Controlled Group/Common Control 5% Attribution Threshold

[Christine Roberts]

The requirement that an individual own at least 5% of a corporation or partnership, for that entity’s interest to be proportionally attributed to the individual, seems to be different depending on whether the attribution is from a corporation or partnership.

Specifically, Treas. Regulation Sections 1.1563-3(b)(2) and 1.414©-4(b)(2) both contain illustrations in which a partner with a 4% direct interest in a partnership is excluded from attribution. No mention is made of other forms of attribution – such as family attribution – increasing the 4% partnership interest up to or past the 5% threshold.

By contrast, Treas. Regulation Sections 1.1563-3(b)(4) and 1.414©-4(b)(4) contain illustrations in which attribution from a spouse of a 1% additional interest in a corporation increases the 4% partner up to the 5% threshold such that the partner is attributed with a proportionate share of the corporation’s ownership interest in another entity. I have copied the Section 414 regulations below for convenient reference.

Does this mean that an individual who is a <5% partner is not attributed with a proportionate share of the partnership's in another entity - period, full-stop, even if, under family attribution rules, the <5% partner's interest would exceed the 5% threshold?

But if the entity were a corporation, attribution from the family members would apply, such that the individual whose direct ownership stake is <5% would be attributed with his proportionate share (including through attribution) of the corporation’s ownership stake in another entity?

Sec. 1.414©-4 Rules for determining ownership.

(a) In general.

In determining the ownership of an interest in an organization for purposes of section 1.414©-2 and section 1.414©-3, the constructive ownership rules of paragraph (b) of this section shall apply, subject to the operating rules contained in paragraph ©. For purposes of this section the term "interest" means: in the case of a corporation, stock; in the case of a trust or estate, an actuarial interest; in the case of a partnership, an interest in the profits or capital; and in the case of a sole proprietorship, the proprietorship.

(b) Constructive ownership--

(1) Options.

If a person has an option to acquire any outstanding interest in an organization, such interest shall be considered as owned by such person. For this purpose, an option to acquire an option, and each one of a series of such options shall be considered as an option to acquire such interest.

(2) Attribution from partnerships--

(i) General. An interest owned, directly or indirectly, by or for a partnership shall be considered as owned by any partner having an interest of 5 percent or more in either the profits or capital of the partnership in proportion to such partner's interest in the profits or capital, whichever such proportion is greater.

(ii) Example. The provisions of paragraph (b)(2)(i) of this section may be illustrated by the following example:

Example. A, B, and C, unrelated individuals, are partners in the ABC Partnership. The partners' interest in the capital and profits of ABC are as follows:

(In percent)

Partner Capital Profits

A 36 25

B 60 71

C 4 4

The ABC Partnership owns the entire outstanding stock (100 shares) of X Corporation. Under paragraph (b)(2)(i) of this section, A is considered to own the stock of X owned by the partnership in proportion to his interest in capital (36 percent) or profits (25 percent), whichever such proportion is greater. Therefore, A is considered to own 36 shares of X stock. Since B has a greater interest in the profits of the partnership than in the capital, B is considered to own X stock in proportion to his interest in such profits. Therefore, B is considered to own 71 shares of X stock. Since C does not have an interest of 5 percent or more in either the capital or profits of ABC, he is not considered to own any shares of X stock.

(3) Attribution from estates and trusts—[….]

(4) Attribution from corporations--

(i) General. An interest owned, directly or indirectly, by or for a corporation shall be considered as owned by any person who owns (directly and, in the case of a parent-subsidiary group of trades or businesses under common control, with the application of paragraph (b)(1) of this section, or in the case of a brother-sister group of trades or business under common control, with the application of this section), 5 percent or more in value of the stock in that proportion which the value of the stock which such person so owns bears to the total value of all the stock in such corporation.

(ii) Example. The provisions of paragraph (b)(4)(i) of this section may be illustrated by the following example:

Example. B, an individual, owns 60 of the 100 shares of the only class of outstanding stock of corporation P. C, an individual, owns 4 shares of the P stock, and corporation X owns 36 shares of the P stock. Corporation P owns, directly and indirectly, 50 shares of the stock of corporation S. Under this subparagraph, B is considered to own 30 shares of the S stock (60/100 x 50), and X is considered to own 18 shares of S stock (36/100 x 50). Since C does not own 5 percent or more in the value of P stock, he is not considered as owning any of the S stock owned by P. If in this example, C's wife had owned directly 1 share of the P stock, C and his wife would each be considered as owning 5 shares of the P stock, and therefore C and his wife would be considered as owning 2.5 shares of the S stock (5/100 x 50).