Control Group Spousal Attribution in Community Property State

[sgoss]

I have a situation where Husband owns 100% of one business and Wife owns 100% of an unrelated business.  They are considering setting up a defined benefits plan for their businesses.

Operation of both businesses is kept completely separate and neither has any involvement in the others business.  Further, neither is an employee or officer of the others business.

They reside in Texas, a community property state.  However, they have a post-nuptial agreement which provides that neither has ownership in the others business and that income from the businesses are also separate property so there appears to be no direct ownership issues.

So long as the property is characterized as separate property, would the exception for aggregation under the control group rules for an independent spousal business apply? 

[Luke Bailey]

Sort of. Characterization as separate property under state law is only the first step, and put them into the same position as if they were in a noncommunity property state. They are then treated as owning the other's stock or LLC interests by attribution, however, unless you comply with 1563(e)(5)(A) thru (D), so you need to look at those rules and make sure you comply.

[PensionPro]

On 9/21/2018 at 11:28 AM, sgoss said:

I have a situation where Husband owns 100% of one business and Wife owns 100% of an unrelated business.  They are considering setting up a defined benefits plan for their businesses.

Operation of both businesses is kept completely separate and neither has any involvement in the others business.  Further, neither is an employee or officer of the others business.

They reside in Texas, a community property state.  However, they have a post-nuptial agreement which provides that neither has ownership in the others business and that income from the businesses are also separate property so there appears to be no direct ownership issues.

So long as the property is characterized as separate property, would the exception for aggregation under the control group rules for an independent spousal business apply? 

You are correct.  If the businesses are treated as separate property under state law by virtue of a valid agreement and the non-involvement exception applies, the two entities can be treated as unrelated but check the details.

[Mr Bagwell]

One of the details/exceptions is whether there are minor children?

I was taught that if there was minor children between the two, then the two plans are a control group.

[Luke Bailey]

Mr. Bagwell, I don't think that is right. Someone might think that that is a correct application of 1563(e)(6), i.e. you meet the requirements of 1563(e)(5) to avoid attribution from your spouse, but then 1563(e)(6) attributes your spouse's stock to your minor children (first attribution), and then your minor children's stock to you (second attribution). But I think 1563(f)(2)(B) blocks the second attribution.

[Mr Bagwell]

Luke,

The premise was that the minor children attributed all of the parents stock, therefore owning both businesses.

Not that the spouse stock went to children, then children's stock went to other spouse.

[Mr Bagwell]

Check out EOB 2013 edition 1A.36 and 1A37.  There is a discussion on this very similar scenario.

I'll closely type the section.

Minor children attribution not disregarded.  Although a husband and wife might not be attributed each other's ownership interests in the respective businesses, if the have minor children (under 21), other attribution rules may result in a controlled group relationship.  Under the stated facts of the example, Husband and Wife are not attributed each other's ownership interests in their respective businesses.  Normally then, Husband's wholly-owned corporation would not be part of a controlled group with Wife's wholly-owned corporation, because the companies have no common owners.  But suppose they have a minor child.  The minor child is attributed the stock in each company.  This creates a controlled group relationship because the minor child, as the common owner by attribution, owns 100% of each company.

Comment: controversy on this issue.   .......At a Q&A session with the IRS at the 2012ASPPA annual conference, IRS representatives indicated that, until there is a statutory change made by Congress, the IRS would follow the literal wording of the statute.

[Mr Bagwell]

Years ago, I was at a Relius training and the speaker was telling a story about this same scenario.  He said he and his neighbor was talking about 401ks and the neighbor told the speaker that he owned 100% of his business and the wife owned 100% of her business.  I don't remember all the middle details of how and why they got onto the discussion, but the speaker gave the husband some warning that the two companies may be a controlled group because the speaker knew the couple had minor children and the husband may want to talk to his 401k provider.  The husband inquired and said his provider did not consider this to be a control group.  The speaker then told the husband to tell the 401k provider the IRS code to look up.  To make a long story short, the speaker had worked for the IRS and helped write the code.  (That's what he said) I understood that the speaker was nice to the neighbor as he was discussing the issue.  The speaker did not drop the trump card that he helped write the code.....lol.

That story is why I'm really cautious of the husband owns 100% of his company and the wife owns 100% of her company scenario.....  my brain always says "do they have minor child/ren?".

[Luke Bailey]

Mr. Bagwell, thanks. Learn something new every day, and this is it for today. Very unlikely to have been the result intended by Congress, of course, since seems unlikely they would have created such an elaborate, but fragile, way for a married couple to separate their respective businesses. Neither family- nor working spouse-friendly.

[K2retire]

16 hours ago, Luke Bailey said:

Very unlikely to have been the result intended by Congress, of course, since seems unlikely they would have created such an elaborate, but fragile, way for a married couple to separate their respective businesses.

When you consider that the purpose of the CG/ASG rules is to keep people from excluding employees by setting up a separate company owned by related parties that employs the staff, it seems like that this was the exact intent.

[Luke Bailey]

K2retire, I would be interested in hearing your rationale spelled out in a little more detail. I completely agree with you, I think, regarding the general purpose and importance of the controlled group rules. But on the narrow issue at hand, I.e., the IRC sec. 1563(e)(5)(A) thru (D) exception to spousal attribution, and the apparent 1563(e)(6) exception to that exception explained by Mr. Bagwell, my understanding at this point is that if two individuals are married and have independent business lives that includes their each owning 100% of their own company, and either no children or only adult children, then if they meet the requirements of the 1563(e)(5)(A) thru (D) exception, their interests in each other's separate businesses are not attributed to each other, so no controlled group. But if this same couple then gives birth to or adopts a child, then they are immediately a controlled group. It's this that makes no sense to me.

[K2retire]

Luke, one example that I heard is even more absurd -- the independent business of a couple who were never married with a minor child are also a controlled group.

My point was that these rules were intended to make it difficult for clever people to find a way to exclude employees from the plan based on convoluted ownership of multiple businesses. Historically, I suspect you would find that one of the ways that was done was by setting up two companies, one owned by the husband and the other by the wife. The business owners were paid from one company and the employees from the other. So rules were established, and as is often the case, they went too far the other direction.

[Luke Bailey]

K2retire, understood. But what you're saying, then, is if you want to use that clever and unscrupulous strategy, don't have children.

[david rigby]

Here is the Q&A column by Derrin Watson.  https://benefitslink.com/cgi-bin/qa.cgi?db=qa_who_is_employer

No.9 addresses this question.  While it makes a cross-reference to No. 1, the latter has been removed.

[Luke Bailey]

David, are you sure that's the right link? Did not seem to work for me.

[david rigby]

https://benefitslink.com/cgi-bin/qa.cgi?db=qa_who_is_employer

[Luke Bailey]

Thanks, David. So that link works now, and if anyone is interested and scrolls down to Q&A-9, they will get a very detailed examination of the issue. As usual, Derrin's prose is crystal clear and very detailed. He expands on the factual possibilities. As Derrin does, I pointed out that a married couple without a child would not create a controlled group, but a controlled group would be formed as soon as the couple gave birth to or adopted a child. Derrin's examples go further and explain how the controlled group is broken if they divorce, and is not formed if they just live together.

As Derrin implies, it doesn't seem to make sense from a policy perspective.

[Mr Bagwell]

On ‎9‎/‎27‎/‎2018 at 12:10 PM, Luke Bailey said:

As Derrin does, I pointed out that a married couple without a child would not create a controlled group, but a controlled group would be formed as soon as the couple gave birth to or adopted a child. Derrin's examples go further and explain how the controlled group is broken if they divorce, and is not formed if they just live together.

Emphasis mine.

??

I read the detail from Derrin as saying if there is a child between married, divorce, or non-married, there is still a control group.

Did I misunderstand your comments?

[Luke Bailey]

Mr. Bagwell, I guess that's right. Divorce breaks the spousal attribution, but not the minor child attribution. Thanks.

[SoCalActuary]

Just sayin' I've never seen this enforced by the IRS, unless the minor child has actual ownership.  Consider that former politician in NC who fathered a child, John Edwards.

Do you think he was in a controlled group with his groupie?