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Answers are provided by S. Derrin Watson
Grandchildren as Highly Compensated Employees
(Posted May 15, 2001)
Question 98: John owns 100% of a company. His granddaughter works for the company. John would like her to be a highly compensated employee, but he doesn't want to pay her the $85,000 needed to put her in that category on her own. But is she an HCE due to deemed ownership of her grandfather's stock?
Answer: Yes, but only if some changes are made.
HCE attribution comes through IRC 318, the same section that describes attribution for purposes of the affiliated service group rules. Under section 318, there is attribution from a grandchild to a grandparent but not the other way (from a grandparent to the grandchild). Hence, she is not deemed to own any stock merely because John does.
So the trick here is to find a way to make her a "5% owner" (defined in the Code to mean a person who owns more than 5% of the company). John might give her an option to buy more than 5% of the company--that is the simplest way of handling things. Or he could give one of the granddaughter's parents an option to buy more than 5% of the company; the parent would be deemed to own the stock through option attribution, and she would then be deemed to own the stock through attribution from her parent.
Of course, this assumes that we aren't dealing with a professional corporation. If so, state law usually restricts ownership to licensed members of the profession, which limits the ability to transfer stock or give options.
The attribution rules for HCEs and ASGs are discussed in more detail in Chapter 14 of my book, Who's the Employer?.
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