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Most Frequently Asked Controlled Group Question
(Posted January 3, 2003)
Question 245: A person owns 51% of a non-service Company A and 100% of sole proprietorship Company B. Company B derives 100% of its business from Company A. Is this is a controlled group for most purposes? For 415 limit purposes?
Answer: You've asked the the most frequently asked question submitted by readers of this column. The answer is no, this isn't a controlled group for most purposes, but there is an argument that you are under common control for purposes of 415.
For a brother-sister controlled group to exist, at some level there must be at least 80% common ownership. There are other factors as well, but if you don't satisfy that 80% test, you don't bother with the other factors. [Q 6:9. References to "Q" are to numbered questions addressed in the third edition of Who's the Employer; they can be viewed online by subscribers.]
Of course, there are various ways of getting to that 80%. If our intrepid owner is deemed-- under the attribution rules-- to own stock actually owned by other persons, that might do the trick. [Q 7:0.] Possibly another shareholder's stock can be excluded. [Q 8:0.] But once you're done with all the rules, if you don't have 80% common ownership, nothing else matters.
Source of income is totally irrelevant in making this determination. It might enter into affiliated service group issues [see e.g. Q 13:10], but it has no place in controlled group determinations. [Q 6:13.] The controlled group rules focus on control of stock or voting power; after applying the attribution and exclusion rules, nothing else matters.
I've been speaking as though this were a controlled group situation, but it could not possibly be one, because B is not incorporated. However, the same rules apply to businesses under common control under 414(c). So, not only is it not a controlled group, it is not a group under common control.
Unfortunately the 415 aspects of this situation are thorny. The issue is discussed at length at Q&A 202 of this column (click) and in Q 12:07 of my book. The bottom line is that if both of the two businesses were incorporated, they clearly would not be a controlled group for 415 purposes, but because one business is a sole proprietorship it's possible the IRS could argue that a controlled group does exist for 415 purposes.
At a recent pension conference a high-ranking IRS official stated that it should not matter for 415 purposes whether or not the businesses in question are incorporated, if no controlled group would exist if both businesses were incorporated. That's a happy result, but until something in the way of official precedent exists, his opinion is not binding on the IRS or anyone else who might stand to gain from making the controlled group argument.
I still think there's doubt. Until authoritative precedent is published, I recommend that your client incorporate the sole proprietorship and eliminate the doubt.
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