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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Credit: TaxFact
