Brother-Sister Group

I'm hoping someone can confirm (or point out where I'm wrong on) the following:

Small Corp is wholly owned by Joe. 

Big Corp is owned 97% by a 401(a)-qualified plan covering Big Corp's employees. Joe owns the other 3% of Big Corp and is an employee of Big Corp. Joe's Big Corp plan account is allocated 1% of Big Corp stock. 

Small Corp and Big Corp are unrelated in every other way (no services, no options, no family relationships, no possibility of an ASG, management group, etc.).

Under the brother-sister stock exclusion rules, stock of Big Corp that is owned by Big Corp's qualified plan is excluded if five or fewer persons who are individuals, estates, or trusts own 50% or more of the vote/value of Big Corp's stock. The regulations do not require that the five or fewer individuals, estates, or trusts own overlapping interests in both corporations, only that five or fewer individuals, estates, or trusts own at least 50% of the vote/value of the corporation whose stock is potentially excluded. (This is confirmed by Who's the Employer as well.)

Because five or fewer individuals or trusts (Joe and Big Corp's plan trust) own 100% of Big Corp, it seems that the exclusion condition is met. If so, and all Big Corp stock owned by Big Corp's plan is excluded, Joe is deemed to own 100% of Big Corp. Given that Joe owns 100% of Small Corp, that would seem to make Big Corp and Small Corp a brother-sister group.

This outcome seems counterintuitive. 

Am I missing something?

I don't see how the 3% ownership is deemed 100% in this case because the qualified plan owns 97% but I'll defer to those who are experts on ERISA law WRT GCs.

To my non-lawyer eyes it looks like you have 3% common and 3% identical control and thus no CG. My limited understanding is the that you don't pass the 1% ownership Joe has in the Plan and add it to 3% he has.

Thanks Lou. As I mentioned, the outcome seems very counterintuitive, so I'm hoping I'm missing a link somewhere and would be glad to have someone point it out. 

More specifically, the rule is in 1.1563-2(b)(3) and (4). Under subsection (b)(3), subsection (4) applies if five or fewer persons who are individuals, estates, or trusts own at least 50% of the vote or value of the corporation. Subsection (4) then treats as not outstanding any stock owned by a qualified plan trust.

There is no distinction I can find that would exclude the same qualified plan trust from being treated as one of the five or fewer individuals, estates, or trusts whose interests are included in reaching the 50% ownership threshold. In other words, if Joe (one individual) and the plan trust (one trust) collectively own 50% of Big Corp, any stock owned by a qualified plan of Big Corp would be treated as not outstanding, leaving only Joe's 3% individual interest outstanding, meaning he owns 100% of the stock of Small Corp and 100% of the non-excluded stock of Big Corp.

Interested to hear others' thoughts as well.

Can you exclude Joe's ownership under the employee rule (i.e., the rule excluding stock owned by employees, if the stock is subject to conditions that restrict his/her right to dispose of the stock)?

Unfortunately not.

It does seem counter intuitive, but it wouldn't be the first time there is an odd result by following the regs. based on real life facts. Sorry I can't be of more help on this one.

EBECatty, if, after you complete your research and analysis, the ESOP-owned corporation and Joe’s corporation are one employer, could the problems that result be solved with qualified separate lines of business? Or is QSLOB treatment unavailable in the circumstances? Or would QSLOB treatment not solve the particular problem Joe seeks to resolve?

Peter, that's a good thought, and one I hadn't considered yet, but in my particular scenario Joe's Small Corp is under 50 employees so would not qualify as a separate line of business.