When it comes to a 401(k) plan, it’s important to understand IRS ownership and family attribution rules, as they can impact all aspects of running a plan, including compliance testing, highly compensated employee (HCE) and key employee determinations, and many other plan functions. Ownership is also important for determining if your company is part of a legally related group.
While ownership of a business may seem straightforward, the rules can be complex in some circumstances.
Constructive ownership
A participant’s ownership interest is the highest level of vote or value held at any point during the year. A participant who holds restricted stock or an exercisable option to acquire stock is treated as owning the stock for purposes of determining ownership.
A few general rules about constructive ownership include:
Stock options: Stock is considered owned by the individual who has an option to purchase it. (This should not be confused with a right of first refusal, which is not attributed.)
Partnership ownership: Stock owned by a partnership is considered owned by a partner, in proportion to the partnership interest.
Estate/trust ownership: Stock owned by an estate or trust is considered owned by a beneficiary, to the extent of actuarial interest (determined by assuming maximum exercise of discretion in favor of the beneficiary).
Grantor trust ownership: Stock owned by a grantor trust is considered owned by the owner of the grantor trust.
Corporation ownership: Stock owned by a corporation is considered owned by an owner of the stock of that corporation.
Generally, for employees who hold vested options or restricted stock, these holdings should be included in determining ownership percentage. Because determining ownership percentages can be complex, we suggest working with your tax advisor.
Individual or family attribution of ownership
Determining ownership doesn’t stop at calculating direct ownership of stock – family attribution must also be considered. Attribution means a person is considered to be an owner simply because they are related to the owner of the stock.
As a result, if one family member owns all or a portion of a business, a close relative is deemed to own the same amount as the actual stock owner. The definition of “close relative” will vary depending on why ownership is being considered.
Family attribution of ownership for HCE, key employee, and required minimum distribution (RMD) purposes
One of the most important determinations that needs to be made to keep the plan compliant is who is considered HCEs or key employees. Family attribution can have a major impact on this determination, which is why we ask for this information each year as part of the compensation task.
When determining ownership for HCE, key employee, and required minimum distribution (RMD) purposes, an actual owner’s shares will be attributed to their:
Spouse, excluding legally separated or divorced
Child, including legally adopted children, regardless of age
Parent
Grandparent
Ownership for the above purposes is not passed along to grandchildren or siblings. Additionally, ownership is only passed along once. For example, a true owner's ownership will be attributed to their parents. However, the attributed ownership of the parent will not be further attributed to the true owner's siblings through the parents.
Ownership, attributed or actual, does not mean that an individual is eligible to participate in the plan. Only family members that are employed by your company and have met all eligibility requirements are eligible to participate in your 401(k) plan.
So, what does this all mean? Simply put, if someone owns all, or part of, a business their spouse, children, parents, and grandparents — if any of them are participants in the plan — are also considered owners and would be designated as HCEs and/or key employees, with the same ownership percentage as the actual owner. This would mean that the family member of a more than 5% owner who has reached their RMD age will still need to take the RMD, even if they’re still employed (since that family member will also be treated as a more than 5% owner).
If the owner of the company (who owns more than 5% of the company) employs their spouse, adult child, and niece as part-time employees, the spouse and child should both be listed as more than 5% owners. The niece does not need to be listed since their relationship is not considered for family attribution rules.
Family attribution of ownership when determining legally related group (LRG) status
When determining ownership for LRG status, an individual's ownership will be attributed to their:
Spouse, excluding legally separated or divorced
Child, if the child is under age 21
Child, regardless of age, if the individual owns (directly or through attribution) more than 50% of the stock
Parent, if the individual is under age 21
Parent, regardless of age, if the individual owns (directly or through attribution) more than 50% of the stock
Grandparent, only if the individual owns (directly or through attribution) more than 50% of the stock
Grandchild, only if the grandchild owns (directly or through attribution) more than 50% of the stock
There are several exceptions to the attribution rules for LRG status. Starting in 2024, marital property laws can be disregarded when determining actual ownership. Additionally, starting in 2024, an LRG will not exist solely due to two individuals having a minor child in common. You can find more information on exceptions to LRG status here.
What does ownership and family attribution mean for your Guideline 401(k) plan?
Because ownership rules can impact your 401(k) plan, it’s important to confirm that all employees, including owners, children, and spouses of owners, have been identified correctly within your plan. Plan ownership must be accurate to ensure correct nondiscrimination testing results, profit sharing allocations, and much more.
Note that family attribution for determining LRG status is not stored in the Guideline system and does not need to be reported to Guideline (Guideline does not determine LRG status of plans). Guideline does, however, need ownership information for purposes of HCE, key employee, and RMD rules. This means that when you report ownership percentages of owners to Guideline, you must also report ownership by attribution to Guideline.