S corps, General Partnerships, and 401(k) Withholding

Let me begin by giving a bit of background:

My understanding is that 401(k) withholding  - also called the employee deferral - max of $19,500 in 2020, must be withheld from a paycheck. That is the gross wages must be high enough so that when the withholding is taken out, there is enough left for a net check that is $0.00 or higher than zero.  For example, I have a doctor group of S Corps who have a partnership. The S Corp /Doctors have salary schedules. They front load their 401(k) withholding in January/February of each year because they can - their cash flow is high enough to allow this.  In order to do it, we have to increase the gross wages to accommodate the withholding of the 401(k) deferral. My understanding is that the law requires the gross wages to be included in this situation so they can collect social security & medicare on those wages. I have had 2 pension “experts” tell me this over the last 10 years.

Recently, the law firm’s pension administrator (internal admin person, not a lawyer) said that the law firm’s policy is to treat all partners the same with respect to 401(k) withholding, and that is to withhold it from their “compensation” - in this case, since the entity is a partnership, the compensation is in the form of guaranteed payments as required by IRS rules.  Partners cannot receive W-2s from the partnership if they are more than 2% owners. They must receive guaranteed payments (GP). GP are subject to “self-employment taxes” if the partner is an individual. But when the partner is an S Corp, there is no self-employment tax at the S Corp level. The S Corp must pay a reasonable salary to the shareholder, but if the shareholder does not take any money out of the S Corp that year, the IRS would not receive any social security or medicare taxes on that “compensation.” It is my understanding that this is therefore NOT an allowable approach when the partner is an S Corp - withholding from GP to take the 401(k) employee deferral of $19,500.00.

 My question is the following:

Were both of the “experts” incorrect, and in fact, the law firm is allowed to handle this the way I stated above, when the partner is an S Corp - withholding 401(k) employee deferrals from GP? Or are they correct and what should happen if the S Corp should have a salary schedule that includes gross ups sufficient to allow for the 401(k) withholding to be paid that way?

Let me see if I understand this correctly - please tell me if I'm wrong

There is a partnership (is this an LLC taxed as a partnership?). The partners(owners) in the partnership are the S-Corps. And then each Doctor owns an S-corp. Income from the partnership is paid/reported to the individual S-corps as partners. 

Which Entity sponsors the retirement plan?

Are the S-corps participating employers in the plan? 

If the S-corps are participating employers, then each Doc should be receiving W-2 compensation from their individual S-corps, and it is that compensation that the deferrals should be processed from. 

1 hour ago, justanotheradmin said:

If the S-corps are participating employers, then each Doc should be receiving W-2 compensation from their individual S-corps, and it is that compensation that the deferrals should be processed from. 

It's kinda hard to follow but I think this gets to the heart of it. and is probably (?) what is happening.

If you (Chris123) are saying that the 401k withholding is coming from partnership income that is really going to an S corp(s) then that is problematic.  The confusion comes because you seem to be describing a scenario where withholding is in fact coming from S corp W-2s, but the pension person is describing something else.

It might help if we knew your role in this.

There is a partnership (is this an LLC taxed as a partnership?). The partners (owners) in the partnership are the S-Corps. And then each Doctor owns an S-corp. Income from the partnership is paid/reported to the individual S-corps as partners.

THE ONE IN QUESTION IS MORE LIKELY AN LLLP PARTNERSHIP. SOME OF THE PARTNERS ARE INDIVIDUALS, SOME ARE LLC/ CORPORATE S CORPS. THE TWO INDIVIDUALS I AM CURRENTLY ASSISTING ARE BOTH S CORPS/P.A.’S PARTNERS IN THE LLLP LAW FIRM.  YES THE PARTNERSHIP ISSUES THE S CORPS K-1S, REPORTING GUARANTEED PAYMENTS (THEY DO THIS ALSO FOR INDIVIDUAL PARTNERS WHO DO NOT HAVE S CORPS SET UP).

Which Entity sponsors the retirement plan? 

LLLP/LAW FIRM - HAVE TO, UNDER THE AFFILIATED SERVICE GROUP RULES.

Are the S-corps participating employers in the plan?

 I AM NOT SURE OF THE TECHNICAL TERMINOLOGY HERE. I DO KNOW THAT THEY S CORPS ARE PARTICIPATING IN THE PLAN, BUT THE WAY I UNDERSTAND IT IS THE LLLP MUST TAKE INTO ACCOUNT THE W-2 ISSUED TO THE S CORP OWNER, AS WELL AS AN ESTIMATE OF THE INCOME ALLOCABLE TO THE S CORP, WHEN DETERMINING TOTAL COMPENSATION AS IT RELATES TO THE CASH BALANCE PLAN CONTRIBUTION LIMITATIONS, ETC.

If the S-corps are participating employers, then each Doc should be receiving W-2 compensation from their individual S-corps, and it is that compensation that the deferrals should be processed from.

SEEMS LIKE YOU ARE CONFIRMING WHAT I HAVE BEEN TOLD BY 2 OTHER PENSION ADMINISTRATORS. 

IT SEEMS TO ME THAT THE LAW FIRM IS DOING THIS WRONG WITH RESPECT TO ALL OF THE P.A./S CORP PARTNERS, BY WITHHOLDING FROM THE GUARANTEED PAYMENTS, RATHER THAN HAVING THE EMPLOYEE DEFERRAL COME OUT OF PAYCHECKS ISSUED BY THE S CORP, WHERE SOC SEC AND MEDICARE CAN BE WITHHELD AND REMITTED. THAT’S MY UNDERSTANDING AT LEAST.

I GUESS THE QUESTION NOW IS ARE THERE ANY EXCEPTIONS TO THIS? THE LAW FIRM SEEMS RETICENT TO CHANGE POLICY OR EVEN ADMIT THAT THEY ARE DOING THIS WRONG. MY CONCERN IS IRS GOING AFTER VERY SUCCESSFUL PARTNERS (AND THE LAW FIRM PARTNERSHIP) AS I HAVE ALREADY SEEN THAT HAPPEN TO HAVE A DOCTOR GROUP PARTNERSHIP WITH INSUFFICIENT PAPERWORK (BEFORE I WAS INVOLVED) RESULTED IN IRS FINE OF $2,500.00 (ALTERNATIVE WAS TRIGGERING $3 MILLION IN ORDINARY INCOME FROM REVOKING COMBINED TOTAL OF ALL DOCTOR SEP IRA’S STATUS). THEY PAID THE FINE.

@Chris123 If an S-corp is the partner, then any guaranteed payments are technically going to the S-Corp. The S-corp can't elect personal deferrals. Only a human person can. So no deferrals should occur from guaranteed payments (or year end income) going to an S-Corp. I think that's the crux of the issue. 

If an actual person is the partner - then yes, deferrals can generally occur from guaranteed payments. Those are self-employment income, and the person can elect to defer from them. 

If the S-Corp pays their owner W-2 compensation - that compensation MIGHT be eligible for deferrals/ contributions etc.  When we ask if the S-corp is a participating employer in the plan, we mean does the plan's legal document specifically cover (usually by name, often times it gets it own page in the doc under a participating employer heading) that S-Corp.  Plan documents are drafted different ways, so it's hard to know without seeing it if the S-Corps are included or not. 

If the S-Corps are participating employers, great. The W-2 employees of those entities (such as the Docs receiving W-2 comp from those entities) count for plan benefits. If the S-Corps are NOT participating employers, the compensation wouldn't count (but there are lots of exceptions like if a person is paid W-2 wages from both the plan sponsor and the associated S-Corp). 

There are lots of special rules for related employer groups (control groups, affiliated service rules, etc) and different types of compensation (self-employment vs. W-2) is treated differently as well. Way too much to get into here. 

If you want to push the law firm on the issue- I would ask for copies of the K-1s. Anyone with deferrals should either have a K-1 in their name directly (not their S-Corp entity), or a W-2 in their name showing the deferrals in Box 12. 

I don't really have full answers, just observations. This all assumes that there are no non-partner/spouse employees

I have only seen this construct when it is entirely a partnership of corporations. In that case the partnership does not have a 401k plan. Rather each corporation has the option of adopting a 401k plan. Having individual partners complicates this, because individual partners are not employers and are not eligible to adopt their own 401k plan. Only the partnership is eligible to adopt a 401k plan. Basing employee deferrals and employer contributions only on guaranteed payments limits employer contributions

My guess is that the partnership adopting the the 401k plan and having guaranteed payments to all "partners" was an attempted workaround to allow individual partners to have access to a 401k plan. However in the case of the S-Corps, they are the partner and the S-Corp 2% shareholder-employees are not partners and I don't see how they are eligible to participate in the partnership's 401k plan.

It would seem to me that the best solution is for the entirety of the partnership's partners to be S-Corps or the entirety of partnership's partners be individual partners. In the latter case, the full self-employed income earned income will be the basis for employee deferrals and employer contributions.

On 2/21/2020 at 3:45 PM, Chris123 said:

THE WAY I UNDERSTAND IT IS THE LLLP MUST TAKE INTO ACCOUNT THE W-2 ISSUED TO THE S CORP OWNER, AS WELL AS AN ESTIMATE OF THE INCOME ALLOCABLE TO THE S CORP, WHEN DETERMINING TOTAL COMPENSATION AS IT RELATES TO THE CASH BALANCE PLAN CONTRIBUTION LIMITATIONS, ETC.

Still hard to follow, and BTW all caps just makes things harder to read.  But the statement above is a warning sign to me...a useful shortcut to determining compensation for self-employeds is "what are they paying self-employment tax on?"  Here they are not really self-employed, so only the W-2 income would have SS and Medicare taxes paid on it (the equivalent of self-employment tax).  Unless I'm missing something, the clause above "AS WELL AS AN ESTIMATE OF THE INCOME ALLOCABLE TO THE S CORP" is inaccurate - that income is not subject to SE tax (or SS/Medicare tax through W-2 wages) and isn't retirement plan compensation.  If they are trying to have it both ways - low W-2 comp to minimize SS/Medicare taxes, but high compensation to maximize contributions, they can't.  

Now all of a sudden we are talking about a cash balance plan and not just a 401(k); that raises an eyebrow.  It may be that everything is perfectly legit but it's hard to say for sure.

Again, it would be helpful to know your position in all of this. It appears you are not on the pension end, maybe payroll?  If so, kudos for raising the question.  

I have engineered these for many law firms. Each corp, whether S or C, must adopt the partnership plan, which it can do because in A-Org ASG relationship with partnership. Then each shareholder employee of a PC that is a partner of firm (i.e, the PC is the partner) must elect 401(k) deferrals from W-2 wages paid by PC to shareholder-employee. All qualified plan testing, contribution determinations, etc., must be done based on the PC's shareholder-employee's W-2.

@Luke Bailey Hello, I know this is an old thread, but I am hoping to get a bit of guidance. Thank you in advance! 

I am a financial advisor and I am currently working on 2 401k's similar to the above discussion.  

The first 401k is an anesthesia physician group (33 partners, average income 425k), no employees, structured as a PLLC (taxed as partnership).  They currently have an old fashioned self directed group plan with Matrix as the trustee and record-keeper.   Recently some (not all) of the partners have requested to have their personal PLLCs (taxed as S-Corps) to be paid instead of themselves directly.  Furthermore the group has become disgruntled with Matrix and would like to resign their plan anyway.  They asked me to help in doing so.  I am no ERISA plan expert, but want to make sure I provide them with great guidance.  I have reached out to a few TPAs, and they have been no help.  I guessing this structure comes down to the group 401k plan document design.  Also what does A-Org ASG relationship from your post above mean?

The second 401k plan is a start-up plan for a small orthopedic surgery practice.  Two surgeons will own the PLLC (taxed as S-Corp), they will have 6 employees.  They desire to pay their own PLLCs (taxed as S-Corps) their portion of productivity income. They plan of paying themselves approximately 400k wage through their individual PLLCs.

In both of the cases above the physicians are trying to reduce their self employment tax.

What does the sponsoring group 401k adoption agreement need to say in both of these cases to allow these physicians to participate in the plan?  How do employee deferrals from the individual PLLCs(S-Corp) get back into the group 401k?  How are profit sharing contributions handled, as everyone wants to max fund their 401k?

The orthopedic surgery group may want a cash balance plan as well, but the focus for now is on the 401k.

On 1/10/2021 at 6:00 PM, SKIERFA said:

@Luke Bailey Hello, I know this is an old thread, but I am hoping to get a bit of guidance. Thank you in advance! 

I am a financial advisor and I am currently working on 2 401k's similar to the above discussion.  

The first 401k is an anesthesia physician group (33 partners, average income 425k), no employees, structured as a PLLC (taxed as partnership).  They currently have an old fashioned self directed group plan with Matrix as the trustee and record-keeper.   Recently some (not all) of the partners have requested to have their personal PLLCs (taxed as S-Corps) to be paid instead of themselves directly.  Furthermore the group has become disgruntled with Matrix and would like to resign their plan anyway.  They asked me to help in doing so.  I am no ERISA plan expert, but want to make sure I provide them with great guidance.  I have reached out to a few TPAs, and they have been no help.  I guessing this structure comes down to the group 401k plan document design.  Also what does A-Org ASG relationship from your post above mean?

The second 401k plan is a start-up plan for a small orthopedic surgery practice.  Two surgeons will own the PLLC (taxed as S-Corp), they will have 6 employees.  They desire to pay their own PLLCs (taxed as S-Corps) their portion of productivity income. They plan of paying themselves approximately 400k wage through their individual PLLCs.

In both of the cases above the physicians are trying to reduce their self employment tax.

What does the sponsoring group 401k adoption agreement need to say in both of these cases to allow these physicians to participate in the plan?  How do employee deferrals from the individual PLLCs(S-Corp) get back into the group 401k?  How are profit sharing contributions handled, as everyone wants to max fund their 401k?

The orthopedic surgery group may want a cash balance plan as well, but the focus for now is on the 401k.

SKIERFA, this is a complex set of facts and would need to be reviewed in detail by your ERISA attorney or consultant who will provide the documents and establish the plans. A CPA should also be consulted.

I have a similar situation and hoping to see if anyone has insight:

Since both businesses are in the field of law, they are automatically service organizations, and you have to consider whether an affiliated service group exists. The answers to your questions will depend heavily upon whether or not there is an ASG (or controlled group, but that seems less likely to me). Based on the way you worded question #4, it seems likely that an ASG does exist, but ASG determinations are highly fact-dependent.

Is Attorney A an employee of partnership B (does he receive a paycheck and a W-2, in addition to the partner's distributions paid to his S-corp)?

Thanks fo your reply. Attorney A is not a W-2 employee of Partnership B. All compensation to Attorney A is via K-1 guaranteed payment. Partnership B does have W-2 employees (associates and support staff)
 

Based on my research, I think an ASG does exist. S-Corp is an A-org and Partnership B is FSO. 

If an ASG exists, then both companies are treated as a single employer for most purposes.

1. No. He can't contribute to the SEP while part of an ASG (unless he wants to provide SEP contributions to all the employees of the ASG). In addition there is a single 415 limit which applies across all plans sponsored by all members of the ASG.

2. Yes. Since A's only comp is his W-2 comp from the S-corp, the S-corp needs to adopt the 401(k) plan in order for him to make 401(k) deferrals.

3. Yes.