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Answers are provided by S. Derrin Watson, JD, APM
Trusts and Losing Businesses
(Posted September 10, 2003)
Question 259: Two companies are owned by two separate trusts. Each trust has the same beneficiaries with virtually identical beneficial interests. One of the companies has gone out of business after a period of operating at a negative net worth. If the value of the business is a negative number, is it accurate to say that the beneficiaries have no actuarial interest in the failed entity and as a result a brother-sister controlled group does not exist due to the fact that there can be no attribution of ownership from the trust?
Answer: No, it would not be accurate at all. And there may be another way of dealing with things. In responding to your question, I will refer to my book, Who's the Employer?. (Subscribers can click to view online the text of references to sections in the book.)
Two corporations are in a controlled group if the same 5 or fewer individuals, estates or trusts own (or are deemed to own) "effective control" and a "controlling interest" over both of them. (See WTE 6:04.) Control can occur by holding a certain percentage of a company's voting power or by holding a certain percentage of the value of its shares. (See WTE 6:08.) If the trust holds 100% of a company's voting power, its beneficiaries hold their pro rata share of that voting power based on their actuarial interest in the trust. (See WTE 7:12.) Voting power has nothing at all to do with valuation questions. So your line of reasoning will not let you escape controlled group status (although you get an E for Effort!).
There is a way out, if the losing business will be terminated soon. In 1982 the Tax Court decided a case involving three businesses: two losers and one profitable. (Robert D. Sutherland, 78 T.C. 395.) The profitable business set up a plan excluding the employees of the unprofitable businesses. The losing businesses folded within 2 years after the company set up the plan, while the determination letter application was pending before the IRS. The Tax Court held that neither losing business could set up a "permanent" plan, as the law requires, because they were going out of business, and that it would be a "cruel hoax" to inform the employees (who would soon be out in the snow, figuratively speaking) that a plan was being set up for their retirement. On those facts, the court was willing to let the profitable business establish a qualified plan without regard to the controlled group rules. (See WTE 11:10.) Although the facts are unusual and the court's reasoning is flawed (because the question should be whether the profitable business could establish a permanent plan and provide benefits for the soon to be departed-- and it clearly could), the case is on the books and gives an indication that a court might be willing to bend under some circumstances.
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