Whether you made the mistake of thinking that you were or were not in either a controlled group of companies (CG) or an affiliated service group (ASG), your plan will have fundamental tax qualification issues that must be corrected before you wind up in an IRS audit.
The problem lies in the fact that under the Internal Revenue Code, CG’s and ASG’s are treated as one retirement plan employer and plan sponsor. If you get this wrong, multiple complications can result in plan disqualification, paying corrective contributions to the plan along with potentially large IRS audit sanction penalties, not to mention upset employees.
What If You Were Wrong and You Are Not in a CG?
Let’s say you thought that all your entities were in a CG and all the entities participated in your retirement plan as a single employer. If it turns out that some entities were not in a CG, you will have a multiple employer plan (MEP), not a single employer plan. You now have potential qualification issues, including:
- The plan document did not contain the proper MEP language and not all of the employers properly adopted the plan. This is both a plan document failure and a failure to operate the plan according to its terms. As a result, employees from multiple entities were improperly allowed into the plan.
- The minimum coverage and non-discrimination testing that was done as a single employer CG must be redone separately for each employer. It is common that one or more of the employers will fail testing when it is redone properly. This is an operational failure that may require adding employees to the plan and making corrective contributions for them in the plan plus earnings.
If these failures are found in an audit, the IRS will require that the plan document operational and testing failures be corrected for all years for which the failure occurred. The IRS will also require the payment of an audit sanction penalty based on a negotiated percentage of the tax due if the IRS disqualifies the plan.
If the plan is not yet under audit, the MEP failures can be corrected by filing an application through the IRS’s Voluntary Correction Program (VCP) requesting the IRS issue a compliance statement accepting the plan corrections. You adopt a retroactive plan document with the MEP language and have the employers who are not in the plan sponsor’s CG adopt the plan. You correct the testing and coverage failures, make any corrective contributions that the testing requires, and pay an IRS filing fee (between $1,500 and $3,500). This prevents the IRS from disqualifying your plan in an audit.
What If You Were Wrong and You Are in a CG?
The issues are very similar if you mistakenly thought that certain entities were not part of the CG or ASG with the employer sponsoring the plan when in fact they were. The employers may all have separate plans and some may not.
In this case, you do not have a plan document failure for failing to have the required MEP language, although you may have a plan document failure involving the definitions of who the employer is and who is covered under the plan or plans.
There are many potential variations to the fact pattern, including:
- A potential operational failure will occur if one of the plans was written so that the employees of all entities in the CG as the plan sponsor are eligible to participate and one employer’s employees did not participate in the plan. In this case, there may be employees improperly excluded who should have been allowed to participate and for whom corrective contributions must be made.
- If wrong about the CG status, this could result in minimum coverage and non-discrimination testing issues. You might have different employers that each sponsor their own 401(k) plan. If those plans (i) are all the same type of 401(k) plan (both traditional or both safe harbor), and (ii) share the same plan year-end, the employers’ plans can be permissively aggregated for coverage testing, making passing coverage testing easier. However, if the types of 401(k) plans and plan year ends are different, you can’t aggregate the plans and perform a single test for all the plans. This means you must separately test each plan, but include the populations of each plan in the separate testing for each plan. This makes it easier to fail the coverage and non-discrimination testing which would require corrective contributions to correct the tests.
- If you have one or more employer(s) in the CG that did not sponsor their own plan or plans, it makes it more likely that the existing plan would fail coverage and discrimination testing, requiring additional corrective contributions to pass.
- You may have different levels of benefits with different employers or groups of employees not benefitting. The likelihood of having to retroactively cover and include employees from some or all of the entities is high. Though, it is possible depending on the demographics of the employee populations in each of the entities that you will pass testing even with some employees not participating.
As noted above, it is best to correct any tax qualification failures in the VCP before being audited by the IRS to avoid plan disqualification and audit sanction penalties.
Watch Out and Be Sure
If there is an ownership group of multiple companies or if there is a group of companies that perform services for one or more of the companies or partners with other associated companies in providing services to third parties, be on the lookout.
- If you have not yet done a CG or an ASG analysis, do it now.
- If there is any possible change in the ownership structure of any of the entities being considered, do a CG analysis before the change.
- If there is any possible significant change in the amount of services that one entity performs for an associated entity and/or a change in the ownership of the entities, do an ASG analysis before the change.
If you take these steps, you will avoid that oops moment.
We’d love to start a conversation about your CG or ASG status to be sure and protect your plan from the perils of getting your CG or ASG status wrong.
For a more detailed discussion of the controlled group and affiliated service group rules, read the following articles: