In Employee Plans News (Issue 2012-3, Nov. 14, 2012), the Internal Revenue Service (“IRS”) provides guidance on maintaining a SEP Plan for employees of businesses under common control. The IRS posits the following situation: I own a sole proprietorship with several common-law employees. Recently I started a separate business as a C corporation. I own 100% of the corporation’s stock and am currently the C corp’s only employee. The C corp plans to adopt a Simpliied Employee Pension (“SEP”) plan. Do I have to include the sole proprietorship employees in the SEP plan?
The IRS answers:Yes. Because the sole proprietorship and the C corp are under common control, any of the sole proprietorship’s employees who meet the SEP plan’s eligibility requirements must be included in the plan.
Commonly Controlled Businesses. For SEP plan purposes, you must treat employees of commonly controlled trades or businesses (whether or not incorporated) as employed by a single employer (Internal Revenue Code Section 414(c)). In this case, the sole proprietorship and the C corp are under common control as a brother-sister group of trades or businesses because you:
• own a controlling interest in both businesses, and
• are in effective control of each business (Treas. Reg. Section 1.414(c)-2(c)(1)).
In turn, you have a “controlling interest” in both businesses because you own the sole proprietorship and at least 80% of the C corp’s total combined voting power of all classes of stock entitled to vote or at least 80% of the total value of shares of all of the C corp’s classes of stock (Treas. Reg. Section 1.414(c)-2(b)(2)). You are in “effective control” of both businesses because you own the sole proprietorship and more than 50% of the C corp’s total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of shares of all of the C corp’s classes of stock (Treas. Reg. Section 1.414(c)-2(c)(2)).
SEP Eligibility Rules. An employer must allow all employees who meet these requirements to participate in its SEP plan:
• are age 21 or older;
• worked for the employer in at least 3 of the last 5 years; and
• received at least $550 in compensation in 2012.
An employer can choose to use less restrictive eligibility requirements. For example, the plan may cover employees:
• who are age 18 or older instead of 21 or older, or
• immediately when hired instead of waiting until after they worked for the employer in at least 3 of the last 5 years.
Example: Your C corp’s SEP plan’s only requirement for participation is an employee must work 2 out of the last 5 years. One of the sole proprietorship’s common-law employees has worked there since you started the business 3 years ago. Both you and this employee immediately meet the SEP’s participation requirement. The other employees of your sole proprietorship and future employees of both the sole proprietorship and the C corp will be able to participate in the SEP plan once they meet the plan’s eligibility requirements.