Question 219: John owns 10% of F Corp and 25% of B Corp. F Corp is a service organization. B Corp derives most of its income from providing employee services to F Corp. John is not an employee of F Corp. He provides services to F Corp as an independent contractor and receives a 1099. Can he be considered an HCE of F Corp for purposes of the B-Org rules under IRC section 414(m)(2)(B)(ii)? IRC 414(q) states that an "employee ... who is a 5% owner" is an HCE. Under the 414(q) regulations, an "employee" must provide services to the employer.
Answer: You've oversimplified the 414(q) temporary regulations. They say that an employee of a given employer is someone who is a common law employee of that employer, a self-employed individual treated as an employee of that employer under IRC 401(c)(1), or a leased employee of that employer under IRC 414(n). The employer includes not only the company sponsoring the plan, but also companies that are aggregated under IRC 414(b),(c), or (m). In other words, anyone that can be treated as an employee of the employer for retirement plan purposes can be an HCE if they satisfy the ownership or compensation tests. Conversely, anyone that cannot be treated as an employee of the employer for retirement plan purposes can be an HCE.
So the question is not whether John provides services. The question is whether he is an employee, a self-employed individual or a leased employee with regard to F Corp. At least on paper the answer is no. But paperwork does not always reflect reality. If he is in fact a common law employee, whether he is paid as one or not, then he is an HCE because he certainly satisfies the 5% owner requirement.
You might wish to have legal counsel review this situation to help you determine his status. Normally, finding that someone is an employee and not an independent contractor might affect his coverage, and might affect the computation of 410(b) tests. But in this case, it affects whether or not F Corp is in an ASG. That, in turn, can affect coverage of many more workers than just the one doctor. With stakes this high, it is likely prudent to have this issue reviewed by someone familiar with employee status issues.
For further discussion of employee status issues, see Chapter 2 of my book, Who's the Employer.