S Corps and Controlled Groups

[Guest LLandau]

Help.

Separate (both subchapter S Corp.s) companies are 100% owned by only two non-spouse individuals. Information provided to me is that together these two individuals own 100% of both companies.

Question: Because these are S Corp.s is it even possible that the two companies are of the same Controlled Group of Companies?

My confusion is that because of the nature of S Corps. Mr. A and Ms. B each own some percentage of each company (and are bro-sis co.s), but unless A and B form a holding co. they do not each/together own 100% of the corp.s as set forth in IRC Section 1563.

The individuals (A and B) insist that together they own 100% and, therefore, the companies are within the same controlled group of companies.

Any guidance would be appreciated.

[Archimage]

Unless I am misinterpreting your post, it sounds like you are saying that each owns 50% of two companies. This would be a bro-sis controlled group. I can't think of a reason why the two companies being S-corps would matter.

[Guest LLandau]

But, according to IRC Section 1563, taking into account only identical ownership, more than 50% (greater than 50%) identical ownership is required.

[Archimage]

You are correct. I forgot that the regs state that the identical ownership has to be MORE than 50%. I would agree that since they equal only 50% it is not a controlled group.

[Kirk Maldonado]

But I think that Archimage had a good point, in that whether an enity is an S corporation or a C corporation is irrelevant for the controlled group rules.

[Guest Derrin Watson]

Let's make sure I understand the facts. The names have been changed because I am ignorant of the true names.

Joe owns 50% of A and 50% of B%. Mary owns 50% of A and 50% of B. There is no attribution or exclusion of either's stock. A and B are S Corporations.

On these facts, A and B are a brother-sister controlled group. There is no question or doubt of this.

First, here's the definition from 1563(a)(2):

Two or more corporations if 5 or fewer persons who are individuals, estates, or trusts own (within the meaning of subsection (d)(2)) stock possessing--

(A) at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of the stock of each corporation, and

(B) more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation

So, 5 or fewer individuals, estates, or trusts, between them, must have a controlling interest (80% ownership) in each corporation, and effective control (more than 50% ownership considering each person's ownership where it is least -- and hence "identical").

I think we all agree that Joe and Mary, between them, have a controlling interest under paragraph A. Some people who have commented in this thread seem uncertain about the second point, effective control.

To cut through the language of 1563(a)(2)(B), a person's effective control ownership of two corporations is the least he or she owns in either. For example, if I own 40% of A and 30% of B, then for purposes of the effective control test, I own 30%. To that extent, my ownership "is identical with respect to each such corporation." The sum of the effective control ownership of all 5 or fewer individuals, estates, or trusts must exceed 50%. The Code does not require that the effective control ownership of EACH shareholder exceed 50%. In point of fact, only one shareholder could meet that requirement, barring attribution. The regulations have further examples supporting this interpretation, which is really the only sensible interpretation of this provision.

In the case at hand, Joe's effective control ownership is 50%. Mary's is 50%. Between them, they have more than 50% and hence there is a group of 5 or fewer individuals who have effective control. Since they also have a controlling interest, A and B are in a controlled group.

I discuss this further, with numerous examples, in Chapter 6 of my book, Who's the Employer.

Incidentally, I concur that status as an S Corporation is irrelevant for controlled group determinations for qualified plans.

[Archimage]

Llandau, I had it right and you had to go and confuse me. Thanks for the excellent clarification, Derrin.

[Guest LLandau]

Thank you Derrin Watson and Archimage for your help. I see the light.