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Controlled Group Analysis Is the Key to Complying with Benefits Rules

In today's business world, companies may be owned by entities that also have an interest in other companies. Business owners may partner with investors on ventures without knowing about all of their partners' business holdings. If the parties sponsor employee benefits plans, there may be "controlled group" implications that result in penalties -- or even disqualification of the plans.

Under federal law, related companies and organizations are treated as a single group for certain employee benefit purposes. In other words, a business with 20 employees may be treated as having 60 employees if it is related to another company with 40 employees.

Specific plan requirements that apply to a "controlled group" include:

  • Non-discrimination rules under Internal Revenue Code Section 401(a)(4) ;
  • Actual deferral percentage test (ADP) under Section 401(k);
  • Actual contribution percentage test (ACP) under Section 401(m);
  • Deduction rules under Section, 404(a) ;
  • Coverage testing under Section §410(b);
  • Vesting requirements under Section 411;
  • Contribution limits under Section 415; and
  • Top heavy rules under Section 416.

Controlled group rules are also applicable in the welfare plan arena. An issue of immediate concern for small employers is the Patient Protection and Affordable Care Act's (ACA) coverage mandates. Beginning in 2015, an employer with more than 50 full-time equivalent employees will face a penalty if it does not provide adequate healthcare benefits to full-time employees. Some employers are assuming they will not be subject to the ACA's coverage mandates, when they may be under the controlled group rules.

Here is a rundown on the three categories of controlled groups.

1. Parent-Subsidiary Relationship

According to the IRS, a parent-subsidiary controlled group exists when one or more chains of corporations are connected through stock ownership with a common parent corporation; and

  • 80 percent of the stock of each corporation, (except the common parent) is owned by one or more corporations in the group; and
  • The parent corporation must own at least 80 percent of at least one other corporation.

If one of the corporations owned at least an 80 percent profit interest in a partnership, the employees of that partnership would also be aggregated with the other controlled group corporations.

2. Brother-Sister Groups

As explained by the IRS, a brother-sister controlled group is a group of two or more corporations, in which five or fewer common owners (a common owner must be an individual, a trust, or an estate) collectively own -- directly or indirectly -- a controlling interest of each group and have "effective control." Effective control requires collective ownership of more than 50 percent of the stock of each corporation, but only to the extent such stock ownership is identical with respect to each corporation.

For example, if a shareholder of A and B corporations owned 80 percent of the stock in A, and 20 percent in B, only 20 percent of that shareholder's ownership in A would be counted in this test.

3. Combined Groups

Combined groups are three or more organizations in which:

  • Each organization is a member of either a parent-subsidiary or brother- sister group; and
  • At least one corporation is the common parent of a parent-subsidiary and is also a member of a brother-sister group

(A full detailed description of the controlled group rules by the IRS and illustrations of how they work is available here.)

Determining stock ownership (or interests in trusts, estates, partnerships and sole proprietorships) to assess controlled group status is complicated, thanks to "attribution rules." These rules treat a person "as owning an interest in a business that is not actually owned by that person," according to the IRS. "Attribution may result from family or business relationships."

In the case of family relationships, that generally means that stock held by a parent, minor child or a spouse can be attributed to a single individual.

Determining Ownership Stakes

When different classes of stock are involved, the actual value of stock used to determine ownership interests for controlled group purposes must be assessed based on such factors as voting, dividend and liquidation rights.

Keep in mind there may be steps an entity can take to revamp a business so it is not treated as part of the group. This is a highly complex area of federal law. Consult with your tax adviser and attorney to ensure your organization is in compliance with the rules.

Also, there is a procedure under Internal Revenue Code §414(r) that allows companies to petition the IRS to separate entities from a controlled group on the basis that they are distinct lines of business. This may be a cumbersome process and restrictions apply. Among them, each entity must have at least 50 employees and there must be a valid business purpose for the request. Also, there are restrictions on permissible highly compensated employee ratios for discrimination testing purposes under this arrangement.

A good time to assess your status under the controlled group rules and their implications for employee benefit plans is before entering into a transaction with another business. But even after the fact, it is important to determine whether you are affected by the controlled group rules.