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socrateaser, Lawyer
Category: California Employment Law
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Experience:  Retired (mostly)
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In California, wife has a medical practice. She has about 10

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In California, wife has a medical practice. She has about 10 employees and has a safe-harbor PS/401k plan. Husband manages their real estate properties through a partnership (100% owned by husband, wife and two grown up sons. Sons have this beneficial interest-total35%- via a generation skip irrevocable trust).

Husband's real estate management business employs several employees. It does not have a pension plan of any kind.

Husband does not manage wife's practice and wife does not manage the real estate partnership.

Question: Is the wife required to make pension plan contributions for the employees of the husband's business? I understand that Control Group situation arises here, but please refer to Example 1 on page 13 of the IRS pdf at this link:

In Orange County, California, there are several businesses where one spouse’s business may have a pension plan but the other spouse's business may not have any (assuming there is no sharing of employees or the management). Are they all in trouble with the law?
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Customer: replied 3 years ago.
Yes, still waiting for answer. Thank you!

Thank you. We will continue to look for a professional to assist you. Please let me know if I can be of any further assistance while you wait.
Customer: replied 3 years ago.
In your selection of attorney, you should also add a category "Employee Benefits".

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, 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.
Customer: replied 3 years ago.

If the husband is taking salary and the passive income from the partnership is under 50%, would the answer be different?

Because wife owns a direct interest in the partnership, this violates subparagraph (A). The regulation requires that all four (A-D) subparagraphs must be satisfied to avoid liability. So, wife would have to divest herself of any direct ownership interest in the partnership, as well as having the partnership generate no more than 50% passive gross income (not profit/net).

Wife's divestment would require a "transmutation agreement" (Cal. Family Code 850-852). California is a community property jurisdiction, so without a formal written agreement under which wife consents to the absolute transmutation of her community property interest into husband's separate property, it is not possible to avoid the creation of a controlled group of business organizations -- because wife has an automatic 50% undivided interest in husband's property -- and visa versa.

Hope this helps.

socrateaser, Lawyer
Satisfied Customers: 37871
Experience: Retired (mostly)
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