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Related Entities for 409(p) Testing


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"Synthetic equity" for purposes of 409(p) testing includes equity compensation in a "related entity." The regs define "related entity" as:

"any entity in which the S corporation holds an interest and which is a partnership, a trust, an eligible entity that is disregarded as an entity that is separate from its owner under § 301.7701-3 of this chapter, or a qualified subchapter S subsidiary under section 1361(b)(3)."

Is a once-remove subsidiary considered a "related entity"? For example, the S Corporation owns Subsidiary A and Subsidiary A owns Subsidiary B. Is Sub B a related entity to the S Corporation?

Second question -- the synthetic equity in a subsidiary is taken into account, "to the extent of the S Corporation's ownership."

So if S Corporation is 70% owner of Sub A and Sub A is 70% owner of Sub B, then would we take into account 49% (70% of 70%) of the synthetic equity granted at the Sub B level?

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I know this post hasn't received a response yet, but I thought I'd try with a follow up. Is there any threshold to determine when an entity is a related entity? Say, for example, the S Corp only holds a 30% interest in an entity -- is it still related?

The definition above doesn't require a percentage ownership, but I'd be surprised if the ESOP had to take into account equity earned in a subsidiary only .5% owned by the sponsoring S Corp.

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