Question 66: Company A is owned 50% by Employee 1 and 50% by Employee 2. They're the only employees. Company B uses Company A for manufacturing and distribution. Company B is 100% owned by Empoyee 1 and employs 100 employees. Company A sponsors a 401k plan; Company B sponsors a SEP arrangement, contributing the maximum amount for its two employees. Does the tax code prohibit this arrangement?

Answer: No.

The two companies aren't a controlled group, assuming the two employees aren't related, and there are no options, rights of first refusal, or other matters which would give rise to attribution or exclusion. Employee 1 owns 50% of A and 100% of B, and his effective control percentage is 50%. Employee 2 owns 50% of A and 0% of B, and so his effective control percentage is 0%. Add the two and you get 50%. That is not greater than 50%, and so effective control does not exist. (There isn't a controlling interest either).

Because your situation deals with manufacturing, presumably both companies are dealing with a product of some kind, and in both cases capital would be a "material income-producing factor." That being the case, neither would be a "service organization" (even if they are in the fields of law, health, consulting, insurance, etc.) and neither could be the "first service organization" of an affiliated service group. You don't say that either is providing management functions, so a management function group is out.

Incidentally, notice the number of assumptions I had to add to answer this question. If I were doing this live for a client, I would want to determine for sure whether these assumptions are correct.

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