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Answers are provided by S. Derrin Watson, JD, APM
Insurance ASG Issues; Referral of Clients Means "Regularly Associated"?
(Posted April 26, 2002)
Question 164: Is this an affiliated service group? Company A sells property and casualty insurance. Company B sells life insurance, group insurance benefits, retirement planning and financial planning. Company A owns 49% of Company B. Both companies regularly refer clients to each other. There are no shared employees or expenses. The only connection between the two companies is the mutual referrals.
Answer: There's little wonder that you aren't confident, considering the fuzzy nature of the ASG rules. Let's start, though, by looking at something that isn't fuzzy.
You did not indicate whether Company B is incorporated. That is frankly the quick and easy way to get a definite answer, because Company B would not be a Professional Service Corporation. If it were incorporated, then it could not be a FSO for purposes of the A-Org test. On the limited facts you have given, that would be enough to prevent formation of an ASG.
Now, let's assume that it isn't incorporated and so the professional service corporation exemption does not apply. Both businesses are service organizations, because both are in the field of insurance. A owns part of B. The only other question is whether A regularly performs services for B or is regularly associated with B in performing services for third parties. I have difficulty seeing making referrals as performance of services for an entity. But are referrals enough to make them "regularly associated"?
Here is the total guidance we have on this issue from the proposed 414(m) regulations:
If you find that excerpt neither helpful nor illuminating, you're not alone. But it does suggest that the total dollar volume of business generated by the referrals is a factor.
The determination of whether a service organization regularly performs services for the First Service Organization or is regularly associated with the First Service Organization in performing services for third persons shall be made on the basis of the facts and circumstances. One factor that is relevant in making this determination is the amount of the earned income that the organization derives from performing services for the First Service Organization, or from performing services for third persons in association with the First Service Organization.
If it were my client, I would advise them to incorporate Company B and eliminate the issue. If they didn't want to do that, I would urge them to request a determination letter from the IRS on the issue. If the case came before Judge Watson, I'd rule that cross-referrals without anything else-- such as common employees, advertising, offices, etc.-- does not make two businesses regularly associated.
It is interesting to compare your situation with an example taken from the B-Org portion of the proposed regs. The main difference in the example in the regulations is a stipulation that one business directly performs services for the other business.
I discuss the affiliated service group rules in detail in Chapter 13 of my book Who's the Employer.
(i) Individual M owns one-third of an employee benefit consulting firm. M also owns one-third of an insurance agency. A significant portion of the business of the consulting firm consists of assisting the insurance agency in developing employee benefit packages for sale to third persons and providing services to the insurance company in connection with employee benefit programs sold to other clients of the insurance agency. Additionally, the consulting firm frequently provides services to clients who have purchased insurance arrangements from the insurance company for the employee benefit plans they maintain. The insurance company frequently refers clients to the consulting firm to assist them in the design of their employee benefit plans. The percentage of the total gross receipts of the consulting firm that represent gross receipts from the performance of these services for the insurance agency is 20 percent.
(ii) Considering the insurance agency as a First Service Organization, the consulting firm is a B Organization because a significant portion of the business of the consulting firm (as determined under the Total Receipts Percentage Test) is the performance of services for the insurance agency of a type historically performed by employees in the service field of insurance, and more than 10 percent of the interests in the consulting firm is held by owners of the insurance agency. Thus, the insurance agency and the consulting firm constitute an affiliated service group.
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