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Retirement plans such as 401(k), 403(b) and defined benefit plans are employer-sponsored arrangements in that employers sponsor them for the benefit of their employees.  That means it is important to understand who the employer is in order to know how to properly design and maintain the retirement plan.

You’re probably wondering if there is a trick question here.  After all, how complicated can it be to identify the employer in any given situation?  In some cases, it really is that straight-forward, but in others, not so much.  The reason is that there are a series of rules that govern when and how different types of company structures might trigger a requirement to treat multiple companies as a single employer for benefit purposes even though they are separate entities for other purposes.  That’s not necessarily a bad thing, but the key is to make sure you know up front if your business falls under those rules.

Before peeling back some of the layers a little bit of context might be helpful.  Back in the 1980s, Congress grew concerned that business owners were manipulating their company structures to avoid providing benefits to their employees.  Consider this example: the owner of Company A decides to create Company B.  All the A employees continue with A, and the owner becomes the only employee of B.  The owner then sets up a really rich retirement plan for Company B and provides little or no benefits to Company A, leaving the owner with really great benefits and the employees with nothing.

Since the retirement system was designed to provide benefits to a broad cross-section of employees, Congress created the rules that require companies to be aggregated when there are certain amounts of overlapping ownership or special types of business relationships.  These are referred to as the controlled group and affiliated service group rules.

There are entire books written on these concepts, but we will spare you that level of detail here.  Here are the basics:



Controlled Groups

There are three types of controlled groups, and the magic number to keep in mind is 80%.

  • Parent/Subsidiary Controlled Group: The parent company owns 80% or more of one or more subsidiaries.
  • Brother/Sister Controlled Group: The same five or fewer individuals have combined ownership of at least 80% of more than one company.
  • Combined Group: A controlled group that includes one or more parent/subsidiary groups and one or more brother/sister groups.

Affiliated Service Groups

These are a little more tricky, because certain parts of the analysis are subjective.  There are three types of affiliated service groups. The actual definitions are confusing, so we will do our best to paraphrase.

  • A-org Affiliated Service Group There must be some overlapping ownership between the entities (though the regulations do not specify a minimum), and one company must provide services to the other or the companies must join together to provide services to common clients.
  • B-org Affiliated Service Group The highly compensated employees of one entity must own at least 10% of another entity. That other entity must derive a significant portion of its business (generally at least 10%) from providing services to the first entity that are similar to services that are traditionally performed in-house by employees.
  • Management Affiliated Service Group This is the only one that does not require any common ownership. In this arrangement, one entity’s principal business function is to provide management functions for another entity.

Common Ownership

 It is worth noting that “ownership” is a bit of a loaded term in this context.  It certainly includes direct business ownership, e.g. the percentage of shares of a corporation that an individual owns.  However, it also includes interest in a partnership or membership in an LLC.  In a not-for-profit where there isn’t any ownership, it includes the percentage of control on the board of directors.

Beyond that, there is attributed ownership, i.e. where one person or entity is deemed to own an interest that is directly owned by another person or entity.  Ownership attribution typically flows between family members, but it is also possible for it to flow from a company to one or more of its shareholders.  If it wasn’t already complicated enough, the regulations contain three different sets of rules for determining attributed ownership depending on the purpose.

The reason all of this matters is that companies that are part of the same controlled group or affiliated service group must be treated as a single employer when it comes to retirement benefits (and healthcare benefits under the Affordable Care Act).  That doesn’t necessarily mean that all employees of all related companies must receive the same benefits, but it does mean that they must all be counted in the nondiscrimination testing that is done each year.

As a result, it is important to run through some detailed analysis when there is a controlled group or affiliated service group to ensure that whatever type of plan is put in place will pass those annual tests when the group is looked at as a whole.


Multiple Employer Plans (MEPs)

Sometimes, there are several companies with common ownership that falls below the threshold to be part of a controlled group or affiliated service group, but there is enough commonality that they still want to have a single retirement plan that covers all the employees of those companies.  That can often be accomplished through what is called a multiple employer plan or MEP.  A MEP is simply a single plan that covers multiple unrelated employers.  This is not to be confused with a multiemployer plan, which is one that covers a group of union members pursuant to a collective bargaining agreement.

A MEP is a single plan, so it files a single Form 5500 each year.  However, each separate employer that is part of a MEP must satisfy the annual nondiscrimination tests separate and apart from the others.

In any of these situations, there is no “right” answer as to whether all the companies should be part of the same plan or have separate plans.  It all comes down to understanding what the objectives are for the group and then designing a plan or plans that best meet those objectives while also staying compliant with the various tests and filing requirements.  Given the complexity of these rules, it is important to work with experienced professionals.


Mergers & Acquisitions

So what happens if there is a structural change in the middle of the year – when  mergers and acquisitions or a spin-off either creates or breaks up a group of related companies?  Good question, and also one that can (and does) fill entire books.

The short answer is that there is usually a transition period that gives the companies time to figure out whether and how to redesign their plans to satisfy all the rules.  That transition period runs through the end of the year following the year in which the business transaction takes place – so at least a year and maybe as long as two years, depending on the exact date of the transaction.  There are a whole host of caveats and conditions, but we will spare you those here.  Suffice it to say that the earlier the better when it comes to reviewing the plan design post-merger. The analysis takes time, and any resulting changes could take longer still. Waiting until the end of the transition period to get started often leads to unpleasant results.

Looking beyond the transition period, the options vary depending on how many plans and how many companies are in the mix.  If ABC Company buys XYZ Company and they both have their own retirement plans, ABC may choose to terminate XYZ’s plan, merge the XYZ plan into the ABC plan, or continue to run both plans concurrently.  The availability of those options depends on the type of transaction – stock or asset – as well as the timing.  For example, if there is a stock acquisition, any plan terminations must occur before the transaction closes.  Once the deal is done, termination is off the table.

This can get tricky, because benefit plans are not usually high on the priority list when a merger or acquisition is being negotiated.  There is also the fact that there is often a high degree of confidentiality surrounding the negotiations.  If you find yourself in this situation, it is important to find a way to bring it to the attention of your TPA or other consultant – even if generically with names removed for protection – so that you can get the guidance you need to preserve all available options.

See…determining who the “employer” is isn’t quite so straight-forward after all.

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