Controlled Group Question

Company A is 100% owned by Husband and has a 401k plan. His spouse works there but has no direct ownership, just the required family attribution. The spouse started her own business in 2020 and is doing so well that she would like to do a SEP for 2021. Husband has no interest in her company and does not work there.

Under section 1563 rules = attribution does not apply if all four of the following conditions are satisfied

1. Spouse does not hold direct ownership in the business

2. Spouse is not an employee and does not participate in the management of the business

3. Business income form passive investment does not exceed 50% of the gross income for the year; and

4 Owner's interest is not subject to disposition restrictions in favor of his/her spouse and the couple's minor children

Based on item 2 if she works and is paid by his company they don't meet all the conditions and thus would be considered a controlled group - correct?

Yes.

Even if she stops working for her husband's company, don't forget to look out for minor children, or community property depending on what  state they're in.

And to discern whether community property might affect some point, one might consider all States or other jurisdictions in which the spouses resided.

That spouses now live in a State that does not ordinarily establish community property for those domiciled or resident in the State might not always undo a community-property interest established under the law of another State.

9 hours ago, C. B. Zeller said:

Yes.

Even if she stops working for her husband's company, don't forget to look out for minor children, or community property depending on what  state they're in.

6 hours ago, Peter Gulia said:

And to discern whether community property might affect some point, one might consider all States or other jurisdictions in which the spouses resided.

That spouses now live in a State that does not ordinarily establish community property for those domiciled or resident in the State might not always undo a community-property interest established under the law of another State.

C. B. Zeller and Peter Gulia, do you think you can get around the community property problem with a separate property agreement?

Yes, an agreement might undo community property.

One would evaluate whether the agreement truly separates the property and, if so, whether the agreement is legally enforceable.

In doing that analysis, one might consider the internal law, and conflict-of-laws law, of each jurisdiction that might have some connection to the situation, including:

the State of company A’s organization or formation,

the State in which the first community-property interest was created,

each State in which there was (or might have been) an addition to community property,

each State in which there was insufficient accounting between separate and community property,

the domicile of each spouse,

the residence of each spouse,

the State in which each spouse signed the agreement,

the State law the agreement specifies as governing the agreement, and

the State law that governs the agreement.

A practitioner would want to fact-check the situation with no less care than Circular 230 calls for.

Before pursuing an agreement, each spouse should consider the consequences, including for property ownership, income taxes, estate planning, and estate and inheritance taxes.

Under some States’ laws, an agreement might be invalid unless each spouse has separate counsel.  Even when that’s not a State-law condition, S. Derrin Watson in Who’s the Employer? (1998) suggested: “Such an agreement should not even be considered unless husband and wife are separately represented by experienced counsel, even in a friendly situation.”  The American College of Trust and Estate Counsel’s Commentaries on the Model Rules of Professional Conduct describes more nuanced views.

This question is outside of my area of expertise, but I will note that the Securing a Strong Retirement Act would, if passed, amend IRC 414(b) to state that community property is disregarded for purposes of determining ownership in a controlled group. So it seems that there is some intent in Congress to get rid of this, but it remains to be seen if the provision will actually end up in law. It would also state that controlled groups will not exist solely due to the existence of a minor child.