Associate Attorney - Tax (Honolulu HI)
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|Question 297: Who can truly sponsor a plan? Or, when is an Employer really an employer? My client has a corporation that (after the owner has died) sells all of its assets (not the stock). The spouse of the deceased owner and his two adult kids simply "manage" the corporation's assets ($5 million; their wages total $500,000 per year to do that, but mostly they engage in helping poor people in Africa with no intent to make income there). Don't they need to be engaged in a trade or business? Doesn't compensation need to be reasonable?|
Answer: You've asked a lot of questions, but the real winner of the bunch is your last question on reasonable compensation. Let me reorganize your questions, if I may, and add a few of my own.
Can a corporation's activities consist of managing its funds and engaging in charitable work? Yes. There's nothing wrong with that.
Can that corporation hire employees to manage its money direct its charitable endeavors? Certainly. Nothing requires those who perform such services to receive less than the $1/year the CEO of an automobile manufacturer has offered to take as compensation.
Is such a corporation an employer of those employees? You betcha.
Can the corporation establish a plan for those employees? Yep. Any employer can set up a plan.
Does that mean an employer not engaged in a business can set up a plan? Of course, yes. Churches and other organizations have employees and have plans without having a profit motive.
Let me take an extreme case. Suppose I set up a qualified plan for my gardener (assuming my gardener is an employee). The plan itself is fine because I am an employer setting up the plan for an employee. I have a problem because my contributions are nondeductible, and are subject to the penalty tax for nondeductible contributions. EGTRRA helped by saying that if I set up a SIMPLE IRA, I wouldn't be subject to the penalty for nondeductible contributions, but EGTRRA didn't make the contributions for personal expenses deductible. But putting all this aside, nothing actually prevents me from setting up a qualified plan. It's just expensive.
So, for purposes of IRC 415 and 404, do we count as compensation whatever the corporation says is compensation? Nope. The final 415 regulations say that compensation includes "The employee's wages, salaries, fees for professional services, and other amounts received . . . for personal services actually rendered in the course of employment with the employer maintaining the plan . . . ." Not everything that is called compensation is an amount received for personal services actually rendered. For example, it's entirely possible that an auditor might find a 10% fee for managing the corporation's affairs is actually a disguised dividend. This comes up all the time in income tax audits, in fact.
Suppose an auditor found that a reasonable fee for the services actually rendered was $50,000. That would mean that the defined contribution deduction limit would be $12,500. And, by the way, the auditor should take the plan contributions and other fringe benefits into account in determining if the entire package represents reasonable compensation. (An astute reader points out that, depending on the facts of the situation, the employer may have other deduction issues under Code 162 with regard to the compensation issues, but that does not directly impact the qualified plan questions.)
Lincoln said it well, when he asked, "How many legs does a dog have if you call the tail a leg?" He then answered "Four. Calling a tail a leg doesn't make it a leg." By the same token, calling a payment salary doesn't make it compensation for plan purposes.
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.
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