When two or more businesses are members of an affiliated service group (ASG), they are considered a single employer for 401(k) plan purposes. Like the controlled group rules, the ASG rules exist to keep business owners from splitting a business into artificial entities to exclude their low- and middle-income employees from plan participation. When a 401(k) plan excludes the employees of an ASG member, failed coverage testing is often the result. A basic understanding of the ASG rules can help business owners avoid this trouble.
The ASG rules are significantly more complicated than the controlled group rule. As such, an ASG determination from a qualified ERISA attorney is strongly recommended when a business needs clarification about its ASG status. Here are the basics.
An affiliated service group (ASG) is two or more entities with a service relationship and, in some cases, an ownership relationship. As described in IRC section 414(m), an ASG can fall into one of three categories:
A 401(k) plan sponsored by one or more members of an ASG must pass coverage testing on an ASG basis (i.e., considering all eligible employees of the ASG).
An A-Org group consists of an entity designated as a First Service Organization (FSO) and at least one “A-Org.”
A first service organization (FSO) must be a “service organization.” Organizations engaged in the following fields are considered service organizations: health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, and insurance fields. Other organizations can also qualify if capital is not a material income producing factor.
Capital is not a material income-producing factor when a business’ income consists principally of fees, commissions or other compensation for personal services performed by an individual.
A FSO can be any entity type (e.g., corporation, partnership, or sole proprietorship).
To be an A-org, an organization must satisfy a two-part test:
Source: Internal Revenue Service
Emily is an incorporated attorney. Her corporation is a partner in a law firm. Emily’s corporation provides paralegal services for other attorneys in the law firm. Emily’s employees work directly for her corporation, not the law firm.
In this example, Emily’s corporation is an A-Org because it is a partner in the law firm and is regularly associated with the law firm in performing services for third parties.
A B-Org group consists of an FSO - or an A-Org related to an FSO - and at least one “B-Org.” The requirements for an FSO are the same for a B-Org group as an A-Org group.
To be a B-Org, an organization must meet the following requirements:
A B-Org need not be a service organization.
Source: Internal Revenue Service
ABC Company is a financial services organization with six partners with equal ownership. Each partner of ABC Company also owns 2% of DEF Company. DEF Company provides services to ABC Company of a type historically performed by employees in the financial services field. A significant portion of the business of DEF Company consists of providing services to ABC Company.
In this example, DEF Company a B-Org because:
A management-type affiliated service group exists when:
There does not need to be any common ownership between the management and recipient organizations.
Management functions must be management activities and services historically performed by employees when determining, implementing, or supervising any of the following:
The ABC Company and DEF Company represent a controlled group, while GHI Company and JKL Company represent an A-Org group. ABC performs “management functions” for GHI and these management functions meet the “principal business” on a “regular and continuing basis” tests.
In this example, ABC and DEF are considered a single management organization due to their controlled group status, while GHI and JKL are considered a single recipient organization due to their A-Org status. In short, all four companies - ABC, DEF, GHI, and JKL – represent an ASG.
When a 401(k) plan fails coverage testing, the consequences for the employer can be severe. To correct a failure, plan eligibility must be expanded retroactively to cover more employees. This process often requires the employer to make a Qualified Nonelective Contribution (QNEC) to the new participants. Stiff IRS penalties – including fines and plan disqualification – may also apply.
Excluding the employees of an ASG member is often the cause for failed coverage testing. If you are unsure about your company’s ASG status, consult your 401(k) provider or legal counsel.