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Common Control and 401(a)(26)
(Posted May 28, 2002)
Question 187: Jane and her husband John jointly own 100% of Corporation J. Jane also owns 100% of the capital and 55% of the profits of JK Partnership. There are no common law employees in the partnership, and Jane is the only employee in Corporation J. Karl, the 45% income partner in JK, set up a defined benefit plan covering his schedule C income and his K-1 income from JK. Jane now wants to set up a defined benefit plan for herself, for her salary from Corporation J. Is there a problem in doing so?
Answer: There are really several questions that need to be answered here.
Can Karl set up a plan for JK? No. Karl is not the employer with regard to JK. The partnership itself is the employer according to Code 401(c)(4). Thus, if there is to be a plan covering the partnership, it is the partnership that must sponsor the plan. Moreover, based on what information you have given me, JK is not under common control with Karl's Schedule C business, so we cannot count the compensation through the back door, as it were. I strongly suggest Karl have a responsible attorney review his plan situation.
Are Corporation J and JK Partnership under common control? Yes. Just as corporation ownership is based on the greater of ownership of voting stock or ownership of value of stock, so partnership ownership is based on the greater of ownership of capital or profits. (More on this point is at Q&A 12:3 of my book, Who's the Employer.) So Jane owns 100% of JK and, thanks to attribution from John, she also owns 100% of Corporation J. Thus, those two enterprises are under common control.
Even though they are under common control, can she set up a defined contribution plan for Corporation J alone? Yes. The common control rules say that for most Internal Revenue Code purposes, all employees of either business are deemed to be employed by the other. But because there are no nonhighly compensated employees in either business, it makes no real difference. The plan will automatically satisfy Code sections 410(b) and 401(a)(4).
Even though they are under common control, can she set up a defined benefit plan for Corporation J alone? No. Because it is a defined benefit plan, Code section 401(a)(26) applies and requires that she cover both of employees of the group of businesses under common control, Jane and Karl.
For more on the consequences of common control status, see Chapter 11 of my book, Who's the Employer?
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