The issue of a successor employer and whether it must be aggregated for IRC Section 415 purposes with a predecessor employer is a fairly common situation when a professional entity such as a law firm operates for many years in a particular form (e.g., sole prop or LLC) and then later becomes part of a larger entity or partnership. Alternatively, sometimes the original entity merely incorporates without changing any other aspect of its business. While this is most common with professionals such as physicians or attorneys, it could occur with almost any business.
As an example, assume that the original entity sponsored a DB plan for five years and then the plan terminated and the sole participant rolled over their 415 maximum to an IRA. The question is whether a “new” entity which began after the prior entity’s DB was terminated can start with a fresh 415 limit (for the participant who comes over from the prior entity) or whether it must consider the distribution and years of participation from the prior plan. To answer that question, we must determine whether the prior entity is treated as a predecessor employer and accordingly whether the new entity is considered as a successor to that employer.
The answer is found in IRC Section 414(a)(1) and (2) and is also addressed in Treas. Reg. 1.415(f)-1(c). There are two possible scenarios laid out in the regulations. The first is answered quite clearly, while the second is far more nebulous:
1. If the new business entity continues to maintain the plan of the prior entity, then that new entity is a “successor employer” and must take into account a participant’s benefits under that plan for 415 purposes. The good news is that the 415 service can also be tacked on from the predecessor entity, which in some cases can allow additional benefits to accrue in the new plan. But it is clear that in this situation the 415 limits would include all benefits under the plan, even if the new employer operates quite differently from the prior entity.
2. If the new entity does not maintain the plan of the prior entity, then the 415 limits would include benefits from the DB of the prior entity only if that employer is treated as a “predecessor employer.” Unfortunately, the determination of that is based upon facts and circumstances. The 415 regulations state that when the employer constitutes a continuation of all or a portion of the trade or business then the prior entity is a “predecessor employer” and the current entity is a “successor employer.” This could occur where the formation of the new employer is a mere formal or technical change in the employment relationship (e.g., from an LLC to a partnership) yet it could also occur if the substance and administration of the business operations are substantially similar from the prior to the current entity.
So, for example, if an attorney in sole practice becomes part of a partnership but continues to perform the same legal services for the same clients, it is reasonable to assume that any DB in his sole practice must be considered for 415 purposes in any DB plan in which he participates in the new entity. In other words, the prior practice would be a “predecessor employer” and the new partnership would be a “successor employer” with regard to that attorney. Would it matter if the new partnership was a 50/50 arrangement or a 200-life law firm with 40 partners? This important distinction is not answered in the regulations.
Does it matter if the attorney services the same clients in the new partnership that he did in his original sole practice? Or should we compare the actual services he provides under the two entities, whether to existing clients or new clients, and if they are substantially similar then presume a predecessor/successor relationship exists? And how does this analysis work for employees of other businesses that become part of a new entity where similar services are provided?
It is important to note that we are not actually making a controlled or affiliated service group determination here, especially since the two entities may never have existed at the same time (or perhaps may have, in the case of a former sole proprietorship). The sole test is whether the new employer resembles the prior employer in terms of the trade or business and the particular employee’s services rendered under that business.
What seems clearest here is that many of these situations require an ERISA attorney to make the proper legal judgment.
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