3932 / Who is an owner-employee for purposes of the requirements that apply to qualified plans?

An owner-employee is an employee ( Q 3827) who owns the entire interest in an unincorporated trade or business or, in the case of a partnership, owns more than 10 percent of either the capital interest or the profits interest in the partnership.¹ Even if a partnership agreement does not specify a more than 10 percent interest in profits for any partner, if the formula for dividing profits (e.g., based on a partner’s earnings productivity during the year) in operation produced a distribution at the end of the year of more than 10 percent of profits to a partner, the Tax Court has ruled that he or she is an owner-employee for the year.²

An individual who owns the entire interest in an unincorporated trade or business is treated as his or her own employer.³ Thus, a proprietor or sole practitioner who has earned income ( Q 3827) can establish a qualified plan under which he or she is both employer and employee.

A partnership is treated as the employer of each partner who is an employee ( Q 3827).⁴ Thus, partners individually cannot establish a qualified plan for a firm or solely for themselves, but the partnership can establish a plan in which the partners can participate.

Persons who are shareholder-employees in professional corporations or associations or in business corporations (including S corporations) are not self-employed individuals. These people participate in a qualified plan of the corporation as regular employees of the corporation.⁵ This is true even of a shareholder-employee who is sole owner of the corporation. S corporation pass-through income may not be treated as self-employment earnings for purposes of a Keogh plan deduction, even where the shareholder performed services for the corporation.⁶

A common law employee is an employee under common law rules, as distinguished from a self-employed individual who is considered an employee only for qualified plan purposes. An individual generally is considered an employee under common law rules if the person or organization for whom the individual performs services has the right to control and direct his or her work not only as to the result to be accomplished, but also as to the details and means by which the result is accomplished ( Q 3928).⁷

The common law rules also apply generally in determining whether an individual is an employee for Social Security purposes. Ordinarily, therefore, an individual who is an employee under Social Security is a common law employee for self-employed plan purposes.

A person’s status for self-employed plan purposes is determined by the definition of employee under the Social Security law, irrespective of whether or how the person’s earnings are covered under Social Security.

Thus, if a person is an employee under the common law rules, it is immaterial that his or her earnings are treated as self-employment income under the Social Security law. For example, a minister or other clergy who is employed by a congregation on a salaried basis is a common law employee, and not a self-employed individual, even though for Social Security purposes the person’s compensation is treated as net earnings from self-employment. Amounts received by the minister directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services, represent earnings from self-employment.

Full-time life insurance salespersons are treated as common law employees for both Social Security and qualified retirement plan purposes even though, under the common law rules, they are self-employed. This is because of special statutory provisions in the Social Security Act and the IRC. Thus, a full-time life insurance salesperson under the Social Security law is prohibited from establishing a qualified plan for himself or for herself.⁸ Depending on the salesperson’s contractual arrangements, he or she may be considered a self-employed individual for some sales or services, allowing them to establish a qualified plan. These provisions do not appear to apply to general agents and most general lines insurance agents and brokers. As a result, based on their situation, they may be considered self-employed individuals and are eligible to establish qualified plans for themselves and their employees.

Attorneys with a law firm, depending on the circumstances, can either be self-employed or have the status of an “employee” of the firm.⁹

An individual may participate in a qualified plan as a self-employed person even though the individual performs work as a common law employee for another employer. For example, an attorney who is a common law employee of a corporation and who in the evenings maintains an office in which he or she practices law is eligible to establish a plan as a self-employed person with respect to the law practice.

An individual may be self-employed with respect to some services the individual sells to a business even though he or she also provides other services to the same business as an employee. In either case, the individual may participate in a qualified plan as a self-employed person with respect to his or her self-employed earnings, even though the employer maintains a qualified plan under which the individual is covered as a common law employee.¹⁰ A tenured university professor who conducted seminars in a separate capacity at the university with which he was employed was determined by the Tax Court to be self-employed, despite objections by the IRS. As a result, he was permitted to establish a Keogh plan with amounts earned from his self-
employment.¹¹