SIMPLE IRA plans are a great choice for a small business. SIMPLE IRA features include:
- elective deferrals of up to $13,000 in 2019 ($12,500 in 2015, 2016, 2017 and 2018) each year (plus an additional $3,000 (in 2015, 2016, 2017, 2018 and 2019) for those age 50 and over),
- required employer matching contributions on the first 3% of elective deferrals or 2% of salary for everyone in the plan,
- no annual forms to file, and
- no nondiscrimination testing required.
A SIMPLE IRA plan must cover every employee who earned at least $5,000 in any two previous years. Also, only an employer with 100 or fewer employees may sponsor a SIMPLE IRA plan.
SIMPLE IRA plan rules can get complicated if you or your spouse are involved in more than one business. If your business is part of a controlled group or affiliated service group, the law considers the employees of the other business your employees and you must include them in your SIMPLE IRA plan.
Generally, you may need to include employees of another business in your SIMPLE IRA plan if you:
- own another business (80% or more ownership),
- are part of a group of 5 or fewer persons who own 80% or more of both your business and another business and identical interests in both businesses owned by the group members total more than 50%, or
- are part of an affiliated group of businesses working together to provide services to customers.
The rules for determining control and affiliation are detailed and you should consult your tax professional if you believe they may apply. Below are a few examples of when the employees of another business must be included in your SIMPLE IRA plan.
Example: You own 100% of Business A, which sponsors a SIMPLE IRA plan for its employees. The employees of Business B are also considered your employees, and must be included in the SIMPLE IRA plan, in the following situations:
- You directly own another business
You own 80% of Business B and the remaining 20% is owned by an unrelated party. A and B are part of your controlled group.
- Your business owns another business
Your business, A, owns 80% of Business B. A and B are part of your controlled group.
- Your spouse owns a business
Your spouse owns 100% of Business B. You do not own any interest in Business B; however, you provide significant management services for your wife’s business. Your spouse’s interest in Business B will be attributed to you and Business B is part of your controlled group.
Your spouse’s business ownership is attributed to you unless you meet all of the following:
- You do not own any direct interest in your spouse’s business,
- You do not participate in your spouse’s business as a director, fiduciary, officer, employee, and do not manage the business any time during the year
- Your spouse’s business’ income is not 50% or more passive income (rent, dividends)
- Your spouse’s ownership interest is not restricted to favor you or your minor children
- You own a business with your children
You own 60% of Business B. Your son, age 10, owns 10% of Business B and your daughter, age 30, owns 30%. Your son’s interest will be attributed to you because he is a minor. Your daughter’s interest will also be attributed to you because you own more than 50% of the business. Business B is part of your controlled group.
Failures that result when you have related businesses
Overlooking the employees of your related business can cause several plan failures:
- Employer ineligibility to sponsor a SIMPLE IRA plan occurs when:
- you have exceeded the 100-employee limit, or
- your related business sponsors another retirement plan;
- Exclusion of employees of related businesses from participating in the plan; or
- Inclusion of ineligible employees can occur if you previously included employees of a related business in your plan but that business is no longer part of your controlled group.
Fixing errors in a SIMPLE IRA plan
These failures can result in the loss of tax benefits for both the employer and employees. To correct these failures, you can use the IRS Voluntary Correction Program.
VCP has a special form for SIMPLE IRA plan sponsors to report common plan failures. Schedule 4 is specifically designed to allow sponsors of IRA-based plans to correct failures relating to:
- plan sponsor ineligibility,
- failure to make required employer contributions,
- failure to provide employees the opportunity to make deferrals, or
- contributing excess amounts to the plan.
Check the boxes for your specific failures and follow the instructions for the correction method.
Standard correction methods for SIMPLE IRA plan failures
The employer must use these standard correction methods to correct a failure in the Voluntary Correction Program using streamlined Schedule 4:
- Ineligible plan sponsor
You may be ineligible to sponsor a SIMPLE IRA plan if the combined number of employees (who earned $5,000 or more during the preceding calendar year) in your related businesses exceeds 100. In most cases, a grace period of two calendar years will apply before you are considered ineligible.
Example: In 2011, the number of employees (who earned $5,000 or more during the preceding calendar year) in your controlled group exceeded 100 for the first time. In 2012 and 2013, you continued to have over 100 employees. You became an ineligible employer in 2014.
To correct this failure, you must stop all contributions to the SIMPLE IRA plan for 2014. Your VCP submission must state the date that contributions stopped. It is not necessary to distribute amounts you contributed to the plan in 2012 and 2013.
- Exclusion of employees
If you erroneously excluded employees who were eligible to participate in the SIMPLE IRA plan, you must contribute additional amounts to the plan for each excluded employee. For employees of related businesses who were entirely excluded from the plan, the contribution will equal:
- 1.5% of compensation to reflect the employee’s missed opportunity to make a deferral election; and
- A 3% matching contribution or 2% nonelective employer contribution, depending on the employer contribution rate used at the time of the failure.
Contributions must include earnings that the excluded employee would have received and these must be calculated up to the date the corrective contribution is made.
Eligible employees are those employees who earned $5,000 or more in any 2 prior years, regardless of their age or hours of service.
If an affected employee does not have a SIMPLE IRA account, set up an account for that employee.
- Inclusion of ineligible employees
It’s possible to have a SIMPLE IRA plan failure by including employees that shouldn’t have been in your plan. If you previously included employees of a related business in your SIMPLE IRA plan, but that business is now no longer part of your controlled group, you may have a failure.
To correct the failure, the excess amounts should be distributed from the plan. The ineligible employees should be informed that:
- the contributions to their account were ineligible and should be removed from their SIMPLE IRA, and
- the distribution is not eligible for tax-free rollover to another retirement account.
Employer contributions, adjusted for earnings through the date of correction:
- should be returned to you; and
- are not included in the gross income of the affected participant or deductible by you.
The amount returned is reported on Form 1099-R as a distribution issued to the affected participant, indicating the taxable amount as zero.
Making sure it doesn’t happen again
In a controlled group, ensure that your payroll system has proper internal controls to properly apply the plan provisions. For example, if each related business determines eligibility for plan participation, they may have different interpretations of who is and who is not eligible. Finally, if you are unsure how your business is affected by the rules for controlled and affiliated service groups, consult your tax professional.