In today’s business climate, it seems it is becoming increasingly common for businesses of all sizes to be structured using multiple companies. Maybe a business person is pursuing multiple ventures with different groups of co-owners. Perhaps a company decides to offer a new product or service and that is best accomplished via a separate entity. Sometimes it makes sense to create a separate company for each of a business’s locations. Still other times the owner of one company decides to buy another business.
Regardless of the reason for structuring a business in this way, there are some complex IRS rules that must be considered when it comes to the retirement benefits being offered.
Background
During the mid-1980s, Congress created a series of complex rules designed to prevent companies from transferring employees to separate but related companies as a way to provide reduced or even no benefits without running afoul of the nondiscrimination rules. Generally speaking, those rules describe two types of related groups—the affiliated service group and the controlled group. For the sake of brevity throughout the rest of this article, we will occasionally refer to these as ASGs and CGs.
In short, these rules require that all companies in a related group must be combined when performing annual nondiscrimination testing on the retirement plan(s). While this requirement can be a limitation at times, with some careful planning it can also be used to provide retirement benefits to multiple companies more cost effectively than if the related companies were treated as separate entities. Before we look at some examples, it is first necessary to dive a little bit into the weeds to understand the gist of the rules themselves.
Affiliated Service Group
The ASG rules focus on the nature of the relationship between the entities in question. Some of the key variables in determining whether an ASG exists include the following:
- Working Relationship: Does one entity provide services to the other that are customarily provided by the recipient’s employees? Alternatively, do the entities involved join together to provide services to the same clients?
- Ownership: Is there any common ownership among the entities? In some instances, as little as 10% common ownership is enough to trigger an ASG.
- Management: Does one entity provide management oversight over the other entity? If so, an ASG may exist even if there is no common ownership.
While ASG relationships can exist in many different industries and entity types, it is not unusual for them to occur in professional settings such as medical practices and law firms. Consider two examples illustrating relatively common professional business structures.
Example #1
A law firm is organized as a partnership and each attorney creates his or her own professional corporation (P.C.). Rather than the attorneys being the partners of the law firm, their respective P.C.s are the partners. The partnership and the individual P.C.s join together to provide legal services to the firm’s clients. As a result, the firm and the P.C.s form an ASG.
Example #2
Several physicians own a medical practice and they have no other employees. However, they also own part of a billing office that includes a number of employees who handle administrative functions for the practice. Since the billing office provides services to the practice that are customarily provided by employees, and there is some overlapping ownership, the two potentially form an ASG.
Controlled Group
The remainder of this article will focus primarily on controlled groups. Unlike affiliated service groups, controlled group determinations are based solely on overlapping ownership. There are two general types of controlled groups—the parent/subsidiary group and the brother/sister group.
Parent/Subsidiary Controlled Group
This type of group is the more straightforward of the two and exists when one entity owns 80% or more of another entity. For example, if Company A owns 80% or more of Company B, the two companies are part of a parent/subsidiary controlled group.
Brother/Sister Controlled Group
This type of group is a little more complicated to explain. In broad terms, there are two thresholds to meet:
- Common Ownership: The same five or fewer individuals must own at least 80% of each company under consideration.
- Identical Ownership: The sum of the identical ownership of the five or fewer owners from the first step must be greater than 50%. The best way to explain identical ownership is via an example. If John Doe owns 10% of one company and 5% of another company, his identical ownership among the two is 5%.
When both of these requirements are met, there is a brother/sister controlled group.
Attribution of Ownership
As we described above, ownership is a key variable in these determinations, and there is a series of additional rules that discuss ownership. Specifically, there are instances in which the ownership held by one person or entity must be attributed to another person or entity. While we will spare you the gory details, it is important to briefly touch on these rules.Attribution from Company to Individual
In simple terms, this essentially means that a person who owns at least 50% of a business is deemed to own a proportionate share of whatever that business owns. For example, if John Doe owns 75% of ABC Company, and ABC owns 60% of XYZ Company, John is deemed to own 45% of XYZ (75% x 60%). There are a number of variations and exceptions, but remember…we promised to spare you the gory details.Attribution Among Family Members
This is when one person’s ownership is attributed to certain family members. Specifically, an individual’s ownership is attributed to his or her spouse as well as lineal ascendants and descendants. In this case, we do need to journey a little further down the rabbit hole to consider some of the very important exceptions:- Spousal attribution generally does not apply if the owner’s spouse does not hold direct ownership in his or her own right and the spouse does not participate in the owner’s company. The spouse need not formally be an employee in order to “participate” in the business.
- There is limited attribution between parents and children over the age of 21, based on the amount of direct ownership held by the child.
- There is no attribution between siblings.
Putting it Together
Assuming you’ve made it this far without either falling asleep or running screaming from the room, it’s time to look at some examples that might pull all of this craziness together. We will do this using a couple of simplified case studies, and our cast of characters will include John, Paul, George, Ringo, Yoko (John’s wife) and Julian (John and Yoko’s 18-year-old son).Case Study #1
Our characters hold the following ownership in two companies:| Beatlemania, Inc. | Yellow Sub, Inc. | |
|---|---|---|
| John | 40% | 30% |
| Paul | 40% | 30% |
| George | 10% | 0% |
| Ringo | 10% | 0% |
| Yoko | 0% | 20% |
| Julian | 0% | 20% |
Case Study #2
John and Yoko each own 100% of Imagine, LLC and Silver Horse, Inc., respectively, and neither one is at all involved in the company owned by the other. Under one of the exceptions noted above, their ownership would not be attributed to each other, so it appears there would not be a controlled group. However, since Julian is under the age of 21, he is attributed the ownership from each of his parents, making him the 100% owner of both companies and causing the two to form a controlled group.Making Sense of it All
So, what does all of this really mean? Basically, it means that when there is a controlled group (or an affiliated service group), all of the related companies are treated as a single employer for purposes of the retirement plan. In other words, the employees of all the related companies must be included in the annual nondiscrimination testing. That might sound onerous but it doesn’t have to be.
Keep in mind that the annual testing compares the benefits provided to highly compensated employees (HCEs) to those provided to non-HCEs. If two companies in the same controlled group have similar numbers of HCEs and non-HCEs, it is completely plausible that the tests would still pass even if the employees of one of the companies don’t receive any plan benefits.
If the goal is to provide similar benefits to the employees of several companies, a controlled group/affiliated service group relationship can make it more cost-effective to do so. The reason is that since all of the companies in the group must be treated as a single employer for purposes of testing, it is perfectly acceptable to have a single plan covering all of the employees. Through the use of more complex forms of nondiscrimination testing, it might even be possible to provide different benefits to the various companies in the group via a single plan. That means only one plan document to maintain, only one plan to administer and only one Form 5500 to file each year.
Conclusion
Before considering how to plan around/take advantage of related group status, the first step is to be sure which companies are/are not “related” based on the rules we have highlighted in this article. There are many facts and circumstances that can affect controlled group and affiliated service group determinations and even seemingly slight nuances can be game changers. As a result, it is usually worth spending a few dollars to hire someone who is knowledgeable and experienced in this area to assist with the analysis.
With some due diligence and careful planning, your controlled group can be under control rather than out of control.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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