Question re QSLOB Analysis

I am looking for some insight into a QSLOB issue. My client has two business entities that are commonly controlled. One entity conducts the business operations ("Entity 1"). The other entity ("Entity 2") provides administrative support (e.g., payroll, HR, etc.) for both entities. Ideally, my client would like to offer a 401(k) plan for the employees of Entity 2. However, due to the demographics of Entity 1 and Entity 2's employees, and due to the fact they are commonly controlled, offering a 401(k) plan to only the employees of Entity 2 would likely result in coverage testing issues.

My initial thought was to have Entity 2 make an election to be a QSLOB. My question relates to the 50 employee requirement. Specifically, Treas. Reg. §1.414(r)-4(b) requires those 50 employers to "not provide services to any other separate line of business of the employer for the testing year." Am I correct in saying that, if Entity 2 made a QSLOB election, that Entity 1 would be treated as a "other separate line of business", even if Entity 1 does not make a separate QSLOB election for itself?

If the question prompts any alternative solutions that would allow Entity 2 to sponsor a 401(k) plan, I would be interested in hearing them. Thank you in advance for your time.

I think both have to claim and satisfy QSLOB and it certainly doesn't pass the smell test when you have one entity providing service to the entire control group - you can't have CG AB where A is a separate line but B is not.

Agree with Cuse. 
 

This might be helpful. 
 

https://www.napa-net.org/news-info/daily-news/case-week-qualified-separate-line-business

@CuseFan is on target with the comment about the QSLOB election. 

A QSLOB must meet certain criteria.  This includes:

• Each QSLOB must have at least 50 employees.
• Each QSLOB must:
  • Be a separate organizational unit,
  • Have separate financial accountability,

  • Have separate workforces, and
  • Have separate management.
• The employer must have filed to be a QSLOB using Form 5310-A Notice of Qualified Separate Lines of Business, that remains in effect until a filing is made to revoke the election.
• The QSLOB election applies to all members of the controlled group, and each employee of the controlled group has to be allocated to a QSLOB.  No employee can be treated as an employee in more than one QSLOB.

For each QSLOB to operate as a QSLOB each year is it must pass administrative scrutiny.  There are two ways for a QSLOB to pass administrative scrutiny.  A QSLOB can either pass the statutory safe harbor coverage test or satisfy any of five administrative safe harbors.

There is even more complexity to keeping QSLOBs compliant so it is prudent to work with someone with experience with QSLOBs.

Regarding @Cephas's second question. Entity 2 can easily have a plan covers only its NHCEs.  If the HCEs are an issue, then look to a non-qualified plan as their consolation prize.  Other structures also may be feasible, but that would require a lot more information about the demographics.

In short, Entity 2 can have a 401(k) plan that does not need to cover Entity 1 without using a QSLOB election.