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Question 161: Our client is a limited liability company ("LLC") owned by 2 corporations, A and B; each owns roughly 50% of the LLC. Corporation A is owned by approximately 10 individuals. No five or fewer individuals own 80% or more of Corporation A. In determining if the LLC is part of a controlled group with another corporation, do we consider that Corporation A is not owned by at least 5 or fewer persons so the LLC is not part of a controlled group because they fail the 80% test? Or do we only consider that the LLC is owned over 80% by only 2 corporations? In other words, do we look through the entities and compare the individual ownership and deem that they own the LLC?
Answer: Yes and no. It depends on which common control test is involved.
In general, a parent-subsidiary group of trades or businesses under common control exists under IRC 414(c) when one company or its subsidiaries owns at least 80% of another company. Thus, you would look to see if either corporation owned at least 80% of the LLC. On these facts, that is not the case.
A brother-sister group of trades or businesses under common control exists when the same five or fewer individuals, estates, or trusts have "effective control" and a "controlling interest." Thus, you must attribute the stock from each corporation to its shareholders. Once you have done that, you no longer care which corporation gave them the stock. You simply look to see if five individuals, estates, or trusts have the required controlling interest and effective control.
For example, suppose Individuals X, Y, and Z, Trust T, and Estate E each own 12% of Corporation A and 20% of Corporation B. The remaining 40% of Corporation A is held by 5 other persons. Accordingly, Individual Z would own a total of 16% of the LLC, 6% (50% multiplied by 12%) through Corporation A and 10% (50% multiplied by 20%) through Corporation B. Thus, these five shareholders would collectively have an 80% effective control interest in Corporation B and the LLC, as well as controlling interests in both. Thus, B and the LLC would be under common control, even though these five owners do not have 80% of Corporation A.
There are a number of shortcuts you can take in apply the common control rules. The one you suggest is not one of them. Apply the attribution rules fully and see how the numbers work out.
For more information on controlled groups and applying the attribution rules, see Chapters 6 and 7 of my book, Who's the Employer.
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