The SECURE Act 2.0, signed into law in December 2022, brought significant reforms to retirement savings, building on the foundation of the original SECURE Act passed in 2019. While much of the focus has been on provisions related to Required Minimum Distributions (RMDs), catch-up contributions, and auto-enrollment, one of the lesser-known but critical areas of reform involves changes to the controlled group rules that impact Solo 401(k) plans.
For small business owners, independent contractors, and self-employed individuals who utilize Solo 401(k) plans, these changes can have profound implications, particularly if they own multiple businesses. This article explores the updates to controlled group rules, how they affect Solo 401(k) plan owners, and steps to ensure compliance.
Overview of the 401(k) Controlled Group Rules
Controlled group rules are part of the Internal Revenue Code (IRC) Section 414 and ERISA (Employee Retirement Income Security Act). They define how companies under common ownership or control must be treated for retirement plan purposes. These rules ensure that businesses cannot use multiple entities to avoid providing 401(k) plan retirement benefits or to bypass ERISA nondiscrimination rules that ensure fair access to retirement plans.
There are four types of controlled groups:
- Parent-Subsidiary Controlled Group: A parent company owns at least 80% of one or more subsidiaries.
- Brother-Sister Controlled Group: Two or more companies are owned by the same five or fewer individuals, trusts, or estates, with at least 80% combined voting power or ownership.
- Combined Controlled Group: A combination of parent-subsidiary and brother-sister groups.
- Affiliated Service: Affiliated service group (ASG) rules were created to ensure that businesses that are economically or operationally connected must be treated as a single entity for retirement plan purposes.
How They Apply to Retirement Plans
For retirement plan purposes, controlled group rules prevent business owners from circumventing contribution limits or testing requirements by operating multiple businesses. If two or more businesses are part of a controlled group, they are generally considered one employer for retirement plan purposes. You must take into account the following:
- Contribution Limits: The combined businesses must adhere to the annual contribution limits as if they were one entity. The owner cannot contribute the maximum amount in multiple Solo 401(k)s for different businesses within a controlled group.
- Nondiscrimination Testing: If a business owner has employees in one business but not in another, controlled group rules ensure that the owner cannot set up a plan solely for their benefit while excluding employees.
Before SECURE 2, the controlled group rules were relatively strict but straightforward, with well-established definitions of control and ownership. However, SECURE Act 2.0 introduced several changes that broaden the scope of what qualifies as a controlled group, potentially affecting Solo 401(k) participants with multiple business interests.
Key Changes to the 401(k) Controlled Group Rules Under SECURE Act 2.0
One of the most significant changes under SECURE Act 2.0 is the expansion of the controlled group definition. Specifically, the act now broadens the conditions under which businesses are considered part of the same controlled group, making it harder for business owners to avoid treating their various enterprises as a single employer for retirement plan purposes.
In particular, the Act introduced changes regarding common ownership thresholds and indirect control:
Common Ownership – SECURE Act 2.0 reduces the ownership thresholds at which businesses are considered part of the same controlled group. This makes it easier for businesses with shared or overlapping ownership to be treated as a single entity for retirement plan purposes.
Indirect Control – The act also extends controlled group treatment to scenarios where indirect control exists, including cases where ownership is held through trusts, estates, or other entities.
Relaxation of Spousal Attribution Rules
Before the changes in SECURE 2, spousal attribution rules automatically attributed ownership from one spouse to the other for controlled group purposes. This often resulted in two businesses, owned separately by a husband and wife, being treated as part of the same controlled group, even if the spouses did not operate the businesses together. If one spouse established a Solo 401(k) plan, the other spouse and his or her full-time employees, if applicable, would be required to receive the plan benefits even if they were separate businesses. This would entail the spouse wishing to establish a Solo 401(k) to abandon the option and instead establish an ERISA 401(k) plan.
The Act relaxes these spousal attribution-controlled group rules, making it possible for businesses owned by spouses to avoid being grouped together as a controlled group, provided they meet certain criteria. Specifically, if one spouse has no active involvement in the other spouse’s business, the attribution rules would likely not apply. This can prevent the businesses from being treated as a single entity for 401(k) plan compliance purposes, allowing each business to administer its own solo 401(k) plan independently.
Impact on Common Law Relationships
The common law relationship rules were similarly impacted. In states that recognize common law marriages, business ownership between partners in a common law relationship could also trigger spousal attribution under the old rules.
The SECURE Act 2.0 ensures that businesses owned by partners in a common law relationship are treated similarly to those owned by legally married spouses, allowing for the relaxation of attribution rules in these cases as well. This provides consistency in how businesses are treated.
Application in Family-Owned Businesses:
For family-owned businesses, these changes are especially relevant. Prior to the SECURE 2, a family’s separate businesses could have been unexpectedly combined into a single controlled group simply because of spousal ownership, which could complicate 401(k) plan administration. The new controlled group rules allow for more flexibility, ensuring that businesses with separate ownership by spouses or common law partners are not automatically grouped together unless there is active involvement in each other’s businesses.
What is a Solo 401(k)?
A Solo 401(k) is a retirement savings plan designed for self-employed individuals and small business owners with no employees (other than a spouse). This type of plan allows business owners to contribute both as an employer and an employee, potentially leading to higher contribution limits than other retirement options like an IRA.
Key features include:
- High Contribution Limits: In 2024, Solo 401(k) participants can contribute up to $66,000 as a combination of employee salary deferrals and employer contributions (or $73,500 if age 50 or older).
- Flexibility: Business owners can choose traditional or Roth contributions, giving them tax flexibility.
- Investment Options: Invest in traditional, as well as nontraditional (alternative) assets.
Solo 401(k)s are attractive because they offer substantial tax benefits and flexible contributions. However, the rules governing them can become more complex when the owner has multiple business interests, particularly due to controlled group rules.
Impact on Solo 401(k) Plans
The changes to the controlled group rules significantly impact Solo 401(k) plan owners, particularly those who own or control multiple businesses. The main impacts include:
Contribution Limits: If multiple businesses are now treated as a controlled group, the owner must adhere to a single annual contribution limit across all businesses. This can reduce the total amount they can contribute to Solo 401(k) plans.
Plan Aggregation: Owners of multiple businesses may be required to aggregate their retirement plans and ensure that all businesses in the controlled group offer the same benefits to employees, if applicable.
Increased Compliance Requirements: Owners may need to reassess their retirement plan structures and ensure compliance with the new controlled group rules, which may require additional record-keeping and administration.
Compliance Steps for Solo 401(k) Owners
Given the changes brought by the SECURE Act 2.0, Solo 401(k) owners should take several steps to ensure compliance:
- Review Ownership Structure: Business owners should conduct a thorough review of their business ownership structures, including indirect ownership through trusts, family members, or other entities.
- Consult a Tax Professional: Given the complexity of the new controlled group rules, it is critical to consult with a tax professional or retirement plan expert to determine whether your businesses now fall under the expanded controlled group definitions.
- Reassess Contribution Strategy: If businesses are now considered part of a controlled group, Solo 401(k) participants should reevaluate their contribution strategies to ensure they stay within IRS limits and avoid excess contributions.
- Update Plan Documents: If changes to the controlled group status affect how businesses administer their retirement plans, owners may need to update their plan documents and ensure that they comply with the new rules.
Conclusion
The SECURE Act 2.0 has made significant changes to the controlled group rules that affect Solo 401(k) plans. For small business owners and self-employed individuals with multiple business interests, these changes mean greater scrutiny and potential aggregation of their retirement plans.
However, the changes to the controlled group rules for spouses and common law relationships under the Act provide much-needed relief for businesses that were previously subject to spousal attribution rules. By relaxing these rules, the Act allows businesses owned by spouses or partners in common law relationships to maintain independent 401(k) plans, reducing the administrative burden, and simplifying plan compliance.
To avoid penalties and ensure compliance, business owners must be proactive in reviewing their ownership structures, understanding the new rules, and adjusting their retirement plan strategies accordingly. By staying informed and seeking expert guidance, Solo 401(k) participants can continue to take advantage of the significant tax benefits offered by these plans while remaining compliant with the evolving regulatory landscape.
