Controlled Groups

January 01, 2018
Top Five
What CPAs Should Know About Controlled Groups

By Christine P. Roberts
Accountants who advise business owners should be aware that controlled group or affiliate service group status can derail otherwise careful benefit plan designs and have other, unintended consequences under federal laws, including the Affordable Care Act. Using a group of family-owned businesses as an example, this overview briefly surveys controlled group and other common ownership rules accountants who primarily advise business owners should be aware of to avoid the potential benefit plan complications that controlled group rules can create. 

1. Why Controlled Groups Matter to Business Owners
Worthy Family Enterprises, Inc. (WFE) is a C corp that provides management and administrative services to Worthy Growers, LLC, an agricultural business, and Worthy Resorts, LLC, which operates several hotel and spa properties in Northern California. 

WFE has 15 employees; Worthy Growers has approximately 80 employees, half of whom are seasonal; and Worthy Resorts has 30 employees. WFE employees are eligible to participate in a standardized 401(k) profit sharing plan after completing six consecutive months of service, and an insured group health plan after completing 60 days of employment. Worthy Growers and Worthy Resorts do not offer employees any benefit plans. Ownership of all three businesses is concentrated in the hands of three Worthy family members and one Worthy Family grantor trust.

If the three Worthy family businesses comprise a controlled group, the IRS will treat WFE, Worthy Growers and Worthy Resorts as a single employer for purposes of retirement and health benefit plan compliance. As a standardized type of plan, the WFE 401(k) plan contains language that automatically covers employees of all businesses within the controlled group, such that it’s subject to potential disqualification for failure to include employees of Worthy Growers and Worthy Resorts. Even if the plan document was non-standardized, the WFE 401(k) plan would have to take employees of the other businesses into account for minimum coverage and nondiscrimination testing purposes, and likely would not pass minimum coverage and nondiscrimination testing on a controlled group basis. 

The WFE group health insurance plan could potentially fail nondiscrimination rules that the Affordable Care Act applies to insured group health plans, which, when implemented by the IRS, will apply on a controlled group basis. Further, employees of all three businesses must be combined to determine status as an “applicable large employer” under the ACA’s employer shared responsibility or “pay or play” provisions, and related reporting and disclosure duties. 

As there are more than 50 full-time employees among the three businesses, reporting and disclosure duties under IRC Sec. 6056 (IRS forms 1094-C and 1095-C) would apply for calendar year 2015 and subsequent, and excise tax liability under IRC Sec. 4980H may also exist. 

2. How to Spot the Two Main Types of Controlled Groups
The Worthy family is a “brother-sister” type of controlled group, which exists when the same five or fewer individuals, trusts or estates (the “brother-sister” group) have a “controlling interest” in, and “effective control” of, two or more businesses, as defined below. 
The other main type is a parent-subsidiary controlled group, which exists when one business owns 80 percent or more of another business, or where there is a chain of such ownership relationships. 

For purposes of the brother-sister group, a “controlling interest” exists when the group members own, or are deemed to own under rules of attribution, at least 80 percent of each of the businesses in question. “Effective control” exists when the brother-sister group owns or is deemed to own greater than 50 percent of the businesses in question, looking only at each member’s “lowest common denominator” ownership interest. (So, a group member that owed 20 percent of one business and 40 percent of another business would be credited only with 20 percent in the effective control test.) 

To pass the 80 percent test, you must use the interests of the same five or fewer persons (or trusts or estates) used for the greater than 50 percent test [see US v. Vogel Fertilizer, 455 US 16 (1982)]. Put otherwise, the two tests consider only owners with a greater-than-zero interest in each of the businesses under consideration. So, in our example, if different unrelated third parties owned shares in each business that exceeded 20 percent, the 80 percent test wouldn’t be met and the businesses wouldn’t comprise a controlled group. 

3. How to Identify Ownership for Controlled Group Purposes
In our example, ownership of WFE, a corporation, means possession of the voting power or value of corporate stock (or a combination thereof). Ownership of the Growers and Resort entities, both LLCs taxed as partnerships, means ownership of a capital or profits interest in the respective LLCs. As mentioned, controlled group rules look at direct ownership and ownership by attribution. The controlled group attribution rules are complex and can only be touched on here. 

If ownership interests were spread among four family members and three family trusts (exceeding the maximum number of owners for a brother-sister group), ownership could potentially be concentrated in five or fewer individuals, trusts or estates through attribution between family members, or attribution from trusts to trust beneficiaries, or from grantor trusts, as defined under IRC Sec. 671-678, to the individuals serving as grantors. 

Complex interest exclusion rules—beyond the scope of this article—may mean that not all ownership interests are counted toward common control; exclusion may turn on the nature of the interest held (e.g., treasury or non-voting preferred stock) or on the party holding the ownership interest (e.g., the trust of a tax-qualified retirement plan).

4. How to Spot an Affiliated Service Group
The IRS created the Affiliated Service Group (ASG) rules in the 1980s to plug a loophole in the controlled group rules that doctors, dentists, lawyers and other professional service providers were exploiting. 

In the classic scenario, two or more doctors, dentists or lawyers each own 100 percent of his or her own professional corporation which each sponsors a retirement plan covering only the professional in question. There is no shared ownership between or among the separate professional corporations, thus foiling the controlled group test. 

However, the professionals share ownership of a separate business, such as a clinic or law firm, that employs support staff and provides services to and alongside the professional corporations. The clinic or firm does not sponsor any retirement plan or sponsors a plan that is less generous than the professionals’ individual plans. 

Within this affiliated service group, all employees are treated as if employed by a single employer for benefit plan purposes, as with controlled groups, and typically, the retirement plans sponsored by the professional corporations will fail minimum coverage and nondiscrimination testing when required to take into account some or all of the employees of the clinic or firm. 

Some shared ownership is required to create this A-Org type of ASG as well the B-Org type of ASG, which may arise when professionals have spun off a separate entity to employ individuals who provide services (such as bookkeeping or billing services) that traditionally were provided by the professional firm itself. However in a management function ASG, no shared ownership is required to exist between the management firm, on the one hand, and its client entity (or businesses related to that client which also receive services from the management firm). 

In the Worthy family example, if the family members and trust owned only Worthy Growers and Worthy Resorts, and third parties owned WFE, a management function ASG could exist between management firm WFE, on the one hand, and, on the other hand, its clients Worthy Growers and Worthy Resorts, provided that WFE’s principal business was to provide management functions for those businesses on a regular and continuing basis. 

In the ASG context, entity, trust and family attribution rules apply, but with certain key differences from the rules used in the controlled group context, so expert advice is advised. Unlike the controlled group rules, which turn on straightforward calculation of ownership percentages, the ASG rules incorporate several “facts and circumstances” tests and accordingly their delineations are more open to interpretation than are those of controlled groups. It’s possible for an ASG to overlap with a controlled group configuration, such that all component businesses are treated as a single employer for benefit plan purposes (see Technical Advice Memorandum 201715001).

5. Where to Go for More Information
The controlled group/common control rules are set forth in IRC Sec. 414(b) and (c) and Sec. 1563, and Treasury Regulations thereunder; however, attribution and other rules require reference to IRC secs. 144, 267 and 318. The ASG rules are found at IRC Sec. 414(m) and related proposed regulations. 

In addition to the referenced IRC sections and Treasury regulations, IRS Tax Exempt and Government Entity Materials on Related Employers by David K. Garrett and John R. Wright, Summer 2013, can be found online. For a comprehensive secondary source, attorney S. Derrin Watson’s manual titled Who’s the Employer is available for online subscription.

Christine P. Roberts is a partner at Mullen & Henzell L.L.P.

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