Excluded Stock in Controlled Group Determination

[Guest lforesz]

Can someone please help us figure out what is considered excluded stock for purposes of determining controlled groups and how such excluded stock is treated. For example, if 25% of the total outstanding stock is held in an ESOP, it was my understanding that 100% is now replaced with 75% when determing brother-sister ownership. I am hearing people say that the ESOP stock is included in each owners ownership percentage, but I never thought it worked this way.

Any clarification would be greatly appreciated.

Thanks

[jaemmons]

Under IRC 1563©(2)(B), as long as the same five or fewer employees own 50% or more of all classes of stock in a corporation, stock held in a "401(a)" plan exempt for tax purposes under 501(a) can be disregarded in determining ownership for brother-sister control groups. In short, if you have 5 or fewer employees who have similar ownership of 50% or more between two or more companies, only taking into account their common controlling interest, you can disregard stock allocated within the ESOP. There are other exclusion, but this one seems to be relevant to your situation.

Keep in mind that the ESOP ownership is counted, however, in determining whether or not you have common controlling interest between the two companies. Only treasury stock and non-voting preferred stock are automatically excluded from determining ownership under IRC 1563©. If you determine that you have common controlling interest, then you can back out the ownership of any shares held within the ESOP. I tried to keep it simple.

[Guest lforesz]

Thanks. So, help me work this out. Five or few people own 50% identical interests in two companies (both with and without including their stock held in the ESOP). So, now we can backout the ESOP stock, but what does this exactly mean. For example, 40% of the stock is held in the ESOP, so is it assumed that the other four individuals own 100% of the company? The problem is the 80% common control. With the ESOP in the equations, they don't have 80%, but if I treat the ESOP as a "non-issue", then they own 100% of the company and the 80% test is met. If not, then they only only 60% and the 80% test fails. Does this make sense? Is this what is meant by excluding the stock?

Please let me know what you think. Once again, I really appreciate your input.

[jaemmons]

Let me try to give you a simple example to help you out.

(Assuming that the only eligible plan participants are the owners)

ESOP shares owned by employees: 40% (assuming all shares are allocated to accounts and not held in suspense).

Owner 1 - 25% (includes ownership in from ESOP shares)

Owner 2- 25% (same as above)

Owner 3- 25% (same as above)

Owner 4 - 25% (same as above)

Company #2

All owners own 25%.

Common control determination: All owners are the same in both companies so we look at the "common" interest (or smallest ownership %) between the two companies, including shares allocated to them under the ESOP. They each own a common interest of 25%, so we have a common ownership between both companies of 100% which is greater than the 50% required.

Since we satisfy the common interest requirement, we can back out the ESOP ownership. Let assume for simplistic purposes that 40% of their ownership (or 10%) is held in the ESOP. Backing the 10% out, leaves 15% ownership in "non-excludable" stock within company one. Now let's look at the regular bro-sis analysis.

Effective Control MUST be 80% or more between the companies:

Since they collectively own only 60% (4*15%), we don't satisfy this first requirement, so we don't have a control group.

You pretty much have to run two control group analysis. However, in determining if the ESOP stock can be excluded from the actual bro-sis determination, you take the same five or fewer owners and look at their common control between the companies, including any allocated ownership by the ESOP. If this is 50% or more, then you can back out the shares allocated in the ESOP when you calculate their actual ownership %'s in each company. Sorry for being long winded.