Question 102: A construction company (CC) is owned 50% by two brothers, Joe and Chuck. Joe and Chuck receive 100% of their compensation from a construction management company (CMC) that is owned 100% by Steve, an unrelated individual. Currently 85% of CMC's revenue comes from CC; the rest comes from outside clientele. Is CMC a separate employer, which can establish a plan totally unrelated to the construction company CC?
Answer: I'd say no.
IRC 414(m)(5) says that two businesses are in an affiliated service group when one of them has as its principal business purpose providing management functions to the other. I'd want to explore what services CMC is providing to CC, but because you describe it as a management company I'll start from the proposition that it primarily provides management functions. Unfortunately, there's no formal definition of a "management function."
If 85% of my revenues come from managing your business, I'd call that my principal business purpose, wouldn't you? In fact, although the term management function remains undefined, I'd say that if more than half my revenues came from managing you, then that was my principal business purpose.
So, would you like to juggle things so that CC accounts for only 49% of CMC's revenue? (Maybe have Joe and Chuck take a salary from CC -- a shocking proposition!) Would that take you out of "principal purpose"? Maybe, but as I said, we don't have a definition. I wouldn't feel comfortable unless the percentage were less than that. If a client came to me at 49%, I'd urge the client either to lower it further or to seek a formal determination letter from the IRS. Given the current uncertainty, there's no way that I, as an attorney, could give an opinion letter at that level.
Of course, where you are now, well above 50%, I'd be willing to give an opinion that an ASG definitely exists under 414(m)(5), assuming the functions involved are management functions. If CMC wants to establish a plan, it will need to take into account the employees of CC.
The affiliated service group rules are discussed in more detail in Chapter 13 of my book, Who's the Employer?.
By the way, this question gives me a good opportunity to remind my readers of the caveat on the front page of my column. This column is just that, a column. It is not legal advice. I generally don't have enough facts in answering these questions that I'd want to give legal advice. Particularly in a management function group situation, one needs to probe in order to understand exactly what's being done.
The purpose of this column is to outline general principles applicable to hypothetical situations. Once one gets behind a quick statement of facts, often there are significant issues which were not mentioned. Although I believe the responses I give in this column are accurate, in preparing the responses I don't do the level of research and verification that I do for clients when I give a formal legal opinion.
Use this column to educate yourself on the issues involved and to point your thinking to the questions you need to ask. But don't rely on it as the last word. If you need a legal advice, get it from me or another qualified attorney after agreeing to establish an attorney-client relationship and then explaining your situation to the attorney in detail. Don't rely on this or any other web posting as legal advice -- it isn't.