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Overlapping Groups and Options in Family Situations
(Posted February 15, 2001)
Question 81: My client is four corporations owned by a father or his son (or both). The son is at least age 21.
I think I have 2 controlled groups: one comprised of the 2 companies owned by the son, and one comprised of 3 companies. If each of the groups adopts a 401(k) plan, does one company get tested in both groups? I am suggesting giving father an option to tie the four corporations together.
Answer: I see the breakdown a little bit differently, but you're on the right track.
You are correct that A and B are in a controlled group, but C is also in that group. Why? Because son owns more than 50% of C, son is deemed to own his father's C stock. Thus son is deemed to own 100% of C as well. (See IRC 1563(e)(6)(B).)
C and D also are in a controlled group by themselves. The father and son, without considering any attribution, have 95% "effective control" and 100% controlling interest. (It is true that father is deemed to own son's stock in D, but that's irrelevant because we can create the controlled group before applying the attribution rules.)
So here we have Corp C as a part of two controlled groups. What does that mean? (This is an issue I discuss in detail at Q&A 31.) Basically there are two views. In my view, for qualified plan purposes you have in effect a single employer. The other view (held by some high-ranking minions of the IRS) is that you have two groups that must be tested separately in any plan adopted by any member of either group.
If you'd like to get rid of the uncertainty, an option may be the easiest way to do so, particularly in a family situation. The easiest way to do the job is to give the son an option to buy 5% of father's stock in D. Son then would be deemed to own 51% of D and hence to own all his father's stock as well. That would give him deemed ownership of 100% of all four companies, and all four would be in the same controlled group.
If the option were given the option instead, to get the desired result he would need to be given an option to buy at least 5% of both A and B. Then, after option attribution, son's effective control would be 46% and father's would be 5%, for a total of 51%, and both together would have a 100% controlling interest. That would put all four corporations together into a single controlled group.
Note: there is a price to pay for creating the single controlled group. Now, because of the component member rules of IRC 1563(b), which do not apply to qualified plans, Corporation D can compute its taxes without regard to the other controlled group-- effectively lowering its tax rate. For more information on this, see Chapter 9 of my book, Who's the Employer?.
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