Representor Winter 2024 - Tax Matters


Avoiding 5 percent owner status for retirement plan distribution purposes

Bruce Bell

by Bruce E. Bell, CPA/Attorney

Bruce E. Bell is a CPA/Attorney practicing at the Chicago law firm of Schoenberg Finkel Beederman Bell Glazer LLC. A founding member of the firm, Bruce chairs the firm’s transactional and tax practices. He concentrates on federal tax, estate planning and general business matters. Bruce can be reached at 312-648-2300 or

Many individuals continue to work into their retirement years, whether due to financial need, personal desire or some other motivation. A meaningful portion of these workers are high-wage earners who pay tax at the maximum or near maximum income tax rates and do not wish to withdraw funds from their retirement accounts which in most cases are fully taxed at ordinary income tax rates. The question becomes whether there is a mechanism to defer the start of required minimum distributions from retirement plan accounts.

Required minimum distributions (RMDs) must be taken at certain ages from profit sharing plans, 401(k) plans, pension plans and other qualified retirement plans as well as individual retirement accounts (IRAs). RMDs must commence on or before April 1 of the calendar year following the year in which a taxpayer attains a specified age — currently age 73 — but eventually scheduled to increase to age 75. Distributions from qualified retirement plans, but not IRAs, can be deferred until April 1 of the calendar year following the year of retirement, except for so-called 5 percent owners of the entity which sponsors the plan. Those workers classified as 5 percent owners must commence RMDs from their company plans without regard for the date of their retirement. However, there are situations that may permit the postponement of RMDs.

For RMD purposes, a 5 percent owner is a person who owns greater than 5 percent of the ownership interests or voting rights of the company sponsoring the plan. There are some technical, constructive ownership rules whereby a person is deemed to own the stock or other ownership interests of his or her spouse and other family members. In a company with non-familial owners, the failure to own more than 5 percent of the company stock may be sufficient to accomplish the individual’s deferral objective.

At the present time, a taxpayer’s status as a 5 percent owner status is generally determined in the taxpayer’s determination year, currently the year the taxpayer attains age 73. If a taxpayer is a 5 percent owner in that year, the taxpayer will be deemed to be a 5 percent owner in all subsequent years, even if the taxpayer no longer owns more than 5 percent of the shares or voting power of the company at a later date. That being said, a taxpayer who is a 5 percent owner but divests himself or herself of ownership and voting rights before the taxpayer’s determination year will not be deemed to be a 5 percent owner and need not commence RMDs from company sponsored plans until retirement.

From a planning perspective, a taxpayer can divest himself or herself of ownership and voting power prior to the determination year or simply decrease ownership and voting rights to 5 percent or less prior to that time. This will permit the taxpayer to avoid the commencement of RMDs and defer the same until the taxpayer’s actual retirement.

A taxpayer might choose to transfer company shares and voting rights to a third party and re-acquire them after the determination year. The IRS may of course challenge an arrangement of this sort if they can establish that the ownership divestment had no business purpose other than avoiding the commencement of RMDs.

It is noteworthy that the 5 percent owner exception only applies to qualified plan funds; IRA funds do not qualify for the retirement exception for non-5 percent owners. However, if a company plan permits IRA funds to be rolled over to the plan, a non-5 percent owner can transfer IRA funds to a company sponsored plan for whom he or she is employed and continue to enjoy tax deferred growth on retirement plan funds so long as 5 percent owner status is avoided.

For the fortunate minority of persons whose financial status does not require them to currently utilize their retirement funds, engaging in some creative planning may be desirable. The Internal Revenue Code imposes excises taxes on taxpayers who fail to timely withdraw their RMDs. However, with a recent decrease in the penalty imposed for failing to take RMDs as required, taxpayers seeking to continue to enjoy tax deferred growth with their retirement plan assets may be more willing to risk an aggressive arrangement designed to defer the commencement of RMDs.