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Answers are provided by S. Derrin Watson, JD, APM
HCE Attribution from Trusts
(Posted July 19, 2002)
Question 217: A trust owns 97% of Company A. Company B is 100% owned by Company A. Company C is 67% owned by Company B and 28% owned by the trust that owns 98% of Company A. A son of the trust's grantor is a 5% owner of Company C. It is not known whether this son is a beneficiary in the trust that owns Company A. Assuming no, would the son who owns 5% of Company C earning $30,000 be considered a highly compensated employee?
Answer: By saying that you don't know whether the son is a beneficiary, you are leaving out a key fact. (I sometimes have the impression people in the pension business don't like trusts!)
Here you have described in detail the ownership of every entity except the trust. Corporations have shareholders. Partnerships have partners. And trusts have beneficiaries. You won't be able to answer attribution and ownership questions without knowing who those beneficiaries are.
Of course, a "5% owner" who is an employee is considered an HCE (highly compensated employee). As defined in the Internal Revenue Code, a 5% owner actually is someone who owns more than 5%. Here the son owns exactly 5% directly, and he might own 95% indirectly, depending on what is in the trust. Given that any additional ownership will do, there are a lot of ways to get him what he needs:
In a case like this, I almost certainly would not rely on a client's assertion that "This is a trust for my friend Charlie." With it being this close, I would want to look at the trust and determine if there is any way in which stock might pass to the son under the terms of the trust. I don't care how remote a beneficiary he might be. If you don't feel comfortable reviewing the language of a trust to determine who is a beneficiary, then you need to involve counsel who can.
- If the trust is a grantor trust taxable to the father, the son will be deemed to own the father's interest.
- If the son is a beneficiary of the trust, he is deemed to own his pro rata interest in the trust assets based on his actuarial interest. As long as that actuarial interest is greater than zero, that will be enough in this case. There is no 5% minimum threshold for attribution to trust beneficiaries under IRC 318. (There is a 5% threshold for attribution from beneficiaries to trusts, however.)
- If the son's child or mother or spouse is a beneficiary of the trust, he will be deemed to own their interest, regardless of age.
- If the son's sister is a beneficiary and the trust provides that the son receives her interest if she dies, that makes him a beneficiary.
Incidentally, I'm sure you are aware that the three Companies are a controlled group (or under common control if one of them is not incorporated). If the son is an HCE of any one of them, he is an HCE of all of them.
For more on the attribution rules applicable to highly compensated employees, see Chapter 14 of my book, Who's the Employer.
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