In today's business climate, it
seems it is becoming increasingly common for businesses of all sizes to be
structured using multiple companies. Maybe a business person is pursuing
multiple ventures with different groups of co-owners. Perhaps a company
decides to offer a new product or service and that is best accomplished via
a separate entity. Sometimes it makes sense to create a separate company for
each of a business's locations. Still other times the owner of one company
decides to buy another business.
Regardless of the reason for structuring a business in
this way, there are some complex IRS rules that must be considered when it
comes to the retirement benefits being offered.
Background
During the mid-1980s, Congress created a series of
complex rules designed to prevent companies from transferring employees to
separate but related companies as a way to provide reduced or even no
benefits without running afoul of the nondiscrimination rules. Generally
speaking, those rules describe two types of related groups—the affiliated
service group and the controlled group. For the sake of brevity throughout
the rest of this article, we will occasionally refer to these as ASGs and
CGs.
In short, these rules require that all companies in a
related group must be combined when performing annual nondiscrimination
testing on the retirement plan(s). While this requirement can be a
limitation at times, with some careful planning it can also be used to
provide retirement benefits to multiple companies more cost effectively than
if the related companies were treated as separate entities. Before we look
at some examples, it is first necessary to dive a little bit into the weeds
to understand the gist of the rules themselves.
Affiliated Service Group
The ASG rules focus on the nature of the relationship
between the entities in question. Some of the key variables in determining
whether an ASG exists include the following:
- Working Relationship: Does one entity provide services
to the other that are customarily provided by the recipient's employees?
Alternatively, do the entities involved join together to provide services to
the same clients?
- Ownership: Is there any common ownership among the
entities? In some instances, as little as 10% common ownership is enough to
trigger an ASG.
- Management: Does one entity provide management
oversight over the other entity? If so, an ASG may exist even if there is no
common ownership.
While ASG relationships can exist in many different
industries and entity types, it is not unusual for them to occur in
professional settings such as medical practices and law firms. Consider two
examples illustrating relatively common professional business structures.
Example #1
A law firm is organized as a partnership and each
attorney creates his or her own professional corporation (P.C.). Rather than
the attorneys being the partners of the law firm, their respective P.C.s are
the partners. The partnership and the individual P.C.s join together to
provide legal services to the firm's clients. As a result, the firm and the P.C.s form an ASG.
Example #2
Several physicians own a medical practice and they have
no other employees. However, they also own part of a billing office that
includes a number of employees who handle administrative functions for the
practice. Since the billing office provides services to the practice that
are customarily provided by employees, and there is some overlapping
ownership, the two potentially form an ASG.
Controlled Group
The remainder of this article will focus primarily on
controlled groups. Unlike affiliated service groups, controlled group
determinations are based solely on overlapping ownership. There are two
general types of controlled groups—the parent/subsidiary group and the
brother/sister group.
Parent/Subsidiary Controlled Group
This type of group is the more straightforward of the
two and exists when one entity owns 80% or more of another entity. For
example, if Company A owns 80% or more of Company B, the two companies are
part of a parent/subsidiary controlled group.
Brother/Sister Controlled Group
This type of group is a little more complicated to
explain. In broad terms, there are two thresholds to meet:
- Common Ownership: The same five or fewer individuals
must own at least 80% of each company under consideration.
- Identical Ownership: The sum of the identical
ownership of the five or fewer owners from the first step must be
greater
than 50%. The best way to explain identical ownership is via an example. If
John Doe owns 10% of one company and 5% of another company, his identical
ownership among the two is 5%.
When both of these requirements are met, there is a
brother/sister controlled group.
Attribution of Ownership
As we described above, ownership is a key variable in
these determinations, and there is a series of additional rules that discuss
ownership. Specifically, there are instances in which the ownership held by
one person or entity must be attributed to another person or entity. While
we will spare you the gory details, it is important to briefly touch on
these rules.
Attribution from Company to Individual
In simple terms, this essentially means that a person
who owns at least 50% of a business is deemed to own a proportionate share
of whatever that business owns. For example, if John Doe owns 75% of ABC
Company, and ABC owns 60% of XYZ Company, John is deemed to own 45% of XYZ
(75% x 60%). There are a number of variations and exceptions, but
remember…we promised to spare you the gory details.
Attribution Among Family Members
This is when one person's ownership is attributed to
certain family members. Specifically, an individual's ownership is
attributed to his or her spouse as well as lineal ascendants and
descendants. In this case, we do need to journey a little further down the
rabbit hole to consider some of the very important exceptions:
- Spousal attribution generally does not apply if the
owner's spouse does not hold direct ownership in his or her own right and
the spouse does not participate in the owner's company. The spouse need not
formally be an employee in order to “participate” in the business.
- There is limited attribution between parents and
children over the age of 21, based on the amount of direct ownership held by
the child.
- There is no attribution between siblings.
Certain attribution to ascendants and descendants
extends only to one generation, while other times it extends to multiple
generations.
Putting it Together
Assuming you've made it this far without either falling
asleep or running screaming from the room, it's time to look at some
examples that might pull all of this craziness together. We will do this
using a couple of simplified case studies, and our cast of characters will
include John, Paul, George, Ringo, Yoko (John's wife) and Julian (John and
Yoko's 18-year-old son).
Case Study #1
Our characters hold the following ownership in two
companies:
| |
Beatlemania, Inc. |
Yellow Sub, Inc. |
| John |
40% |
30% |
| Paul |
40% |
30% |
| George |
10% |
0% |
| Ringo |
10% |
0% |
| Yoko |
0% |
20% |
| Julian |
0% |
20% |
At first glance, it does not appear that the same five
people own at least 80% of both companies. However, once we consider family
attribution, John's total ownership in Yellow Sub is 70% (30% direct +20%
attributed from Yoko +20% attributed from Julian). Together, John and Paul
own 80% of Beatlemania and 100% of Yellow Sub and their identical ownership
is greater than 50%, making the two companies part of the same controlled
group.
Case Study #2
John and Yoko each own 100% of Imagine, LLC and Silver
Horse, Inc., respectively, and neither one is at all involved in the company
owned by the other. Under one of the exceptions noted above, their ownership
would not be attributed to each other, so it appears there would not be a
controlled group. However, since Julian is under the age of 21, he is
attributed the ownership from each of his parents, making him the 100% owner
of both companies and causing the two to form a controlled group.
Making Sense of it All
So, what does all of this really mean? Basically, it
means that when there is a controlled group (or an affiliated service
group), all of the related companies are treated as a single employer for
purposes of the retirement plan. In other words, the employees of all the
related companies must be included in the annual nondiscrimination testing.
That might sound onerous but it doesn't have to be.
Keep in mind that the annual testing compares the
benefits provided to highly compensated employees (HCEs) to those provided
to non-HCEs. If two companies in the same controlled group have similar
numbers of HCEs and non-HCEs, it is completely plausible that the tests
would still pass even if the employees of one of the companies don't receive
any plan benefits.
If the goal is to provide similar benefits to the
employees of several companies, a controlled group/affiliated service group
relationship can make it more cost-effective to do so. The reason is that
since all of the companies in the group must be treated as a single employer
for purposes of testing, it is perfectly acceptable to have a single plan
covering all of the employees. Through the use of more complex forms of
nondiscrimination testing, it might even be possible to provide different
benefits to the various companies in the group via a single plan. That means
only one plan document to maintain, only one plan to administer and only one
Form 5500 to file each year.
Conclusion
Before considering how to plan around/take advantage of
related group status, the first step is to be sure which companies are/are
not “related” based on the rules we have highlighted in this article. There
are many facts and circumstances that can affect controlled group and
affiliated service group determinations and even seemingly slight nuances
can be game changers. As a result, it is usually worth spending a few
dollars to hire someone who is knowledgeable and experienced in this area to
assist with the analysis.
With some due diligence and careful planning, your
controlled group can be under control rather than out of control.
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