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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

How to Handle Ex-Employees After Spinoff to Form an Unrelated Company

(Posted February 7, 2001)

Question 75: Company A, an e-business consulting firm, plans to spin off Company B, in the same business. Company A will own 20% of Company B. The other 80% of Company B will be owned by its employees (who had been employees of Company A). These individuals no longer will be Company A employees or shareholders. There are no options, and the shareholders in the two companies will be unrelated. Both companies are incorporated. Neither will perform services for the other. Can we still continue to cover these 17 employees under Company A's current 401(k) plan? Do we have to?

Answer: Let's start with the notion that after the spinoff, the two businesses are totally separate entities. You need at least 80% common ownership to have a controlled group, and you don't have that here. Because neither is performing services for the other, they are not a management function group under IRC 414(m)(5), nor a B-Org type of affiliated service group. Because both are incorporated but neither is a professional service corporation, they are not an A-Org type of affiliated service group, even if they are related in providing services to the public.

Hence, after the spinoff these 17 employees are not employees of Company A. Period. They have separated from service from Company A and are now working for a different company. As such, Company A's 401(k) document doubtless excludes them, and indeed would be forced to exclude them under the exclusive benefit rule of IRC 401 and the compensation limitations of IRC 415. Similarly, your health plan doesn't cover them (other than through COBRA benefits), any more than it covers me.

If you want to cover these individuals under Company A's 401(k) plan, you can have Company B adopt the plan and become a co-sponsor of the plan. However, if Company B does not do so, then there is no way Company A's plan should continue to cover them after the spinoff.

Probably the easiest thing to do is to let Company B adopt its own plan for its own employees.

Important notice:

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 or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.