Now let's see what happens if the stock is John and Mary's community property, notwithstanding the fact that the title of the stock does not reflect community ownership.

A. John directly owns 5%. Mary directly owns 5%. This follows from rule 6.

B. John is deemed to own Mary's stock and vice versa. This follows from rule 2. Hence John and Mary each are HCEs.

C. John's parents are deemed to own John's stock by rule 3. John's parents are not deemed to own Mary's stock by rule 4. Hence John's parents each are deemed to own exactly 5% of the stock.

D. Therefore, John's parents are not HCEs because they do not own more than 5% of the stock.

The bottom line is that, in terms of determining HCE status of John, Mary, or those who are children of both of them, it doesn't matter whether one owns the stock separately or whether it is community. But in terms of attribution to parents it makes a huge difference.

Let's change the facts just a little. Let's say John has 20% of the company, and that Mary's parents also work at the company. Regardless, John and Mary are both HCEs. Regardless, John's parents are HCEs, because whether it is separate or community they own more than 5% by attribution from John. The difference now is Mary's parents. If the stock is John's separate property, Mary's parents are not deemed to own any of it. If it is community property, then Mary actually owns 10% of it and Mary's parents are deemed to own her 10% and thus to be HCEs.

The IRC 318 attribution rules are discussed in detail in chapter 14 of my book, Who's the Employer?.

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