Good news for spouses who own and run separate businesses—revised family attribution rules under the SECURE 2.0 Act of 2022 (the Act), effective for plan years after December 31, 2023, will permit businesses owned separately by spouses to provide benefits to their respective employees without necessarily having to count the employees of the other spouse. Given the nature of these changes, family-owned entities in particular should understand how the Act may alter the employee populations counted for qualified retirement plans and also for identifying Applicable Large Employer status under the health insurance mandate of the Affordable Care Act (ACA).
What is Family Attribution, and Why Should We Care?
Family attribution is one way that two separate employers can be connected to create a group of Related Employers for employee benefits compliance purposes. Related Employers are two or more entities that are sufficiently connected with one another, under the rules of the Internal Revenue Code, to be treated as a single employer for qualified plan purposes. The types of Related Employer are controlled groups (CGs) and affiliated service groups (ASGs).
It is important to identify what entities are in a Related Employer group because any benefit plan sponsored by an entity in a group must take into account the employee population of the entire group in annual compliance testing, as though they were all a single employer. Additionally, under the ACA regulations, Related Employers are counted together for the purpose of meeting the threshold of 50 or more full-time equivalent employees. Considering the range of penalties that can accrue under ERISA and ACA as a result of failing to identify a Related Employer group, it is important for every plan sponsor to know whether they’re in a Related Employer group.
What creates a Related Employer group? A key element is cross ownership. For example, two otherwise separate operating entities owned by one person are Related Employers under the Code. In addition to such direct ownership, constructive ownership can be assigned to a person under the family attribution rules of the Code arising from the person’s family relationships. For example, spouses may be deemed to own one another’s entities, and children may be deemed to own their parents’ entities.
The Act eliminates ownership arising from community property principles.
Before SECURE 2.0, the Related Employer rules have treated spousal ownership in community property states differently from the non-community property states. Direct ownership was attributed between spouses in the nine community property states in the country; while inthe non-community-property states, ownership between spouses is presumed but can be overcome if the facts under a four-part test demonstrating that the non-owner spouse is completely uninvolved in the owner spouse’s business.
The Act addressed this inequity between community property and non-community property states by removing the application of the community property rules from the Related Employer analysis. Specifically, the Controlled Group definition at Code section 414(b) and the Affiliated Service Group definition at Code section 414(m) are amended to disregard community property rules for purposes of identifying ownership. As a result, as of the effective date of the Act, the non-involvement exception will be applicable in all states when determining the Related Employer status of spouse-owned entities.
Child-to-Parent attribution is no longer the sole basis for linking parent-owned entities.
Prior to SECURE 2.0, the Related Employer ownership attribution rules linked two otherwise unrelated businesses because the owners were parents of the same young child. The Act reforms this overly broad attribution rule by amending Code section 1563 (for Controlled Groups) and section 318 (for Affiliated Service Groups) to eliminate ownership attribution between individuals arising solely as a result of being parents of the same child (under age 21).
For benefits plans that experience changes to their Related Employer status as a result of these provisions, the Act grants relief under the transition rule of Code section 410(b)(6)(C). This generally means that plans affected by the change would have a year after the change before disaggregated testing is required.
These sensible reforms will permit small businesses to design their employee benefits on their own terms, without reference to an unrelated set of employees. However, the change will require entities that are currently in Related Employer groups under the affected family attribution rules to disaggregate their employee populations after January 1, 2024.
Examples of how the change will work
Example 1 (Qualified Plan Non-Discrimination Testing):
A married couple in California (a community property state) each has their own, separate business, one a doctor’s office, employing mostly highly compensated employees (HCEs), and the other an auto repair shop employing mostly non-highly compensated people (NHCEs). Each spouse is completely uninvolved in the other spouse’s business and meets the 4-part test under Code section 1563(e)(5) to qualify for the exception from spousal attribution.
The doctor spouse would like to offer a defined benefit retirement plan to her employees; but this would be quite expensive to do under the current Related Employer rules, which (in California) treat the doctor as an employer of the auto shop employees. As of January 2024, the doctor will be able to offer her employees a plan without having to also cover any of her spouse’s auto shop employees.
Example 2 (ACA Applicable Large Employer Definition): An unmarried couple with minor children each owns a separate business that meets the attribution exception at Code sec. 1563(e)(5), one with 40 full-time equivalent employees and the other with 15. The current child-parent attribution rule creates a single Related Employer entity of the two businesses, because the 100% ownership of both companies is attributed to the children, creating a Related Employer group. Accordingly, the total employee count of the Related Employer entity is 55, which makes them an Applicable Large Employer under ACA, subject to the employer health insurance mandate. Following the effective date of the Act, however, neither spouse-owned employer will be an Applicable Large Employer (ALE), as each business will be evaluated separately.
As employers who are not ALEs, the two small entities will now have the choice to:
- Not offer insurance coverage,
- Offer coverage that is not minimum essential coverage, or
- Require employees to pay the full cost – ACA affordability is not an issue.
The period before the January 1, 2024 effective date (for calendar year plans) provides a valuable opportunity for small businesses to take a look at the effect of the Act on their Related Employer group. Employers may well find that adjustments are warranted not only for compliance but also for a better fit with their business and benefits goals.