Question 309: Can the spouse of a limited partner in a limited parnership be treated as an employee?
Answer: Thank you for asking a fascinating and subtle question.
The issue arises because partners are not employees. So, is there some attribution rule operating here that prohibits spouses from being treated as employees?
The answer is no, for almost all purposes. Spouses of partners can be employees.
IRS Publication 15 ("Employer's Tax Guide") is fairly clear on the subject. It states, "If your spouse is your employee, not your partner, you must pay social security and Medicare taxes for him or her." It adds that a spouse's wages generally are subject to income tax withholding (but not FUTA), even in a partnership situation. Thus, it recognizes that a spouse can be an employee.
But is there something special in the retirement plan rules that would change that treatment? No. If the spouse satisfies the tests of being a common law employee of the partnership, the spouse counts as an employee for all plan purposes, such as eligibility to participate and coverage.
There's an important concept at play here that many people miss: family attribution applies only if, and to the extent that, a statute or regulation says family attribution applies.
For example, suppose my mother owns 10% of a partnership. I am an employee of the partnership. I am an HCE by virtue of my mother's ownership, which the law attributes to me. How do I know that? Because I can point to a chain of code sections that say I am deemed to own her interest. But I am not a self-employed individual or an owner-employee, because no provisions in the Code or ERISA apply attribution for that purpose.
There is one important exception, which exists because a regulation tells us it exists. DOL Regulation 2510.101-3(c) states that for the limited purpose of determining if a plan is subject to ERISA, neither a partner nor the partner's spouse is deemed to be an employee of the partnership. (The same is true of a business wholly owned by an individual or an individual and the individual's spouse.) Does that mean a spouse is not an employee for plan purposes? No. It means that a partnership plan is not subject to ERISA unless it covers someone other than partners and their spouses.
For example, suppose Jack owns 50% of a partnership as its general partner and my wife owns the other 50% as a limited partner. I am the only common law employee of the partnership. The partnership maintains a 401(k) plan covering Jack and me. The partnership's retirement plan is not subject to ERISA because it does not cover anyone the DOL regulation calls an employee. But the partnership certainly can sponsor the plan (it would file Form 5500-EZ each year), and I can participate in the plan based on my W-2 compensation from the partnership.
Now suppose the plan covers another common law employee (who is someone other than Jack's wife). With this, the plan becomes subject to ERISA. Are Jack and I entitled to ERISA protection as participants, even though we are not employees for purposes of determining if ERISA applies? Yes, according to the U.S. Supreme Court's 2004 decision in Raymond B. Yates, M.D., P.C. Profit Sharing Plan et al. v. Hendon (541 U.S. 1). In other words, the rule in DOL Regulation 2510.101-3(c) is limited to the one purpose of determining if a plan is subject to ERISA. In this case, for all other purposes, I would be a common law employee.
For a complete discussion of partners, employee status and related ERISA and qualification issues, see Chapter 2 of the new 6th edition of my book, Who's the Employer.