How SECURE 2.0 Affects Family Attribution Rules

Will the reform of family attribution rules in SECURE 2.0 affect the administration of my client's 401(k) plan? 

SECURE 2.0 is the hot topic in the retirement industry right now and has been hailed as the most important retirement enhancement legislation in more than a decade. One of the changes effective for plan years beginning after December 31, 2023, reforms the family attribution rules by redefining “employer” for qualified retirement plan (QRP) purposes.

A QRP may define “employer” to include related employers that are part of a controlled group of corporations (Internal Revenue Code Section (IRC Sec.) 414(b)), partnerships and sole proprietorships under common control (IRC Sec. 414(c)), and affiliated service groups (IRC Sec. 414(m)). Employers that are part of a related employer relationship are treated as a single employer for QRP purposes. Currently, to identify these related employer relationships, certain factors must be considered, such as community property laws and attribution rules.

NOTE: The full scope of the rules in determining controlled group and affiliated service group relationships can be extremely complex and are beyond the scope of this article.

Through Section 315 of SECURE 2.0, Congress has amended IRC Sec. 414(b), which provides guidance when determining whether certain ownership by family members is attributed to other family members for purposes of determining whether two or more companies are considered to have common ownership through a controlled group or affiliated service group. For plan years beginning in 2024, IRC Sec. 414(b) is amended as follows.

1. Community property laws are disregarded in applying the spousal exception under IRC Sec. 1563(e)(5) when defining a controlled group of corporations. Employers should seek competent tax advice when determining if they reside in a community property state and whether this change affects them.

2. If an individual’s stock ownership isn’t attributed to her spouse because of the spousal exception rules described in IRC Sec. 1563(e)(5), then the stock will generally not be attributed to the spouse under the minor children attribution rule. A minor child is defined as an individual who has not attained the age of 21.  

The amendment to IRC Sec. 414(b) appears to have limited applicability to entities taxed as corporations. It does not, however, appear to apply to other unincorporated business entities (such as partnerships or sole proprietorships). But until final guidance is provided, this may be open to interpretation.

Similarly, in defining ownership when determining affiliated service group relationships for plan years beginning in 2024, Congress has amended IRC Sec. 414(m)(6)(B) to provide for special rules in applying family attribution under IRC Sec. 318.  

1.       Community property laws are disregarded. Unlike the change to IRC Sec. 414(b), this appears to have a broader application that may affect incorporated and unincorporated business entities alike.

2.       If an individual’s stock ownership isn’t attributed to his spouse under the attribution rules described in IRC Sec. 318(a)(1)(A)(i) because of legal separation under a decree of divorce or separate maintenance, then the stock will generally not be attributed to the spouse under the minor child attribution rule. Again, minor children are defined as individuals who have not attained the age of 21. 

The amendment to IRC Sec. 414(m)(6)(B) in (2) appears to have limited applicability to stock: it may apply to entities taxed as corporations, however, it does not appear to apply to other unincorporated business entities (such as partnerships or sole proprietorships). However, until final guidance is provided, this too may be open to interpretation.

If applying these rules results in having two or more entities being treated 1) as part of a controlled group, or 2) as no longer being part of a controlled group or affiliated service group, then the change would be treated as a transaction that is eligible for IRC Sec. 410(b)(6)(C) transitional relief.  As a result, the plans would generally be deemed to have satisfied IRC Sec. 410(b) coverage testing during the transition period, which may end as late as the plan year following the year in which the change in the related employer relationship occurs (i.e., the end of the 2025 plan year). Reliance on IRC Sec. 410(b)(6)(C) transitional relief is optional and applies specifically to the IRC Sec. 410(b) coverage test.

If employers who were considered related employers under existing rules are participating in a single employer plan, it appears that once the related employer relationship ends, the plan may become a multiple employer plan (MEP) beginning on the first day of the 2024 plan year.

When reviewing the impacts of these new rules, plan administrators should contact their outside advisors and coordinate with their document provider or recordkeeper/third party administrator to 1) determine whether a plan amendment is necessary; and 2) review the compliance testing implications that may become effective the first day of the 2024 plan year.

The following examples show how SECURE 2.0 affects the family attribution rules.

Example 1

Brad and Christie are married and reside in Texas (a community property state), with no children. Both are young entrepreneurs who are operating their own incorporated start-up companies. Each spouse wholly owns 100% of the stock in their respective corporation and the spousal attribution exception under IRC Sec. 1563(e)(5)(A-D) applies.

Under current rules, when residing in a community property state, state law may (with some exceptions) treat the other spouse as having ownership in the other spouse’s business. In this example, Brad and Christie could be considered 50/50 owners in each corporation, thereby creating a controlled group relationship. Therefore, for QRP purposes the two corporations would be treated as a single employer, which may prompt both employers to 1) participate in a single plan; or 2) if maintaining separate plans, potentially be restricted in flexibility of plan design and operation.

Under Section 315 of SECURE 2.0, community property laws would be disregarded. Under the fact pattern presented above, a controlled group relationship would not exist, potentially allowing each spouse to maintain their own plan without being influenced by the other spouse’s plan.  

Example 2

Same scenario except Brad and Christie reside in Minnesota (which is not a community property state), and have a child under age 21.

Under the current rules, Brad’s ownership would be attributed to the child and Christie’s ownership would be attributed to the child. This would result in the child being a 100% owner of the stock in each corporation, creating a controlled group relationship.

Under Section 315 of SECURE 2.0, Brad and Christie’s ownership in the corporation for purposes of determining controlled group or affiliated service group relationships would not be attributed to the child. If ownership is not attributed to the child, and if the conditions for the spousal exception apply, a controlled group relationship would not exist, potentially allowing each spouse to maintain their own plan without being influenced by the other spouse’s plan.