Controlled Groups and Affiliated Service Groups

Controlled Groups and Affiliated Service Groups

To qualify for tax deductions, retirement plans have to meet requirements of the Internal Revenue Code. The major emphasis of these rules is to ensure that plans provide lower paid employees with retirement benefits and do not disproportionately favor higher paid employees and business owners.

To prevent employers from circumventing these rules with various entities, Congress created laws that treat certain groups of entities as a single company for purposes of retirement plan coverage. These laws create what are commonly called “controlled groups” (“CG”) and “affiliated service groups” (“ASG.”). All employees of a combined group of entities must be considered together in measuring whether or not a plan passes the IRS coverage and nondiscrimination tests.

FREQUENTLY ASKED QUESTIONS

Q: Why it Matters?
A: Failure to properly identify a CG/ASG can cause the plan to lose it tax qualification. This can occur when a plan omits coverage of a CG/ASG member. A plan may also get in trouble where it is improperly assumed that the employer is part of a CG/ASG and it actually is not.

Q: What is a controlled group?
A: Very briefly, if there is 80% or more overlapping ownership among entities, they are generally a controlled group. This can be a parent-subsidiary relationship, or just common ownership of at least 80% among 5 or fewer individuals (brother-sister controlled group).
 
Usually, the most complicated aspect of a controlled group analysis is determining the applicable ownership for each company. There are rules that attribute ownership to and from certain family members, rules that attribute ownership to individuals from stock held in trusts, rules addressing ownership of non-corporate entities, as well as consideration of state community property rules. A person cannot reduce his ownership share by giving ownership to a spouse, child, parent, etc. They are still considered to own what the family members own. In addition, stock or other ownership options are frequently considered as ownership for controlled group purposes.
 
Here is a simple example of a controlled group. Acme Corporation is owned 80% by John and 20% by Tom (John and Tom are not related.) In addition, John operates a frozen yogurt shop as a sole proprietor. John owns 80% of Acme and 100% of the yogurt shop, there is at least 80% overlapping ownership, Acme and the yogurt shop are a controlled group. Any retirement plan that Acme sets up will have to consider eligible employees of the yogurt shop in passing its coverage tests. It may have to cover those employees (i.e. include as benefiting participants) in the plan to pass the coverage test, depending on the size of the company. Now let’s change the example slightly. Suppose John sells 5% of Acme to Tom. There is now just 75% overlapping ownership, the two are no longer a controlled group. Looking at yet another twist to the same example, assume John takes Tom on as a 5% partner in the
yogurt shop. Because Tom is an owner of both businesses, both his and John’s ownership are considered in both entities. There is 100% overlapping ownership, they are again a controlled group of businesses.
 
Q: What does “ownership” mean?
A: Ownership is not limited to an individual’s actual stock ownership or Partnership share. The attribution rules of Code Sections 414(b) and (c) and 1563 must be taken into account. In general and most commonly, ownership by an individual’s spouse and lineal ascendants
 
Q: What is an affiliated service group?
A: An ASG determination is more subjective than a CG. Two or more service companies with some common ownership, no matter how small, that provide significant services to each other or are associated together in providing services to others form an ASG. Furthermore, if a significant portion of a company’s business is providing management services to another company (even if not a service company); they are also an affiliated service group.
 
The IRS has not done much to define a service company; it is a facts and circumstances determination. If
capital is not a material income-producing factor, it is likely a service company. For example,
professional services (medical, dental, law, engineering, accounting, etc. are service companies. A
trucking company would not be, even though it provides transportation services, because capital
(trucks) is required to generate income.)
 
The most easily identified ASG is the professional law, medical or accounting practice organized as a
partnership of professional corporations. Each professional may be separately incorporated, but the
corporations are all partners in the firm, and income flows from the firm to the individual corporations.
The corporations’ employees provide professional services to the firm’s clients on behalf of the firm. In
such a case, any retirement plan will have to consider the employees of the entire firm in passing
coverage tests.
 
As another example, a business owner cannot escape the retirement plan coverage rules by setting up a
separate company for himself and then have the main business pay his company a management fee.
Even if he structures the ownership to avoid a controlled group, this would still be considered an
affiliated service group.