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Who's the Employer?

Question 38: A corporation is 100% owned by X. A new corporation is created with X as 65% shareholder and Y as 35% shareholder. (1) Does this constitute a brother-sister controlled group? (2) If not, shouldn't we treat it as a controlled group, just to be safe? (3) If it were a controlled group, would it qualify for the transition rule of IRC 410(b)(6)(C)? Answer: The answer to the first question is probably no, but I need to make some assumptions. The answer to the second question is NO. The answer to the third question is of course it would. In giving these answers, I am assuming that there is no reason to exclude Y's stock. For example, suppose Y were an employee of the new company, and had given X a right of first of refusal on his shares (without a corresponding provision going from X to Y). In that case, we would ignore Y's shares, and X would be deemed to own 100% of both companies. I am also assuming that there is no reason to attribute Y's stock to X. If Y were X's daughter or grandson, for example, regardless of the age, X would be deemed to own Y's stock under these facts, since X already owns more than 50% of the new company. Barring attribution or exclusion, X does not meet the 80% controlling interest test on his own. Y is ignored for purposes of the controlling interest test, thanks to the 1980s Vogel Fertilizer Supreme Court case. That means you can own 79% of 50 corporations, and so long as the remaining 21% is owned by 50 unrelated individuals (i.e., 21% of corp 1 is held by X1, 21% of corp 2 is held by X2, etc.), none of them are in a controlled group. Being part of a controlled group has both benefits (or, at the least, planning opportunities) and pitfalls. While you avoid the pitfalls if you are not in a controlled group, you also do not receive the benefits. For a variety of reasons, treating two businesses as part of a controlled group when they are not is not being on the safe side. It is wrong and could, depending on the circumstances, lead the unwary plan to penalties or disqualification. An example of one of the benefits of joining a controlled group is the transition rule of IRC 410(b)(6)(C). Whenever a corporation becomes part of a controlled group, that provision gives them a free pass of the coverage requirements of 410(b), lasting through the current year and the following year, so long as certain conditions are met. You don't have the free pass if you didn't join a group, even if you administer the plan as though you had. The controlled group rules are vital to understand clearly. They are black and white rules with clearly drawn lines. Unfortunately, many practitioners administer plans based more on what they suspect the rules ought to be than what they actually are. That is why my book, Who's the Employer?, discusses the controlled group rules, including the transition rules of 410(b)(6)(C) in depth in chapters 6 through 11.

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