Qualified retirement plans, such as 401(k)s, are designed to provide tax-deferred retirement benefits for all eligible employees of a company whether they’re highly compensated or not. Non-discrimination and coverage rules are designed to prohibit a company from favoring owners and other highly compensated employees. Closely related entities that are within a controlled group or affiliated service group (referred to these as a legally related group) are generally treated as one employer for purposes of 401(k) plan nondiscrimination rules.
Some businesses that are not controlled groups work closely together and are considered related as an affiliated service group. Guideline requires all members of an affiliated service group to have a 401(k) plan at Guideline in order to service any plan of the affiliated service group. In addition, each plan of the legally related group must have the same plan design and be considered together for profit sharing and other discretionary contributions.
What is an affiliated service group?
An affiliated service group is a group of two or more organizations that have a service relationship and, in some cases, an ownership relationship. An affiliated service group is often a professional law, medical, or accounting practice. A common example of an affiliated service group has individually incorporated practices who share employees, such as a receptionist, to provide services to their clients. Any 401(k) plan set up by one practice would need to be tested for nondiscrimination purposes generally including all employees of all the practices.
Affiliated service groups can be broken down into two main categories: traditional affiliated service groups (which are further broken down into A or B Organizations) and management groups.
A traditional affiliated service group consists of a First Service Organization (FSO) and one or more other entities (which could be one or more A-Orgs and/or B-Orgs). The FSO must provide service and there must be at least some ownership between the FSO and the other organization (note that ownership can be attributed between entities and certain family members). “Service” is a keyword in determining whether a traditional affiliated service group exists. Health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, and insurance are deemed to be service fields but any entity where capital is not a material income-producing factor for the organization can be a service organization.
B-organization group (A-Org). This group consists of at least one FSO and at least one A-Org. A service organization is an A-Org if it owns some interest (no matter how small) in the FSO and the organization regularly performs services for the FSO or is regularly providing services to third parties with the FSO. The key to a service group is that at least one of the organizations (the FSO) must be providing services rather than goods.
Examples of A-Org Affiliated Service Groups:
A doctor is incorporated as a professional corporation and the doctor’s professional corporation is a partner in a Surgical Group. The doctor is regularly associated with the Surgical Group in performing services for third parties. The Surgical Group is an FSO. The doctor is an A-Org because it is a partner in the medical group and is regularly associated with the Surgical Group to perform services for third parties.
A corporation that is a partner in a law firm provides paralegal and administrative services for the attorneys in the law firm. All of the employees of the corporation work directly for the corporation, and none of them work directly for any of the other offices of the law firm. The law firm is an FSO. The corporation is an A-Org because it is a partner in the FSO and is regularly associated with the law firm in performing services for third parties.
B-organization group (B-Org). This group consists of an FSO and at least one B-Org. An organization is a B-Org if at least 10% of the B-Org is owned or deemed to be owned by one or more highly compensated employees of the FSO and/or its A-Orgs. In addition, a significant part of the B-Org’s business is performing services for the FSO and/or its A-Orgs and the services are those performed by employees in the same field as those of the FSO and/or its A-Orgs. If at least 10% of the B-Org’s business is performed for the FSO and/or its A-Org then it is deemed to be significant (if 5% but less than 10% of the business is performed for the FSO or A-Org, a facts and circumstances test must be met). Interestingly, however, the B-Org doesn’t need to be a service organization.
Example of a B-Org affiliated service group:
A financial services organization has 11 partners. Each partner owns one percent of the stock in a corporation that provides services to the partnership (as well as other financial services organizations). The corporation's services are of a type historically performed by employees in the financial services field and a significant portion of the corporation’s business (more than 10%) consists of providing services to the financial services organization. The financial services organization is an FSO and the corporation is a B-Org.
If the financial services organization’s 11 partners each owned 1% of a landscaping business that earned a significant portion of its business mowing the lawn for the financial services organization this would not be an affiliated service group since landscaping is not historically a service provided by financial services organizations.
A management group is more of a facts and circumstances determination. Although the entities must be “related”, there is no “service” requirement and no ownership requirement. A management group consists of a management firm and its client. A management firm is an organization that performs management functions for a client and/or organizations related to that client on a regular and continuous basis. The related organizations would then be part of the affiliated service group. There doesn’t need to be any common ownership between the two organizations, nor does the recipient organization need to be a service organization.
Example of a management group affiliated service group:
A doctor with a busy practice decides she no longer wants to deal with managing employees and paying the bills. She hires a business that manages several doctor’s offices. One owner of the management business decides to break apart as a sole proprietor and just focus on managing the doctor’s practice (but keeps one employee on her staff). Once the sole proprietor earns substantially of her income and spends all of her time managing the doctor’s practice, the two businesses become a management group and are treated as one employer.
Unfortunately, there is very little guidance on what creates a management group. If the facts are not clear, we would suggest working with legal counsel to determine whether an affiliated service group exists.
Conclusion
As noted earlier, all employees of all the businesses in an affiliated service group are considered to be employed by a single employer for purposes of several plan functions including:
ADP/ACP tests
Coverage tests
Participation rules
Vesting rules
Top-Heavy rules
Eligibility for Distributions
As a result, any 401(k) plan sponsored by one business in an affiliated service group must consider all the entities in the affiliated service group and the participants generally must be considered together for benefits and testing. This is why Guideline requires all members of an affiliated service group to have a 401(k) plan at Guideline with the same plan design in order to service any plan of the affiliated service group. Report related companies to Guideline so we can help ensure your plan complies with IRS requirements. If you believe that related companies may not have been included in compliance testing for the prior year, please notify Guideline immediately.
What happens if my company is part of a legally related group?
If your company is in a legally related group with another business (as parent/child, sister/brother, a combined group, or affiliated service group), compliance testing will be conducted at the group level as though the related entities were one entity. Guideline, or any other organization that is performing testing for companies in the legally related group, will need employee data, including each employee's salary, age, and contribution amounts, as well as year-end contribution balance, for each company in the legally related group.
Whether your plan passes compliance testing will depend in part on the coverage and participation of employees in the legally related companies. This creates challenges if one company in the group offers a more generous 401(k) plan than another, has higher participation rates, or even just has a different ratio of highly compensated and non-highly compensated employees. If any tests don’t pass, plan corrections will need to be made.
This is why Guideline requires all members of a legally related group to have a 401(k) plan at Guideline with the same plan design in order to service any plan of the legally related group.
Report legally related entities to Guideline so we can help ensure your plan complies with IRS requirements. If you believe that related companies may not have been included in compliance testing for the prior year, please notify Guideline immediately.