My Spouse and I Each Own a Company… Is That a Pension Problem? by Ilene Ferenczy
It is increasingly common nowadays for two spouses to be entrepreneurs, each with their own company, and each with their own retirement plan. However, this situation should give everyone a little pause, because it may be an unexpected danger zone.
When someone owns more than one company, both companies together are considered to be one entity for retirement plan rules. (This is called the “controlled group” rule.) For example, if I own all of both Company A and Company B, I need to treat the two entities as one company when applying retirement plan rules. This means I either need to cover all employees of both companies or I need to demonstrate, through certain technical testing, that the plan covers a fair cross-section of non-highly compensated employees when both companies are considered to be one big entity.
In an attempt to get around the controlled group rule, some business owners placed the ownership of the company that employed the rank-and-file employees with their spouse or other close relatives. Then, the owner could say that he or she owned only one company and did not need to cover the employees of the other entity. To forestall this, the Internal Revenue Code provides for “attribution requirements,” under which certain family members are treated as owning the entities that are owned by their relatives. So, for example, a husband is considered to own everything his wife owns, and vice versa.
This produces a special challenge in today’s world, however, where two spouses very commonly own their own, independent companies. Surely, you may ask, the Code does not require you to treat those two companies as if they were one?
Before you start hyperventilating, there is an exception to this attribution of ownership for spouses, commonly called the “Noninvolvement Exception.” The two companies will not be a controlled group if four requirements are met:
- Each spouse owns nothing in the other’s company;
- Neither spouse is a director, employee, or management participant in the other’s company;
- The companies do not derive more than half of their income from royalties, rents, dividends, interest, and annuities; and
- There is no limitation or restriction on either spouse’s ability to sell his or her company that runs in favor of the other spouse or their minor children.
So, if one spouse is Dr. Jones and the other spouse is Attorney Jones, and neither has any involvement in the other’s company, there’s no controlled group. Each entity can have (or not have) a retirement plan, and need not consider the other spouse’s company and its employees.
Are you calmer? Good, because now I’m going to make your heartbeat speed up again. There are two situations in which the Noninvolvement Exception does not apply.
First, the exception does not apply if you are in a community property state, and your spouse has a community property ownership in your company. The Noninvolvement Exception deals with the attribution of ownership under the controlled group rules, not actual ownership. Community property interests are actual ownership. So, if you are in Louisiana, Arizona, California, Texas, Washington, Idaho, Nevada, New Mexico, or Wisconsin, you should probably check with your pension expert to see if you have a controlled group problem.
Second, and I warn you that this will seem unreal, is the minor child situation. Under the attribution rules, the ownership of a parent in his or her company is considered to be owned by his or her minor children. Again, this rule forestalls business owners from putting their company ownership interest in a child’s name to avoid the controlled group rules.
So, imagine that Dr. Jones owns a medical practice and Attorney Jones, her husband, owns a law firm. The Noninvolvement Exception applies, and things are going swimmingly. Then, Dr. Jones gives birth to a bouncing baby girl, Joni. Dr. Jones’ interest in the medical practice attributes to Joni. Attorney Jones’ interest in the law firm attributes to Joni. Joni now is considered to own a controlling interest in both the medical practice and the law firm and boom! We have a controlled group. And the Noninvolvement Exception, which relates only to spouses, no longer applies. (And, note: the attribution of ownership to the child occurs regardless of whether the parents are married, or even in a relationship.)
The IRS has not been aggressive in enforcing these rules, but when its representatives are asked at conferences and such whether the IRS has a policy of nonenforcement, the answer is “no.” So, if you assume that this is not a “real issue,” you are taking a risk that should be addressed.
The Takeaway: if you and your spouse are both business owners, you need to discuss these rules with your benefits expert to make sure that any controlled group issues are examined and resolved.
Ilene H. Ferenczy, J.D., CPC, APA, is the Managing Partner of Ferenczy Benefits Law Center, an employee benefits law firm in Atlanta, Georgia. She advises clients on all types of employee benefit plans, particularly focusing her practice on qualified retirement plans, benefits issues in mergers and acquisitions, and advising third-party administrators of employee benefit programs on technical and practice issues.
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