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No Double Family Attribution
(Posted November 30, 2004)
Question 271: Arthur is 100% owner of his sole proprietorship. His wife, Betty, owns 99% of Partnership A. Corporation C (wholly owned by Arthur) owns the other 1%. Arthur provides management services to Partnership A. Arthur's child by a previous marriage, Daniel, works for Partnership A. I know this is a controlled group, but is Daniel considered to be an HCE by virtue of ownership?
Answer: Yes. I'll explain, including references to my book, Who's the Employer?. (Subscribers can click to view online the text of references to sections in the book.)
Let's start with Partnership A. We use the attribution rules of IRC 318 to determine HCE status. (See WTE Chapter 14.) Under those rules, there is always attribution between parent and child. (See WTE 14:07.) Moreover, Arthur is deemed to own the 1% of Partnership A that his corporation holds. (See WTE 14:12.) Put those two rules together and Daniel is deemed to own 1% of Partnership A. That is all, and that is insufficient to make Daniel an HCE by ownership. Of course, he could be an HCE by reason of his compensation. (See IRC 414(q).)
There is no attribution between a step-mother and a step-child under Code 318. The Code directly states that adoptive children are treated the same as natural born children (IRC 318(a)(1)(B), but does not provide any such rule for stepchildren. Accordingly, Daniel is not deemed to Betty's 99% directly from her. See generally Q&A 83.
It is true that Arthur is deemed to own that 99% by attribution from Betty. (See WTE 14:07.) However, the prohibition against double family attribution prevents that 99% from being attributed a second time to Daniel. (See WTE 14:04.)
However, all this does is establish that if Partnership A were alone, Daniel would not be an HCE. But Partnership A is not alone. Partnership A is under common control with Arthur's sole proprietorship. The common control rules are applied before you apply the HCE rules. (See WTE 10:21.) What that means is that if an employee of any business under common control is a 5% owner of that business or another business in the same group of businesses under common control, then that employee is an HCE of the resulting single employer. For further discussion and examples, see Q&A 157.
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