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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

Voting Power Creating Controlled Group

(Posted April 19, 2002)

Question 160: Company A and Company B each own 50% of the common stock of Company C. The common stock is the only class of voting stock of Company C. Pursuant to a shareholders' agreement between Company A and Company B, Company A has the sole right to appoint the directors of Company C. Are Company A and Company C in a controlled group?

Answer: According to the IRS, yes, they are a parent-subsidiary controlled group.

A parent-subsidiary relationship exists when the parent owns 80% of the "voting power" of the subsidiary or 80% of the value of the subsidiary's stock. We frequently use the term "voting stock," but the actual requirement in IRC 1563(a)(1) is voting power.

Treasury Regulation 1.1563-1(a)(6) expands on this concept:

In determining whether the stock owned by a person (or persons) possesses a certain percentage of the total combined voting power of all classes of stock entitled to vote of a corporation, consideration will be given to all the facts and circumstances of each case. A share of stock will generally be considered as possessing the voting power accorded to such share by the corporate charter, by-laws, or share certificate. On the other hand, if there is any agreement, whether express or implied, that a shareholder will not vote his stock in a corporation, the formal voting rights possessed by his stock may be disregarded in determining the percentage of the total combined voting power possessed by the stock owned by other shareholders in the corporation, if the result is that the corporation becomes a component member of a controlled group of corporations. Moreover, if a shareholder agrees to vote his stock in a corporation in the manner specified by another shareholder in the corporation, the voting rights possessed by the stock owned by the first shareholder may be considered to be possessed by the stock owned by such other shareholder if the result is that the corporation becomes a component member of a controlled group of corporations.

That sounds to me like what you have in your situation. Of course, shareholders can vote on things other than election of directors, such as whether to dissolve the corporation, but most of a shareholder's voting rights are tied up in the ability to elect directors. Where one shareholder has the sole right to choose the board, I think it is likely that the IRS would hold that the shareholder has 100% of the voting power (and certainly more than 80%).

I discuss this issue, and give further examples, in Chapter 6 of my book Who's the Employer.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.

Copyright 1999-2017 S. Derrin Watson
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