Question 206: In an emergency medical partnership, one partner is a medical corporation. The rest of the partners are sole proprietorships. The partnership does not have any employees and has no plan. The corporation, consisting of the owner only, has a profit sharing plan. Most of the sole proprietors each sponsor a SEP. Each partner dervies 40-85% of his income from the partnership. Is this a problem?
Answer: Yes, from several standpoints. Let's focus first on the sole proprietorships.
The IRS entity regulations describe a sole proprietorship as being disregarded as a separate entity. Thus, it is not the sole proprietorship that is the partner. Rather, each individual doctor is the partner.
Why does this make a difference? For one thing, income from the partnership should flow to each partner's Schedule E. The only thing that should be on the partner's Schedule C is that partner's outside income.
Accordingly, for a SEP sponsored by a sole proprietor, you are only counting the sole proprietorship income, not the partnership income. So, for example, suppose a sole proprietor had $30,000 of Schedule C income (after considering 1/2 of self-employment tax) and $200,000 of partnership income. The maximum deductible SEP contribution would be $6,000. The self-employed person rules are very clear that the partnership is the employer of its individual partners, and that it must establish any plans for those partners.
Although this isn't true, just for a moment let's explore this from the other angle. Pretend the proprietorship really is the partner, and so the income flows to Schedule C. In that case, the proprietorships would be in an affiliated service group with the partnership. As such, each SEP would have to cover each doctor and all of their employees, if any. Any way you call it, the SEPs are likely in trouble.
Now let's look at the corporation. It is clearly in an affiliated service group with the partnership. Thus all employees (or deemed employees) of the partnership are treated as employees of the corporation, including all the other doctors. The first thing you need to check is the corporation's plan document to make sure it doesn't automatically cover those employees. If it is a standardized plan, it likely does. Next you need to run your coverage testing on a combined basis. Fortunately, it doesn't sound like you have any NHCEs, so that should not be a problem.
Entity rules are discussed in chapter 1 of my book, Who's the Employer. Affiliated service groups are discussed in chapter 13.