8726 / Can a self-employed individual participate in a retirement savings plan?
While employers are often required to include all employees in fringe benefit plans and retirement plans, the same requirement does not apply with respect to independent contractors. If an employer includes non-employees (including independent contractors) in a qualified plan, that plan may lose its qualified status by violating the “exclusive benefit” rule of IRC Section 401(a). Therefore, most self-employed individuals who operate as independent contractors will be ineligible to participate in retirement savings plans maintained by another taxpayer-entity.
For plan qualification purposes, a self-employed individual, as an owner-employee, is considered an “employee” for purposes of qualified plans established by that owner-employee.1 An “owner-employee” is an employee 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 profit interest in the partnership.2
Even if a partnership agreement does not specify that a “more than 10 percent interest in profits” exists 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 the partner is an owner-employee for the year.3