I’ve been working with my personal attorney and financial advisor on some estate planning. and one item I’m considering is placing some of my assets, including my company ownership, in a trust. While this is all for personal estate planning purposes, I’ve been told that anything that changes company ownership could also have an impact on how our 401(k) plan operates.
Are there any considerations or potential unintended consequences I should keep in mind while deciding whether I should move my company ownership into a trust?
When it comes to the retirement plan, knowing “who’s the owner” is incredibly important. Ownership percentages are used to determine things as routine as who your highly compensated and key employees are for nondiscrimination testing to more involved items such as whether your company must be aggregated with any others as part of a controlled group or affiliated service group.
This is truly a fundamental determination for both plan set-up and design as well as ongoing administration. So, as much as we’d like to tell you that this important determination is an easy one to make, it’s probably not going to come as a surprise that sometimes it’s anything but.
What can make this determination such a challenge are the ownership attribution rules. We cover these rules in more detail here, but the Cliff’s Notes summary is that the Internal Revenue Code provides rules that require ownership held by one person or entity to be attributed to one or more other family members or entities. Spoiler alert, there are three different sets of attribution rules, and the one to use in any given situation varies based on “why” you’re asking (i.e., controlled group determination versus HCE determination or Key employee determination).
When individuals hold company ownership directly, it’s relatively straight-forward to work through the attribution; the challenge in these situations is often gathering all the relevant familial relationships. But, if you’ve got ownership held in trust, it’s a whole different ballgame! This is where we find twists and turns stemming from trust law, individual state laws, trust beneficiaries, and more.
Given the complexity and the different sets of laws that can converge in situations like this, we pretty much always recommend you seek guidance from a tax attorney who has experience with to employee benefits law to help you understand how the various options for designing the trust can impact how ownership is attributed for purposes of your retirement plan. That said, let’s take a birds-eye view at some of the potential nuances.
If the trust is revocable, it’s possible the ownership is attributed back to the grantor of the trust. If the grantor is attributed the stock, that stock would then be attributed to other family members in the same fashion as if the grantor directly owned the stock (this is one of the few times that double attribution is required). However, to know for certain if the stock is attributed to the grantor (rather than the beneficiaries) of the trust, you must first review the trust language and applicable state law.
If we switch up the fact pattern and the trust is instead irrevocable, it’s still possible the grantor of the trust may still be considered the owner of the shares held by the trust. But, it’s also possible that the beneficiaries of the trust must be attributed their portion of the ownership based on actuarial factors. We know, it’s all enough to make your head spin. That’s a lot of caveats and “if/thens” even for people like us who geek out over this kind of thing.
To unscramble some of these scenarios, let’s take a look at a simplified fact pattern.
Johnny directly owns 100% of Great Nights Hotel, and his adult kids, David and Alexis, each own 50% of Video Heaven. Since the kids are over age 21, there is no attribution between them and Johnny (at least not for determining whether there is a controlled group – attribution still applies for other purposes). With no attribution, there is no overlapping ownership between the companies and, therefore, there is no controlled group. This means each entity can independently maintain its own retirement plan without any concern for the other.
Now, let’s say Johnny places his ownership into a trust (rather than holding the ownership directly) and names David and Alexis as equal beneficiaries. Depending on how the trust is designed (revocable vs. irrevocable, conditions on inheritance, etc.) as well as any state-specific variations, trust assets may be attributed to either Johnny (the grantor) or the kids. If the attribution goes to Johnny, we have the same result as above, i.e. no attribution to the kids and no controlled group. However, if trust assets are attributed to David and Alexis as beneficiaries, this does create a controlled group. Now, Great Nights Hotel and Video Heaven must be combined for purposes of retirement plan nondiscrimination testing.
There isn’t much that is clear about any of this, but one thing is - understanding how the design of the trust impacts ownership attribution is of paramount importance to making sure the retirement plan(s) is/are handled correctly. Who can or must be covered by the plan and the benefits necessary to satisfy all applicable testing hinges on knowing who the actual owners (direct and attributed) are each plan year. That brings us back to our earlier recommendation to make sure you get input from an attorney who has experience with not only trusts but also the tax laws that address attribution.
Whether you’re considering utilizing a trust or looking at making some changes to your current ownership structure, reach out to us for some initial consultations. If the situation calls for input from a benefits attorney, we’re happy to make an introduction!