"Non-working partner" - count as an employee?

I'm working with a partnership that is split 95%/5%.  I'm being told that the 5% partner isn't really an employee - they perform no services for the entity.  I think that I'm able to exclude them from any plan consideration, yes?

Does your answer change if I add the detail that the two are married to each other?

Thanks...

My answer would depend on how the 5% partner's income is taxed - probably as earned income and eligible for retirement plan contributions - and also how many hours this partner works (you seem to be saying 0) and finally what the plan says about hours requirements to enter and share in contributions.

Darrin Watson did a webinar on earnings from self-employment a few years back.

He stated that net earnings from self-employment (NESE) come from a trade or business in which the self-employed individual's (SEI) services are a material income producing factor. He then gives the following examples:

• Janice owns and operates a bookstore as sole prop
• Janice has never worked in the store
• Instead, she leaves everything to a hired manager
• Janice pays SE tax on her Schedule C income
• She can set up a plan for her employees, but she can’t participate she isn’t an SEI

• Sue has a successful internet consulting business
• Sue wants to make her 3 year old daughter a partner
• The daughter receives a K 1 and pays SE tax on her share of partnership income
• Daughter isn’t an SEI her services aren’t a material income producing factor

Just because a person is a partner in a partnership, that in and of itself does not make them a self-employed individual for retirement plan purposes. So I think not only CAN you exclude that person but that you MUST exclude that person as not an employee of the business.

37 minutes ago, CuseFan said:

• Janice owns and operates a bookstore as sole prop
• Janice has never worked in the store

fwiw I find these two items incompatible. "...and operates" indicates some level of involvement. I'd say it is practically impossible to own a small business and not be "employed." I don't have a problem including a 5% owner as being "employed" but would be careful about any hours requirements.

4 minutes ago, Bird said:

fwiw I find these two items incompatible. "...and operates" indicates some level of involvement. I'd say it is practically impossible to own a small business and not be "employed." I don't have a problem including a 5% owner as being "employed" but would be careful about any hours requirements.

100% agree, but I think its a terminology issue.  In this case I believe it means that the bookstore entity is a sole prop rather than the Janice performing "operational services".  

The example was probably better explained during the webcast than how it is written.  The normal functions of a small business owner are usually needed to pay the bills, which is certainly a material income producing factor...

Thanks!  And interesting side notes.  I think in my case, the 5% spouse is not even paying the bills... but I'll double-check.

I think it's pretty simple. You need to ask whether they are going to (or should) treat the 5% as self-employment income under IRC sec. 1402, which determines whether it's subject to SECA. If yes, then check the plan document, which will probably say that a person with SECA (a self-employed person or individual (SEI)) is covered and their 1402 self-employment income is their compensation for plan purposes.

Whether what the individual earns is self-employment income will depend in part on the type of partnership (general, limited, LLC taxable as partnership) and the terms of the partnership agreement.

I agree it's a very rare occurrence for a small business owner not to provide some service to their business, but there are people who simply own businesses they let someone else run.

The better example, and more relevant to initial question, is where a minor daughter is given a partnership ownership share but provides no services for the entity.