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Who's the Employer?

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

Attribution From Entities Under Different Rules

(Posted August 8, 2002)

Question 223: My understanding is if Corporation A owns 5% or more of Corporation B then a 5% or more shareholder of Corp A is deemed to own a proportional ownership of Corp B and, likewise, if Partnership A owns 5% or more of Partnership B then a 5% or more partner of Partnership A is deemed to own a proportional ownership of Partnership B. Would the same hold true for a shareholder of an S corporation that owns 5% or more of Partnership B?

Answer: Your understanding is close, but not accurate. There are three different sets of attribution rules, each with its own nuances. You did not specify which set of rules you are using, so I'll address all three.

Under each set of rules, if an owner is deemed to own his pro rata share of what the entity owns, then there is no threshold on the entity itself. An example might make that clearer. Under the controlled group rules of IRC 1563, a 5% partner is deemed to own his pro rata share of whatever the partnership owns (whether or not the partnership owns 5% of the second entity). Suppose John is a 50% partner in the JK partnership, and JK owns 4% of the XYZ corporation. John will be deemed to own 2% of XYZ.

The table below summarizes the attribution rules for all three sets of rules. It shows which owners are deemed to own their pro rata interest of what the entity owns. The 1563 rules are for controlled groups. The 318 rules are for affiliated service groups, highly compensated employees, key employees, and several other purposes. The 267 rules are used in determining related parties for management function groups and leased employees.

	1563	318	267
C Corp	5% shareholder	50% shareholder (5% for HCE/key employee)	All shareholders
S Corp	5% shareholder	All shareholders	All shareholders
Partnership	5% partner	All partners	All partners

All of the attribution rules are laid out on a table appearing as Appendix D in 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.