of the primary objectives of the qualified plan rules is to make the tax
advantages contingent upon covering a significant number of the nonhighly
compensated employees. As this goal could be thwarted by creating separate
legal entities for the highly compensated and nonhighly compensated
employees, a complex set of rules has evolved concerning the aggregation of
related employers for purposes of the minimum coverage rules and other
qualified plan requirements.
Unnoticed, these aggregation rules can cause serious negative
ramifications. Let's look at an example: Jean the pension consultant goes to
visit her client Exterminator, Inc. that sponsors a profit sharing plan.
When she arrives, she also sees the name of Bug Analysis, Inc. on the door.
Immediately she becomes concerned, since she knows that the plan only covers
employees of Exterminator, Inc.
She discovers that both companies are wholly owned by the same two
individuals. Since this is a situation in which the employees must be
aggregated, the profit sharing plan could be disqualified if it cannot
satisfy minimum coverage after counting the excluded employees of Bug, Inc.
As failure to identify required aggregation can result in plan
disqualification, employers need a basic understanding of these rules.
There are several aggregation rules. The controlled group rules require
aggregation of employers that have a sufficient amount of common ownership,
and the affiliated service group rules apply to other situations in which
related businesses work together to provide goods or services to the public.
When either rule applies, aggregated employers are treated as one entity
for most qualified plan rules. Specifically, such organizations must be
combined for purposes of the coverage requirements, nondiscrimination
provisions, vesting requirements, maximum limitations on benefits and
contributions, compensation limitations and top heavy requirements. Both
rules apply to corporations and "trades and businesses," including
partnerships, proprietorships, estates and trusts.
A third type of affiliation relates to situations in which individuals
are "leased" on a long-term, full-time basis. An individual who meets the
definition of "leased employee" is treated as working for the recipient for
purposes of the qualified plan requirements. Each of these rules is covered
more fully below.
Controlled Group Rules
There are three types of controlled groups: brother-sister,
parent-subsidiary and combined groups.
Brother-Sister Controlled Group
A brother-sister controlled group exists whenever the same five (or
fewer) owners of two or more entities own 80% or more of each entity, and
more than 50% of each entity when counting only identical ownership. Let's
look at an example:
In this case the 80% ownership test has been met, because the three
individuals (Joe, Sally and Ralph) who have ownership in each entity own
100% of both businesses. However, the 50% identical ownership interest test
has not been satisfied. Identical ownership is determined first by
determining the common ownership interest for each individual. For example,
Joe's identical interest is 12%. The second step is to add up the identical
ownership interests of Joe, Sally and Ralph. Since these only add up to 46%,
this group does not constitute a controlled group.
When performing the 80% test, only shareholders owning interests in each
potential member of the group are counted--any shareholder who does not own
stock in all of the companies being considered is ignored.
Another key consideration is the stock attribution rule that applies to
stock owned by certain family members. A spouse is generally deemed to own
an interest owned directly or indirectly by or for his or her spouse.
However, attribution is not required if the spouses are separated or
divorced or in situations in which an individual has no direct ownership
interests in the entity owned by his or her spouse and is not an employee,
director or otherwise involved in the management of the company.
An individual is considered to own an interest owned by the individual's
children who are under age 21. Also, children under age 21 are attributed
ownership interests of parents. Because of this attribution rule, if a
husband and wife each own 100% of their own businesses and they have a child
under age 21, the child is deemed to own both businesses. Therefore, a
controlled group will exist even if the spousal exception would otherwise
In addition, when a person owns more than 50% of an entity, he or she is
deemed to own any interest owned in that entity by his or her adult
children, grandchildren, parents and grandparents.
Parent-Subsidiary Controlled Group
A parent-subsidiary controlled group exists whenever one entity (referred
to as the parent company) owns at least 80% (measured by vote or value) of
another entity. Additional entities may be brought into the group if a chain
of common ownership exists.
Example: Corporation A owns 80% of Corporations B and C, and Corporations
B and C each own 40% of Corporation D. Because Corporation D is 80% owned by
entities within the group, Corporation D is part of the parent-subsidiary
controlled group that includes all four corporations.
The last type of controlled group is the combined group under common
control. A combined group exists if an entity is both a common parent in a
parent-subsidiary group and a member of a brother-sister group. If this is
the case, the two related controlled groups are treated as one controlled
Affiliated Service Group Rules
Congress first enacted the affiliated service group rules to address the
concern that small corporations had managed to divide management and the
rank-and-file into separate entities and avoid the controlled group rules.
The rules have been expanded several times over the years to address new
avoidance schemes. Today, the law is quite complex. There are several
threshold issues that help to identify when affiliation may exist. Except
for management services affiliation (discussed below), affiliated groups
exist only when all three of the following elements are present:
- When two or more business entities work together to provide one
service or product to the public;
- When at least one of the entities is a service organization; and
- When at least some common ownership exists between the two entities.
A service organization is an organization for which capital is not a
material income-producing factor. Generally, capital is to be deemed a
material income-producing factor if a substantial portion of gross income is
attributable to substantial investments in such things as plant and
inventory. Organizations in the fields of health, law, engineering,
actuarial science, consulting and insurance are automatically deemed service
These affiliation rules come into play regularly in the medical world,
where there are partnerships between doctors and hospitals that provide
services in outpatient clinics, MRI testing centers and other cooperative
medical centers. In these cases, there must be careful analysis to see if
the MRI testing center, for example, is affiliated with the doctor's medical
practice or with the hospital.
Management services affiliation is defined by a much broader rule, which
essentially prohibits an executive of any size company from separating
himself from the company for the purpose of establishing his or her own
Leasing of Employees
Instead of hiring employees directly, a business may lease employees from
a third party for a number of legitimate reasons. Unfortunately, at one
time, leasing of employees was also used as a way to circumvent the minimum
coverage requirements. The employer would lease rank-and-file employees and
then exclude them from plan eligibility. Code Section 414(n) was enacted to
eliminate such practices by requiring that individuals leased on a
full-time, ongoing basis would be treated as employees for purposes of the
A leased employee is a person who provides services to the recipient and
meets all three of the following requirements:
- The services are provided pursuant to an agreement between the
recipient and a leasing organization;
- The services are provided on a substantially full-time basis for a
period of at least one year; and
- The individual's services are performed under the primary direction or
control of the service recipient.
Even if an individual is a leased employee under the above conditions, he
or she will not be treated as an employee of the recipient if leased
employees constitute no more than 20% of the recipient's nonhighly
compensated workforce and the leasing entity maintains a safe harbor plan.
Note that leased employees do not necessarily have to be covered under
the plan, they simply have to be counted for purposes of the coverage test.
The affiliation rules are quite complex. It's helpful to remember that
they were, for the most part, enacted to eliminate perceived abuses, and any
situation in which employees are artificially separated to avoid coverage is
probably prohibited. Unfortunately, the rules can also extend beyond
situations that were not originally foreseen. With the potential adverse
affects of failing to miss these situations, it's crucial for everyone
involved in the plan to keep an eye out for hidden aggregation problems.
IRS and Social Security Annual Limitations
Each year the U.S. government adjusts the limits for qualified plans and
social security to reflect cost of living adjustments and changes in the
law. Many of these limits are based on the "plan year." The elective
deferral and catch-up limits are always based on the calendar year. Here are
the 2009 limits as well as the three prior years for comparative purposes:
| Maximum compensation limit
|Defined contribution plan maximum
|Defined benefit plan maximum benefit
|401(k), 403(b) and 457 plan maximum elective deferrals
| Catch-up contributions*
|SIMPLE plan maximum elective deferrals
| Catch-up contributions*
|IRA maximum contributions
| Catch-up contributions*
| Highly compensated employee threshold
|Key employee (officer) threshold
|Social security taxable wage base
*Available to participants who are or will be age 50 or older by the
end of the calendar year.
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