Parity for Owner-employees After Tefra
| Publication year | 1984 |
| Pages | 1189 |
1984, July, Pg. 1189. Parity for Owner-Employees After TEFRA
The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") purports to achieve parity in retirement plan incentives after 1983 between owners of "C" corporations and owners doing business as sole proprietorships, partnerships or "S" corporations.(fn1) Two examples of this purported parity, among others, are that: (1) annual contributions limits for all defined contribution plans cannot exceed the lesser of 25 percent of compensation or $30,000;(fn2) and (2) self-employed individuals, partnerships and S corporations can act as the trustee for their plan(s).(fn3) Indeed, so sanguine was Congress that parity was achieved, it also enacted a TEFRA transitional rule, which would allow personal service corporations to liquidate during 1983 or 1984 under § 333 (one month liquidation) without the risk that the corporation would incur tax on its unrealized receivables.(fn4)
However, such ostensible parity has not really been achieved, as manifested by (1) an analysis of a TEFRA amendment regarding the computation of earned income; (2) the continued prohibition from borrowing from their plans; and (3) service termination provisions which limit the use of rollovers to other plans and ten-year averaging of a lump sum distribution. Depending upon the owner's desires and circumstances, these subtle distinctions can have a substantial impact on the owner's decision to incorporate, disincorporate or elect Subchapter S status, especially in light of the nonretirement tax distinctions.
This article describes the circumstances that result in these discriminatory distinctions for business owners and outlines the nonretirement tax distinctions that not only were generally untouched, but were also extended to S corporations by TEFRA.(fn5)
Historically, Congress has chosen to discriminate in favor of "employees" over "owners" in the fringe benefit and retirement plan areas. However, this desirable employee status for business owners could be obtained by merely incorporating. By so doing, the corporation was considered the employer due to state law recognition of its separate legal identity regardless of whether a Subchapter S election was made.
On the other hand, unincorporated business owners were only deemed employees for certain purposes and were, and continue to be, designated as "owner-employees" or simply IRC § 401(c)(1) employees. For example, under § 401(c), self-employed individuals and partners owning more than a 10 percent capital or profits interest in the partnership are deemed to be employees for the purpose of § 401, dealing with qualified pension and profit-sharing plan trusts.
Unfortunately for business owners, many statutory fringe benefits and retirement benefits either specifically exclude owner-employees or § 401(c)(1) employees, or refer only to "employees." Consequently, § 401(c)(1) owner-employees currently are denied numerous benefits. Also, these employees are denied tax-free fringe benefit treatment on a number of items, delineated below, because S corporation employees are deemed to be owner-employees rather than employees in the following two situations: (1) if the employee is a 2 percent shareholder(fn6) and (2) the right to borrow from their qualified retirement plans, if the employee is a more than 5 percent shareholder.(fn7) In these two situations, S corporation employees are referred to as "shareholder-employees."
In contrast to owner-employees and shareholder-employees, "C" corporation employees enjoy the following nonretirement fringe benefits paid in before-tax dollars: (1) group-term life insurance (§ 79); certain accident and
health plans (§§ 105 and 106); certain employee death benefits (§ 101); meals and lodging furnished for the convenience of the employer (§ 119), and qualified transportation expenses (§ 124). Moreover, owner-employees and shareholder-employees cannot participate in the firm's "cafeteria plan," which allows the owner-employees the luxury of choosing which fringe benefits, either taxable or nontaxable, they desire without recognition of income under the constructive receipt doctrine.(fn8)
Although, commencing in 1984, all defined contribution...
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