Question 202: Sherman owns a sole proprietorship. He also owns 60% of a C corporation; the remaining 40% is owned by an unrelated party. Are these businesses under common control for purposes of the Code section 415 limits?
Answer: Perhaps, depending on how IRC 415(h) applies to the sole proprietorship.

415(h) says that, for purposes of 415, the parent-subsidiary controlled group rules are based on ownership of more than 50%, instead of ownership of at least 80%. 415(h) does not change the brother-sister rules, just the parent-subsidiary rules.

To illustrate the difference, suppose Corporation A owns 60% of Corporation B. The two would be a controlled group for 415 purposes, but not for purposes of any other Code provision. Contrast that with a situation in which someone owns 60% of Corporation A and 60% of Corporation B. The two are not a controlled group for any purpose, because 415(h) does not change the brother-sister rules.

Now, let's look at your situation. If you view it as a brother-sister arrangement, with Sherman owning two businesses, then 415(h) does not apply and the two are not under common control for any purpose. However, suppose the C Corporation stock is viewed as being held by Sherman's sole proprietorship. In that case, you have a parent-subsidiary arrangement; 415(h) would apply, and the two businesses would be under common control for purposes of 415.

Although not directly on point, Treas. Reg. 1.415-7(h)(5) implies your situation is to be viewed as a parent-subsidiary arrangement. Moreover, given that under the IRS entity regulations the sole proprietorship is disregarded as a separate entity, there is no difference between ownership by the sole proprietorship and ownership by the sole proprietor. This reasoning also leads to the conclusion that the arrangement should be viewed as a parent-subsidiary arrangement and hence subject to 415(h).

Given the uncertainty over the issue, sole proprietors concerned about 415(h) should seriously considering incorporating their sole proprietorships. Then the ambiguity is eliminated. We are simply dealing with brother-sister arrangements and 415(h) cannot apply.

I discuss these issues, with further examples, in Chapter 12 of my book, Who's the Employer.

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