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Answers are provided by S. Derrin Watson, JD, APM
Domestic and Business Not Aggregated
(Posted July 15, 2002)
Question 214: My client has a professional practice as a sole proprietorship, with a defined benefit plan. He also has several domestic employees: gardener, housekeeper, nanny, etc. He is concerned about the domestic employees and wants to do something for their retirement, but he doesn't want to include them in the defined benefit plan. I'm concerned about whether I need to count them in the plan regardless. What can we do?
Answer: Fortunately, this is an issue which became somewhat more clear after EGTRRA, especially since it added an important tool for these situations.
One of the real problems of covering the household workers under the sole proprietorship defined benefit plan is that the contributions for those workers will be nondeductible, just as the salaries for those workers are nondeductible. Because they are nondeductible, they are subject to the 10% penalty tax on nondeductible pension contributions.
With EGTRRA, Congress realized it didn't want to discourage people from providing retirement benefits for their household workers, at least to the extent of paying a penalty tax for the privilege. So IRC 4972(c)(6)(B) was passed, which allows your client and those like him to set up SIMPLE 401(k) plans or SIMPLE IRAs covering domestic employees without paying the penalty tax. This only applies to SIMPLES; it not does apply to SEPs or to other types of 401(k) plans, even safe harbor plans.
In passing this addition, the House Committee Reports include this fascinating discussion:
I have long contended that the household workers do not need to be counted in the business plan because the common control rules of IRC 414(c), which would aggregate the two, are inapplicable. IRC 414(c) only applies to trades or businesses; the household employees are not employees of the trade or business. Congress not only implies that my reasoning is correct, but also adds that the plan for the domestic workers need not take the business employees into account.
As under present law, a plan covering domestic workers is not qualified unless the coverage rules are satisfied by aggregating all employees of family members taken into account under the attribution rules in section 414(c), but disregarding employees employed by a controlled group of corporations or a trade or business.
The bottom line is that your client should be able to continue his defined benefit plan covering only his business employees. The household employees do not need to be counted in determining whether than plan satisifies the coverage and participation requirements of the law. In addition, your client should be able to establish a SIMPLE IRA or a SIMPLE 401(k) covering only the household employees, ignoring the business workers. Obviously, the client himself would only participate in the defined benefit plan.
This is discussed with additional examples in the forthcoming third edition of my book, Who's the Employer.
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