Customer service asked me to review your question. It's actually more of a tax law question, becausea while ERISA is found in Title 29 (Labor) of the U.S. Code, Title 26 (Internal Revenue Code) controls the tax-related details.
That said, you ask that I refer to http://www.irs.gov/pub/irs-tege/epchd704.pdf, in my answer.
Page 12 of the Guide provides that a spouse's interest his or her spouse's "brother-sister" business is attributed to that spouse, creating a controlled group of non-corporation businesses, unless there is "no: direct ownership, participation in company, and no more than 50% of business gross income is passive investments. See Treas. Reg. 1.414(c)-4(b)(5)(ii)."
At this point, I feel obliged to mention that, "instructions and other IRS publications are not authoritative sources of federal tax law. Casa de La Jolla Park, Inc. v. Commissioner, 94 T.C. 384, 396 (1990)
. Taxpayers must look to authoritative sources of Federal tax law such as statutes, regulations, and judicial decisions and not to informal publications provided by the IRS. Zimmerman v. Commissioner, 71 T.C. 367, 371 (1978),
aff'd, 614 F.2d 1294 (2d Cir. 1979)
." Brombach v. C.I.R., 2012 TC Memo 265 (USTC 9/12/2012).
Thus, while the Guide 704 may be a useful tool, it is not the law of the United States of America, and taxpayers rely upon the Guide at their peril. Caterpillar Tractor Co. v. United States, 589 F. 2d 1040, 1043 (12/13/1978).
Treasury Regulation 1.414(c)-4(b)(5)(ii) (i.e., the law), actually provides as follows: Exception.
An individual shall not be considered to own an interest in an organization owned, directly or indirectly, by or for his or her spouse on any day of a taxable year of such organization, provided that each of the following conditions are satisfied with respect to such taxable year:
- (A) Such individual does not, at any time during such taxable year, own directly any interest in such organization;
- (B) Such individual is not a member of the board of directors, a fiduciary, or an employee of such organization and does not participate in the management of such organization at any time during such taxable year;
- (C) Not more than 50 percent of such organization's gross income for such taxable year was derived from royalties, rents, dividends, interest, and annuities; and
- (D) Such interest in such organization is not, at any time during such taxable year, subject to conditions which substantially restrict or limit the spouse's right to dispose of such interest and which run in favor of the individual or the individual's children who have not attained the age of 21 years. The principles of § 1.414(c)-3(d)(6)(i) shall apply in determining whether a condition is a condition described in the preceding sentence.
Applying the above-quoted law to your hypothetical, the medical practice and partnership are part of the same brother-sister controlled group. The reasons for this are: (1) wife owns an interest in the partnership; and (2) substantially all of the gross income from the partnership is passive rental income. This violations subsections (A) and (C) of the Treasury Regulation, therefore this is a controlled group, and an ERISA-qualified retirement plan provided for employees of the medical practice must extend to employees of the partnership (or the partnership must provide a substantially equivalent retirement plan).
Concerning your question about what other businesses do in Orange County, California, I can't comment intelligently. What I can say is that because the only time that the IRS would ever likely audit this set of circumstances, would be if an employee of the partnership were to complain to either the IRS or U.S. Department of Labor Employee Benefits Security Administration (EBSA). And, if the employees of the partnership have no knowledge of the medical practice 401(k) plan, they would have no reason to complaint. Moreover, even if they were aware of the medical practice 401(k), it's unlikely that any of the employees would "connect the dots," because this is a very complicated subject.
It's certainly possible that an IRS investigator, if he/she were to select the husband's and wife's joint tax return for audit, could make the connection that wife owns a medical practice and husband and wife are partners in a real estate investment, both with employees and only one with an ERISA-quaified retirement plan. But, that seems a remote possibility to me.
Nevertheless, based upon your hypothetical and my interpretation of the Treasury Regulations, the employees of the partnership are entitled to be included in the medical practice 401(k) plan (or a substantially equivalent plan).
Please let me know if I can clarify or assist you further.
Hope this helps.