Who's the Employer?

Answer: Surprisingly, the answer is yes. Although it is counter-intuitive, using the strict language of the Code parent-child attribution can cause businesses owned separately by the parents to become a controlled group. Consider the following examples:

1. Childless Separate Property. John and Mary are a married couple living in New York. Each owns 100% of the stock of a medical corporation as his or her separate property. Neither has anything to do with the other's business, and each corporation makes all its income from the practice of medicine. They have no children. The marital exception to attribution (IRC 1563(e)(5)) applies. There is no aggregation between the businesses and they are not part of a controlled group.

2. The Blessed Event. Same facts as the previous example, except John and Mary have been blessed with a baby. The child is deemed to own 100% of John's corporation and 100% of Mary's corporation. Hence the two corporations are a brother-sister controlled group. This is not double family attribution. The stock of each corporation is attributed only once, from the parent to the child.

3. Divorce Follows. The facts in the prior example cause John and Mary so much difficulty that they get divorced. It does not solve their problem. Their businesses will still be aggregated until their youngest child is 21.

4. Nonmarital Union. Same facts as the prior example, except John and Mary were never married. Their child was the result of a night of passion after studying for exams while they were medical students. They went their separate ways after medical school, and their only contact now is child support checks. Since marital status does not affect attribution between parents and children, the two corporations will be part of a controlled group until the child reaches age 21.

Practitioners have noted that the foregoing, while logically valid, seems senseless and contrary to the intent to create a separate property spousal exemption. Unfortunately, the courts have held that where the statutory language is clear, legislative intent is irrelevant. The language is astonishingly clear in this case. The conclusions stated above are inescapable. The only reason this has not created more controlled groups is that the IRS has not aggressively pursued this issue.

It is important to remember that the controlled group rules are intended to be clear, bright line tests. There are few "facts and circumstances" elements to them. That means that there is a clear road for practitioners to follow. The price of clarity is that sometimes the road goes places you do not expect, and there are no convenient ways off the path. If there is to be a solution for this problem, it will probably have to come from Congress.

Some practitioners have taken heart in the fact that the IRS has not yet pursued this issue. The operative word in the foregoing sentence is "yet." Nobody wants their client to be the test case, especially if they have not informed the client of the potential risk involved.

The preceding is taken from Q 7:18 of my new book Who's the Employer?, along with my suggestion of statutory language to correct this issue.

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