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Who's the Employer?

Question 303: John is the one of three equal general partners of a general partnership (not an LLC). The general partnership does not have any employees. Could John set up a defined benefit plan for himself? Answer: No, for several reasons. The most fundamental of these is that John is not an employer, and therefore cannot establish a plan. Let's assume that John's services are a material income-producing factor for the partnership. Why do I make that assumption? Because that is crucial to finding that John is an employee. If John isn't an employee, a qualified plan cannot cover him. There are a great many general partners who don't serve in their partnerships. These partners have net earnings from self-employment ("NESE" or SE taxable income), but they don't have earned income. NESE is earned income only if the owner's services are a material income-producing factor of the business generating the income. [Code §401(c)(2).] If a sole proprietor or partner has earned income, then he or she is a self-employed individual ("SEI"). [Code §401(c)(1)(B).] An SEI is an employee for plan purposes. [Code §401(c)(1).] That is all just a prelude to the real question here. Not to be cute, the question is "Who's the employer?" — Is it John, or is it the partnership? Code §401(c)(4) is quite clear that it's the partnership, and not John individually. If the partnership is the employer, then the partnership must establish the plan. John cannot establish the plan because the plan would cover someone who is not John's employee (John), and thus would violate the exclusive benefit rule. Now let's look at the question you didn't ask. Can the partnership set up a defined benefit plan just covering John? Because all the partners are HCEs, and there are no other employees, the partnership certainly could establish a defined contribution plan just for John, because the plan would automatically satisfy coverage. [Treas. Reg. §1.410(b)-2(b)(5).] But the partnership would be unable to set up a defined benefit plan just for John. Such a plan would violate the minimum participation rule of Code §401(a)(26), which requires, in this case, that the plan cover at least two employees. It doesn't matter whether the employees are HCEs or NHCEs. So the plan would need to cover both John and at least one of his partners.

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