Owner Only Exemption from PBGC Coverage

All defined benefit plans (including cash balance plans) are covered by the PBGC unless the plan qualifies for a statutory exemption from PBGC coverage.

There is an exemption for plans that cover only substantial owners. If a defined benefit plan covers even one employee who is not a substantial owner, then the plan does not qualify for this exemption.

In order to be a substantial owner, an individual must meet one of the following requirements:

Own 100% of an unincorporated trade or business
Own directly or indirectly more than 10% of the capital interest in a partnership
Own directly or indirectly more than 10% of the profit interest in a partnership
Own more than 10% of the voting stock of a corporation
Own stock representing more than 10% of a corporation’s value

In determining stock ownership, the ownership attribution rules used for determining controlled groups apply. Under the controlled group ownership attribution rules, an owner’s spouse is treated as owning the stock of the owner. Thus, the owner only exemption applies if all participants are substantial owners or spouses of substantial owners. However, the child of a substantial owner is not generally attributed ownership, so if defined benefit plan covers a substantial owner and his child, the plan is not exempt from PBGC coverage.

There are some other rules that are similar, but different for owners in the qualified plan arena. These differences might lead to different reporting or testing requirements, but they do not necessarily change whether a PBGC coverage exemption applies. First, certain owner-only plans are either exempt from filing a Form 5500 or may file a Form 5500-EZ in lieu of the longer Form 5500-SF or Form 5500. A plan may file a Form 5500-EZ instead of a Form 5500-SF/Form 5500 if the following requirements are met:

The plan covers the 100% owner of an incorporated or incorporated business, or the plan covers only the partners of a business partnership.
The plan may additionally cover the spouse of an owner or partners.
The plan may not cover any other employees.

Thus, to file a Form 5500-EZ, unlike the PBGC substantial owner exemption, there is no requirement that each partner own more than 10% of the employer for a plan to be eligible to file a Form 5500-EZ in lieu of the Form 5500-SF or Form 5500. Thus, not all plans that are eligible to file the Form 5500-EZ are exempt from PBGC coverage.

Second, a 5% owner of an employer is considered a Highly Compensated Employee (HCE) for nondiscrimination testing (5% owner in this context means a person owning more than 5%). The threshold for being an HCE and being a substantial owner are different. So, a defined benefit plan that covers all HCEs is not necessarily exempt from PBGC coverage.

Third, when a PBGC covered plan terminates without enough assets to pay all benefits, the PBGC will allow a majority owner to waive a portion of his benefit so that other participants will receive their entire benefit. To be a majority owner, the participant must own 50% or more of the employer. The substantial owner standard used to determine whether a plan is PBGC- covered is different from the majority owner standard used to determine whether an owner in a PBGC-covered plan may waive his benefit.