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Robert Bloink and William H. Byrnes

Regulation and Compliance > Federal Regulation

This Overlooked Secure 2.0 Change Helps Business-Owning Spouses

By Robert Bloink By William H. Byrnes

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What You Need to Know

  • The directives governing nondiscrimination testing in the retirement plan context are extremely complicated.
  • Before the 2022 law, family attribution rules limited the flexibility of some businesses offering retirement benefits.
  • Small-business owners in community property states and owners with minor children should pay close attention to the changes.

The Secure 2.0 Act has had a widespread impact on retirement plans, especially in the small-business context. Changes to the beginning age for required minimum distributions and the “Rothification” of catch-up contributions for higher earnings have gained significant attention.

One commonly overlooked adjustment is expected to make it easier for closely held businesses to satisfy existing retirement plan nondiscrimination rules.

Before the 2022 legislation, two spouses who each have ownership interest in separate businesses often ran into problems trying to pass nondiscrimination testing due to the family attribution rules. This often limited the flexibility of businesses offering retirement benefits solely due to state community property laws or the existence of minor children.

While much of the law is beyond the scope of this article, Secure 2.0 created two important exceptions that can help owners of closely held businesses offer retirement plans without running afoul of the Internal Revenue Service.

Family Attribution: Background

The government prohibits business owners from establishing retirement plans that primarily benefit highly compensated employees while excluding other less highly compensated individuals. To prevent businesses from using multiple entities to provide benefits primarily to highly compensated employees and pass the anti-discrimination tests, the law treats certain related entities as a single entity for nondiscrimination testing purposes. 

These “controlled group” rules evaluate the ownership structure of related entities. If enough common ownership exists, the entities are deemed to be a single business for retirement plan testing purposes. Similarly, when applying the law, individuals may be regarded as owning business interests owned by certain family members — including spouses and minor children.

Before Secure 2.0, one spouse was always viewed as owning the business interests that were owned by their spouse unless a spousal exception applied. 

Under IRC Section 414, the spousal exception applies if all of the following are true:

  • The spouse has no direct interest in their spouse’s business.
  • The spouse does not participate in management of their spouse’s business, and is not a director, officer or employee of that business.
  • No more than 50% of that business’ income is passive, deriving from rents, royalties, dividends, interest and annuities.
  • The spouse’s ownership interests are not subject to restrictions on the spouse’s ability to dispose of them that favor the other spouse or their minor children.

Ignoring attribution rules can expose the sponsoring business to penalties and potential disqualification.

Attribution in Community Property States

Couples who live in community property states were previously unable to qualify for the spousal exception. In such states, each spouse is deemed to own 50% of their spouse’s assets acquired during the marriage. Secure 2.0 overrides community property laws for purposes of the Section 414 spousal exception.

For example, assume David and Judy are a married couple residing in Texas, a community property state. During the marriage, each spouse established their own separate business, owning 100% of the interests. The two businesses are unrelated, but before the 2022 legislation, David was treated as owning 50% of Judy’s business and vice versa under Texas law. The couple was unable to qualify for the spousal exception because they could not satisfy the “no direct interest” requirement.

Since Secure 2.0, no controlled group is deemed to exist because Texas’ community property laws are disregarded. Beginning in 2024, David and Judy can each establish individual retirement plans for their business, structured to pass the nondiscrimination testing rules considering only the individual company’s employees. 

Attribution and Minor Children

Before Secure 2.0, children younger than 21 were treated as though they owned 100% of their parents’ business assets when determining whether a controlled group existed. Therefore, if two individuals owned separate businesses, a child in common would be deemed to own 100% of each parent’s business. That was true regardless of whether the two parents were ever married. 

Considering the example above, assume that David and Judy had a 7-year-old child, Meredith. Before the 2022 legislation, Meredith was deemed to own 100% of David’s business and 100% of Judy’s business. David and Judy were unable to qualify for the Section 414 spousal exception solely because of Meredith’s existence.

Secure 2.0 changed the rules to disaggregate ownership of two businesses where common ownership was based solely on the existence of a minor child.  

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Robert Bloink

William H. Byrnes

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