If you and your spouse own separate businesses, and those businesses each qualify for a Solo 401k (presence of self-employment business activity and the absence of full-time W2 employees) – then generally speaking you are both eligible for a Solo 401k.
Whether you will share one Solo 401k or if you can maintain totally separate Solo 401k plans has to do with whether the IRS considers your two businesses part of a Controlled Group.
All businesses in a controlled group must exist under one retirement plan with one exception.
Parent-Subsidiary Controlled Group
The IRS defines two types of controlled groups. When one company owns 80% or more of another company, the two companies become a parent-subsidiary controlled group.
Let’s look at an example. A husband owns an LLC Physical Therapy practice with no full-time employees. The LLC owns 90% of his wife’s S-Corp consulting business (no employees). The two businesses are part of a parent-subsidiary controlled group.
Since neither business has full-time employees (other than the spouses), the businesses are eligible for a Solo 401k. However, the spouses will use one Solo 401k plan together. That’s because they are part of a parent-subsidiary controlled group. If the husband’s LLC owns less than 80% of his wife’s S-Corp, the two businesses may still be part of a controlled group because the two people are married. In fact, the IRS states: “Generally the ownership interests of one spouse are attributed to the other.”
Brother-Sister Controlled Group
When 5 or fewer individuals own 80% or more of each company, the two companies become a brother-sister controlled group. Example: Husband owns 100% of his single-member LLC consulting business. Wife owns 100% of her sole-shareholder S-Corp. Because the husband and wife are legally married, they are automatically considered to have shared ownership of each other’s businesses and become a brother-sister controlled group.
If we simply stop there, under IRS controlled group rules, the spouses would have to share a Solo 401k plan. If the wife decides to hire a full-time employee, both the husband and wife lose their Solo 401k eligibility. That’s because they are part of a brother-sister controlled group. The IRS views them as one big business/retirement plan.
Solo 401k Controlled Group Spousal Exception
The IRS states there isn’t any ownership attribution between spouses as long as all three rules below apply:
- “No direct ownership or participation in the management of such corporation at any time during the taxable year. Additionally, the spouse cannot be a member of the board of directors, a fiduciary, or an employee of such organization at any time during such taxable year.
- No more than 50% of business gross income is from passive investments.
- Stock is not subject to conditions that restrict a spouse’s right to dispose of the stock and that run in favor of the individual or his children under age 21.” (Source)
Let’s return to our example of the husband and wife having separate businesses but being a part of a brother-sister controlled group.
The husband setup his Solo 401k and is happily making investments. His wife’s (totally separate) business is beginning to grow and she decides it’s time to hire a full-time employee.
If we were to simply view the husband and wife as a part of the same brother-sister controlled group, the husband would lose his Solo 401k eligibility as soon as his wife hires a full-time employee.
That would mean he needs to roll out all his assets/funds/investments from his Solo 401k and shut down his Solo 401k plan.
Then Things Get Interesting
If the husband and wife meet the IRS three criteria above, they qualify for a spousal exception.
That means the wife can hire a full-time employee and lose her Solo 401k eligibility for herself and her business without affecting the husband and his Solo 401k.
The wife can grow her business (without the benefits of a Solo 401k of course). The husband can continue in his business and keep his Solo 401k.
In order to execute this successfully, the wife must not be listed on the husband’s Solo 401k documents.
That means she cannot participate or be a trustee in her husband’s plan. It also means the husband must maintain those three IRS criteria. Namely, he can’t work for, be a board member of, or own any part of her business. Second, her business can’t have more than 50% of its revenue from passive investments. Finally, their children must be older than 21 years old.
Do you and your spouse own separate businesses?
Are you wondering if you’re part of a controlled group? The best way to find out is to ask your legal counsel or tax advisor. First determine if you are part of a controlled group. Then you can determine what type of controlled group it might be (parent-subsidiary or brother-sister). Further, determine if the spousal exception applies to your situation.
This can be a very tricky part of the tax code. Make sure you engage the help and support of your trusted advisors.