The affiliated service group rules are some of the most confusing tax rules to navigate if one is seeking to establish a Solo 401(k) plan and the owner of the business has some close affiliation to one or more other companies. The affiliated service group rules expand the scope of what businesses must be treated as a single employer beyond the traditional controlled group rules under Internal Revenue Code (IRC) Section 414(b) and 414(c). This article will provide a short, but informative, explanation of how the affiliated service rules work and their impact on the triggering of the controlled group rules when establishing a Solo 401(k).
Three Types of Affiliated Service Groups
There are three types of affiliated service groups:
A-Organization (A-Org)
- An A-Org occurs when the organization is a partner or shareholder in the First Service Organization, FSO, (regardless of the percentage interest it owns in the FSO) determined by applying the constructive ownership rules as specified in section 318(a), and
- The organization “regularly performs services for the FSO,” or
- Is “regularly associated with the FSO in performing services for third parties.
Regardless of whether the above subparagraph applies, an organization engaged in any one or more of the following fields is a service organization:
- Health
- Law
- Engineering
- Architecture
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Insurance
B-Organization (B-Org)
A B-Org, consists of a FSO and at least one “B organization”.
For a B-Org, a significant portion of its business must be the performance of services for a FSO, for one or more A-Org’s determined with respect to the FSO, or for both:
- The services must be of a type historically performed by employees in the service field of the FSO or the A-Org’s, and
- Ten percent or more of the interests in the organization must be held, in the aggregate, by persons who are highly compensated employees
Management Group
A management-type affiliated service group exists when:
- An organization performs management functions, and
- The management organization’s principal business is performing management functions on a regular and continuing basis for a recipient organization.
There does not need to be any common ownership between the management organization and the organization for which it provides service. Any person related to the organization performing the management function is also to be included in the group that is to be treated as a single employer.
How Do Affiliated Service Group Rules Impact the Solo 401(k) Controlled Group Rules?
While controlled group rules focus primarily on common ownership and financial control, affiliated service group rules emphasize the service relationships between companies, regardless of ownership.
Here’s how these rules affect 401(k) plans:
Single Employer Treatment
If two or more companies form an affiliated service group, they are treated as a single employer for 401(k) plan eligibility purposes. This means that for plan design, eligibility, contribution limits, and nondiscrimination testing, employees across all entities must be considered as if they work for one employer.
Both controlled groups and affiliated service groups require any adopted 401(k) plans to cover employees across all entities to meet ERISA nondiscrimination requirements. The primary intent behind the IRS controlled group rules is to prevent businesses from offering better retirement benefits to one subset of employees while excluding or limiting access to others.
Nondiscrimination Testing
Under the ERISA rules, the nondiscrimination tests (such as the Actual Deferral Percentage (ADP) test and Actual Contribution Percentage (ACP) test) ensure that retirement plans, such as 401(k) plans, do not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).
When businesses are part of an affiliated service group, all employees of the affiliated entities must be included in these tests. Failing to consider employees across the ASG could result in plan disqualification.
Eligibility and Coverage Requirements
Employees of all entities in an affiliated service group must be offered access to the 401(k) plan. This includes complying with the coverage rules under IRC Section 410(b), which mandate that a 401(k) plan must cover a minimum percentage of non-highly compensated employees across all entities in the group.
In the case of a solo 401(k) plan, all employees of an affiliated service group would be deemed eligible participants of the plan and, hence, the solo 401(k) plan would need to be converted to an ERISA 401(K) plan.
Contribution Limits
The annual contribution limits and compensation limits for retirement plans are applied across all entities within the affiliated service group. This means that contributions made on behalf of employees in one entity affect contribution limits for employees in other entities.
Example of Affiliated Service Group Impact on a 401(k) Plan
Let’s assume a law firm (Company A) owns 15% of an accounting firm (Company B), and both companies regularly provide services to each other. Under the affiliated service group rules, these two companies would be considered part of an A-Organization affiliated service group.
- 401(k) Plan Coverage: Company A’s 401(k) plan must cover employees from both Company A and Company B because they are considered a single employer under the ASG rules.
- Nondiscrimination Testing: The ADP and ACP tests must take into account all employees from both companies (Company A & Company B) to ensure the plan doesn’t favor highly compensated employees.
- Contribution Limits: If an employee works for both Company A and Company B, their contributions to the 401(k) plan must be aggregated for purposes of determining whether contribution limits are exceeded.
Conclusion
In the case of a business owner that is involved with multiple businesses that are affiliated, understanding the affiliated service group rules are crucial to determine whether a business owner could establish a Solo 401(k) plan or be forced to adopt an ERISA 401(k) plan and include all employees from the multiple businesses.
As discussed above, the affiliated service group rules expand the scope of the controlled group rules by incorporating businesses connected through service relationships, not just ownership. For 401(k) plans, this means employers must ensure that their plans cover all employees across the group and comply with nondiscrimination requirements.
Employers with multiple business structures should work closely with a provider that has the expertise and experience working with the affiliated service group and controlled group rules. This ensures that if you are establishing a Solo 401(k) plan and have multiple businesses, you will establish the correct type of plan and provide benefits fairly to all eligible employees.
