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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.]
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