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Who's the Employer?

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

Effective Control, But No Ceegar

(Posted June 20, 2003)

Question 255: In a brother/sister organization, does effective control have any relevance if the company is not a controlled group? Say Andy, Bob and Corey (unrelated) own equal interests in A Corp totalling 100%. Each also owns 25% of B Corp. Doug owns the other 25% of B Corp; he is unrelated to the other 3 owners. A Corp and B Corp are in separate industries and don't share any common-law employees. Because common ownership is less than 80%, there's no controlled group. Does the fact that Andy, Bob and Cory own more than 50% in both entities have any significance whatsoever?

Answer: It has no significance in the situation you describe. A Corp and B Corp are two totally separate businesses.

For two businesses to be in a brother-sister controlled group, there must be effective control and a controlling interest. (See WTE 6:4 of my book, Who's the Employer?; subscribers can click to view online the text of the referenced items.) To have effective control, the same 5 or fewer individuals, estates or trusts must own more than 50% of each company, considering each person's ownership where it is the least. [WTE 6:6.] You are correct that your situation satisfies the effective control test.

To have a controlling interest, these shareholders also must own at least 80% of each company. [WTE 6:5.] In testing for a controlling interest, we consider only those who (i) own stock in both businesses, and (ii) were counted as something other than "0" in the effective control test. [WTE 6:7.] Effectively, this means that if you have someone like Doug, who owns more than 20% of one business and does not own any interest in the other(s), then a controlled group cannot exist involving Doug's business. [WTE 6:9.]

Is there a consequence to effective control without a controlling interest? None.

Many practitioners mistakenly believe that in such a situation the businesses are considered a single entity for purposes of IRC 415, but that's wrong. The special rules of IRC 415(h) only apply to parent-subsidiary groups. [WTE 10:14.]

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.