Understanding Ownership Attribution for Retirement Plans
By Cole Bauer JD, LLM
Each spouse owns 100 percent of their own business; are their businesses considered separate employers or a single employer for qualified retirement plan purposes?
That depends. . . under Internal Revenue Code Section (IRC Sec.) 1563(a)(2), as modified by IRC Sec. 1563(f)(5), when five or fewer individuals commonly own 80 percent or more of multiple businesses and have effective control of greater than 50 percent, a brother-sister controlled group exists, requiring the businesses to be treated as a single employer for many qualified retirement plan purposes. To arrive at the level of control needed to form a controlled group of businesses, an individual’s direct ownership of a business is considered along with any indirect ownership of a business that may be held and attributed to the individual by family members, business entities, trusts, or estates. Regarding attribution of ownership from a family member, an individual is generally treated as owning the same interests in a business held by their spouse. But this attribution of the spouse’s ownership to the individual does not occur if the spouses are legally separated under a decree of divorce or separate maintenance, or the spouses’ manner of ownership in their businesses meets the spousal exception.
For the spousal exception to attribution to apply under IRC Sec. 1563(e)(5), an individual must meet the following requirements:
the individual may not have direct ownership in the spouse’s business;
the individual may not participate in the management of the spouse’s business, nor can the individual be a director, officer, or employee of the spouse’s business;
the gross income of the spouse’s business for a tax year may not consist of more than 50 percent in passive investments (dividends, interest, royalties, rents or annuities); and
the spouse’s ownership in the business does not have any restrictions on dispositions that favor the individual or the minor children of the individual and spouse.
If the spousal exception applies, the spouses are not considered to have any ownership in each other’s businesses. There would be no common control and no effective control of multiple businesses by either spouse that would lead to a controlled group; the businesses would be separate employers for qualified retirement plan purposes.
Are there any other rules regarding spouses that could cause these businesses to be treated as a single employer?
Yes, if the spouses reside in a community property state, each spouse is considered to own 50 percent of the property that has been acquired during the marriage (unless they executed an agreement that considers specific property as separate). The U.S. Tax Court has determined that the 50 percent community property interests held by the spouses are treated as direct ownership interests in their community property. Therefore, an individual residing in a community property state would not meet the first requirement for the spousal exception of IRC Sec. 1563(e)(5). Spouses who each own 100 percent of their own businesses in such states may not take advantage of the spousal exception and are considered to own 100 percent of each other’s businesses. This would cause either spouse to have 100 percent common control and 100 percent effective control of both businesses. A controlled group would then exist, and the businesses would be treated as a single employer for qualified retirement plan purposes.
NOTE: At the time of this article, the Securing a Strong Retirement Act bill has been submitted for consideration by the U.S. House of Representatives. As written, this bill would disregard community property state laws when determining spousal ownership for controlled group purposes. If passed, spouses who each own 100 percent of their own businesses in community property states would not be considered to have direct ownership interests in each other’s businesses and would otherwise meet the first element of the spousal exception of IRC Sec. 1563(e)(5).
Do any other family attribution rules apply to spouses who each own 100 percent of their own businesses but do not reside in community property states?
Yes, under IRC Sec. 1563(e)(6)(A), a minor child under the age of 21 is considered to own the same interests in a business held by their parent. Although the spouses would not attribute their ownership interests to each other because of the spousal exception; each spouse would attribute their ownership interests in their own businesses to their minor child. That minor child would be considered as owning 100 percent of each spouse’s business, which would amount to one individual having 100 percent common control and 100 percent effective control of multiple businesses. A controlled group would exist and the businesses would be treated as a single employer for qualified retirement plan purposes.
This attribution rule effectively treats sets of spouses differently based on whether the spouses are parents and the age of their children. The IRS has informally commented that it would follow the guidance found in the Internal Revenue Code until Congress makes a change, which creates the possibility of having a controlled group of the spouses’ businesses, controlled by a minor child.
NOTE: At the time of this article, the Securing a Strong Retirement Act bill has been submitted for consideration by the U.S. House of Representatives. As written, this bill would not attribute the ownership interests each parent has in their own business to their minor children under IRC 1563(e)(6)(A) if those spouses meet the spousal exception to attribution under 1563(e)(5). If passed, a minor child would not be considered as owning 100 percent of both of parents’ businesses. As a result, a controlled group would not exist because the parents, as spouses, would not be considered as owning each other’s businesses.
