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Answers are provided by S. Derrin Watson, JD, APM
HCEs in controlled groups
(Posted January 27, 2003)
Question 248: Employer A is a partnership with 4 S corporations as its partners. Each S corporation is owned by a single individual. The S corporations render professional services only to the partnership. The partnership has employees and sponsors a deferrals-only 401(k) plan. Can each S corporation sponsor its own SEP arrangement for the benefit of its sole shareholder? Are these affiliated businesses? If so, must contributions be made to the partnership plan if SEP contributions are made to the S corporation plans? Must testing be done on a controlled group basis?
Answer: The five businesses are an affiliated service group, and this seriously affects what they can do.
(In analyzing this situation, I will refer to specific questions from my book, Who's the Employer. Subscribers to the web edition will be able to click and read the relevant discussion.)
Each S corporation owns an interest in the partnership. Each corporation regularly performs services for the partnership. The partnership and each corporation are professional service organizations. All the elements exist for a classic A-Org style affiliated service group. (Q 13:6.)
For almost all purposes, an affiliated service group is treated just as a controlled group is treated. (Q 13:21.) In other words, for most purposes other than deductions, all employees of ASG members are treated as though they are employed by a single employer.
What does that mean for a SEP arrangement? A SEP arrangement must cover all eligible employees of the employer. So, if any of the S corporations establishes a SEP arrangement, then that SEP arrangement must cover all employees of all 5 businesses who satisfy the SEP arrangement's age, service and compensation requirements. (Q 10:28.)
So, can each S corporation sponsor its own SEP arrangement? I guess it could, but each such arrangement would have to cover each eligible employee of all 5 businesses. There are no provisions in the Internal Revenue Code that would allow a SEP arrangement to offset benefits provided under another plan. In practical terms, it makes no sense to go with a SEP arrangement in this situation, unless you wish to set up one for the entire group.
That being the case, it makes absolutely no difference what the partnership does with its 401(k) plan. Regardless of the presence or absence of nonelective contributions to the 401(k) plan, a SEP arrangement must cover all eligible employees.
You might be interested in a presentation I am doing on controlled and affiliated service groups at Corbel's Advanced Pension Conference in Orlando on Feb. 12-14, 2003. I often speak about the rules for controlled groups. At this conference, I'll be discussing the process of analyzing a controlled group situations, so you can use the rules sensibly. At that conference I will also be discussing Rev. Proc. 2002-21, as well as new developments in the 401(k) world.
Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice
to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the
law to the particular facts of this and similar situations.
The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness
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