Have never run into this in 30 years

We have administered a profit sharing plan sponsored by a corporation for more than 20 years. The 100% shareholder owns a large home on many acres of land. The place is so special the upkeep (including horses) requires 5 full time employees. He wants to offer and cover these 5 employees in a profit sharing plan similar to the company (that he is the 100% shareholder of) plan. He made it clear that this needs to be a separate plan.

Question: It seems like a plan can only be sponsored by an entity with earned income (sole proprietorship, partnership, LLC, LLP, corporation). In this case he is just an individual paying household employees. I don't believe an individual can sponsor a qualified plan.

Does anyone agree? Disagree? if so why?

Thanks.

Internal Revenue Code of 1986 § 4972(c)(6)(B) relieves from counting as nondeductible contributions (for the extra § 4972(a) tax on them):

“so much of the contributions to a simple retirement account (within the meaning of section 408(p)), a simple plan (within the meaning of section 401(k)(11)), or a simplified employee pension (within the meaning of section 408(k)) which are not deductible when contributed solely because such contributions are not made in connection with a trade or business of the employer.”

http://uscode.house.gov/view.xhtml?req=(title:26%20section:4972%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section4972)&f=treesort&edition=prelim&num=0&jumpTo=true

Congress enacted this, in Economic Growth and Tax Relief Reconciliation Act of 2001 § 637, to help make it feasible for an employer, even if the employer is not a trade or business, maintain some individual-account retirement plan for domestic workers.

You might advise your client about which of the three kinds of recognized plans, and which benefit structures, fit the needs and interests of the employer of the domestic workers.

For an explanation about how an employer of domestic workers might not be a part of the same § 414(b)-(c)-(m)-(n)-(o) employer as trades or businesses, even if commonly controlled by the same natural person, see Derrin Watson’s Who’s the employer? book.

Thank you Peter - very helpful

Perhaps I am wrong but it then looks like an employer of domestic workers could have a SEP or SIMPLE 401(k) for the domestic workers but employer funded contributions are not deductible to the employer but are also not considered non deductible (for the extra § 4972(a) tax on them).

So, for example, suppose an individual who happens to employ 5 domestic workers maintains a SEP for them. Suppose further that a 10% contribution was funded every year (approx. $25,000). The individual is not able to get a $25,000 deduction on his/her personal tax return correct? However, for purposes of section 4972(a) the $25,000 is not considered non-deductible and therefore not subject to penalties. Is this correct?

Thanks again.

Yes. If the domestic worker is not employed in a trade or business, for a farm, or in some other way that makes the worker’s compensation deductible, the employer’s contribution:

is allowed (within the plan’s limits),

is not an expense the employer deducts, but

does not—if within § 4972(c)(6)(B)—attract the excise tax on a nondeductible contribution.

I wonder then. Since the employer funded contribution is not deductible (income tax is paid on the contribution) I would think that distributions to participants would be either tax free or only subject to income tax on earnings. Would this be the case?

It is the employer that might lack a deduction.

The employee gets the same exclusion from income, for non-Roth contributions, that any employee gets for the kind of plan used.

Likewise, a distribution to a participant gets the income tax treatment that follows from whether the contributions were non-Roth or Roth contributions.

Dougsbpc, this is an idea that may seem like its coming from out of left field, but it may be attractive to the shareholder in this particular case. 

Has the owner considered offering a qualified small employer HRA (QSEHRA)?  Help with medical expenses may be very attractive to the employees, and any unused amount can accumulate inside the plan and be invested much like in an IRA or DC plan.  HRAs in general when used to cover medical expenses can be more tax advantageous for everyone, and the ability to include spouses and legal dependents may also be an added attraction.

Just a thought.