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Who's the Employer?

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

Common Control Depends on Controlled Group Type

(Posted June 18, 2002)

Question 201: If several C corps within a controlled group own 80% of a partnership, then it seems that a parent-sub situation exists. Thus, can an employee of one of the C corps participate in the 401(k) plan of the partnership?

Answer: Technically, your first sentence is not necessarily true, and so we had best start there.

There are three types of controlled groups: parent-subsidiary, brother-sister, and a combination of the two. Your supposition would be correct if we were talking about a parent-subsidiary group, but it would not necessarily be true for the other types.

A parent-subsidiary group exists when a parent owns at least 80% of a subsidiary, and at least 80% of each subsidiary is owned by the parent or one of its other subsidiaries. So, if the C corps in the group, regardless of whether they were parent or subsidiary companies, owned at least 80% of the capital or profits of a partnership, the partnership would be a subsidiary member of a parent-subsidiary group of trades or businesses under common control. Thus, if you are talking about a parent-subsidiary group, your assumption is always true.

That is not the case, however, with a brother-sister group. A brother-sister group exists where 5 or fewer individuals, estates, or trusts own a controlling interest (at least 80%) and have "effective control" (more than 50%, counting each shareholder's ownership where it is least) in two or more businesses. If a corporation or a partnership is the owner, that cannot count towards the 5 or fewer shareholders. Rather, its stock must be attributed to its shareholders. With that in mind, consider the following situation:

Four friends each own 25% of Corporation A and 20% of Corporation B. The remaining 20% of B is held by 10 other unrelated individuals whose interest is ignored thanks to the Vogel Fertilizer Supreme Court decision. Suppose that Corporations A and B each own 40% of ABC Partnership, with the remaining 20% held by yet another unrelated individual. After applying attribution, each of the four friends is deemed to hold 10% of ABC through attribution from Corporation A (25% times 40%). Each of the four friends is deemed to hold an additional 8% of ABC through attribution from Corporation B (20% times 40%). Thus, the four together hold only 72% and ABC is not under common control with A and B.

Accordingly, you must look at the actual facts to determine whether common control exists. It likely does, but one cannot assume.

Let's say you've checked things out and indeed ABC is under common control with A and B. What does that mean? It means that, for a host of pension and welfare benefit plan rules in the Internal Revenue Code, all employees of all three entities are deemed to be employed by a single employer.

Does that mean an employee of A or B can participate in ABC's 401(k) plan without violating the IRC's exclusive benefit rule? Yes. Moreover, they must be counted in determining whether the plan satisifies IRC 410(b). However, assuming that the plan can pass 410(b) without them, the plan is not required to cover them. Hence, you should look at the document carefully. In any case, to deal with deduction issues, it makes sense for the corporations to cosponsor the plan.

I discuss the types of controlled groups in Chapter 6 of my book, Who's the Employer. Attribution is covered in Chapter 7. The consequences of controlled group (or common control) status are explained in Chapter 10. I examine groups of trades or businesses under common control in Chapter 12.

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.