Controlled group with company owned 100% by ESOP?

So, if a company is owned 100% by an ESOP, is there any exception to the excluded stock rule in 1563(c)(2)(A) that would allow (or require) this company to be considered part of a controlled group? It seems like the stock is initially attributed under 414(b), but then disregarded under 1563.

You need to own Derrin Watson's book: Who's The Employer.

http://employerbook.com/

I hope you will find this useful; from his book:

Q 10:37 How do the controlled group rules affect ESOPs?   

ESOPs are designed to invest primarily in employer securities. [Code §409(a), Code §4975(e)(7), (8)] An employer security is stock issued by the employer or by a corporation in a controlled group with the employer. [Code §409(l)(1)] Therefore the controlled group rules determine whether stock of a related corporation is an employer security. [Code §409(l)(4)]

However, some corporations which would not ordinarily be part of a parent-subsidiary group may be brought into the group through some special rules. These rules consider what could be termed “block ownership.” A corporation is the block owner of another corporation if it owns directly at least 50% of the voting power of all classes of voting stock in that corporation, and at least 50% of each class of nonvoting stock in that corporation. Only direct ownership will do; no attribution rules are applied in determining block ownership. Using this definition, there are several modifications of the controlled group rules. These are described and illustrated below. In each case, assume Corporation P is sponsoring an ESOP.

A parent-subsidiary group will be deemed to exist for the ESOP rules if a parent is a block owner of a subsidiary. This rule only applies to the subsidiary directly below the parent in the chain of ownership, the “first-tier subsidiary.”

Example 10.37.1 Corporation P directly owns exactly 50% of the stock of Corporation S1. Although the two are not a controlled group for any other purpose, they are a controlled group to determine whether stock is an employer security under the ESOP rules. S1 stock can be an employer security for P’s ESOP.

Example 10.37.2 Assume the same facts as Example 10.37.1, except P does not own the S1 stock directly. Instead, it has an option to acquire 50% of the stock of S1. P is not block owner of S1 because only direct ownership is considered. Stock in S1 is not considered an employer security for P’s ESOP.

Example 10.37.3 Corporation P directly owns 51% of the stock of Corporation S1. Corporation S1 owns 75% of the stock of Corporation S2. P and S1 are part of a parent-subsidiary controlled group to determine whether stock is an employer security under the ESOP rules. S1 and S2 are also part of a parent-subsidiary group for ESOP purposes. However, these are two separate groups. Stock of S2 is not considered an employer security for P’s ESOP. (Barring attribution, the three corporations are totally separate for most normal retirement plan purposes, because no corporation owns at least 80% of any other corporation. However, for the 415 limitations, the three corporations are a single parent-subsidiary group, because of the adjustments of Code §415(h). [Q 10:11]

If a parent corporation is block owner of a first-tier subsidiary, and that subsidiary is the parent of a parent-subsidiary controlled group (determined under the normal rules requiring ownership or deemed ownership of at least 80%), then all of these corporations are part of a controlled group for the ESOP rules.

Example 10.37.4 Corporation S owns 80% of the voting power of Corporation S1, and 80% of the value of the stock of Corporation S2. S, S1, and S2 are therefore a parent-subsidiary controlled group under the normal controlled group rules. Corporation S has three classes of stock outstanding, voting common, voting preferred, and nonvoting preferred. Corporation P owns 60% of the voting power of the common stock, 55% of the voting power of the voting preferred stock, and 50% of the outstanding shares of the nonvoting preferred stock. P is block owner of S, and so is in a controlled group for ESOP purposes with S, S1, and S2. Stock of any of those four corporations can be employer securities for P’s ESOP. (Additionally, since P owns more than 50% of the voting stock of S, the four corporations are a single controlled group for the 415 limitations under Code §415(h).)

Example 10.37.5 Assume the same facts as Example 10.37.4, except S owns only 79% of the value of S2. For P’s ESOP, stock in S2 is not considered an employer security, because it is not part of a parent-subsidiary controlled group with S under the normal rules.

Example 10.37.6 Assume the same facts as Example 10.37.4, except P owns only 49% of the nonvoting preferred stock of S. P is not block owner of S, even if it owns at least half of the value of all S stock. To be block owner, P must own at least 50% of each class of S nonvoting stock. Accordingly, only stock of P will be considered an employer security.

If a corporation directly owns 100% of the voting power and 100% of each class of nonvoting stock of a first-tier subsidiary, and that subsidiary, in turn, is block owner of a subsidiary (a “second-tier” subsidiary to the parent), then that second-tier subsidiary and all corporations of which it is the parent of a parent-subsidiary group under the normal controlled group rules will be part of the controlled group for ESOP purposes. Just as with block ownership, the 100% ownership requirement does not consider attribution.

Example 10.37.7 P directly owns all outstanding shares of S. S owns 60% of T. T owns 80% of T1. For most retirement plan purposes, there are two parent-subsidiary groups here, P and S on the one hand, and T and T1 on the other. For ESOP purposes, as well as Code §415, all four are a single controlled group. Stock of P, S, T, or T1 can be considered an employer security for P’s plan.

Example 10.37.8 Assume the same facts as Example 10.37.7, except P owns 95% of the stock of S directly and has an option to acquire the other 5%. The special ESOP rule does not apply to P because it does not directly own 100% of S. However, P and S are still a controlled group under the normal rules. For P’s ESOP, only stock in P or S can be considered an employer security.

Example 10.37.9 Continuing Example 10.37.8, suppose S sponsors an ESOP. It is in a controlled group with P under the normal rules. It is block owner of T as its first-tier subsidiary, and hence is in a controlled group with T and T1 under the ESOP rules. Accordingly, for purposes of S’s ESOP, stock of P, S, T, or T1 can be considered an employer security.

Example 10.37.10 Continuing Example 10.37.8, suppose T sponsors an ESOP. It is in a controlled group with S and T1 under the ESOP rules, but not with P. Accordingly, for purposes of T’s ESOP, stock of S, T, or T1 can be considered an employer security.

This special definition of controlled group applies in determining whether an individual is ineligible to receive an allocation of stock under Code §409(n)(1)(B), because the individual owns (or is deemed to own under the attribution rules described in Chapter 14.) at least 25% of any class of stock of the employer sponsoring the ESOP, or any member of a controlled group with that employer.

Only the controlled group rules are impacted here. The common control rules and affiliated service group rules have no direct bearing on this issue.

Thanks Larry.

On 6/1/2018 at 2:14 PM, Larry Starr said:

Example 10.37.1 Corporation P directly owns exactly 50% of the stock of Corporation S1. Although the two are not a controlled group for any other purpose, they are a controlled group to determine whether stock is an employer security under the ESOP rules. S1 stock can be an employer security for P’s ESOP.

 

.What MIGHT be interesting here is they are only a controlled group for employer security reasons.  Maybe everyone else sees that right away but just to be clear does that mean they aren't a controlled group for testing (like coverage testing) purposes?  

I fully admit controlled group rules aren't a strength of mine so I wouldn't mind learning a bit here.   

It would be helpful to know the other facts. Is there a concentration of allocations among a small group of ESOP participants, or just one, who also own another company? I seem to recall dealing with an issue like that a couple of decades ago and it was not simple.

On 6/4/2018 at 7:37 AM, ESOP Guy said:

.What MIGHT be interesting here is they are only a controlled group for employer security reasons.  Maybe everyone else sees that right away but just to be clear does that mean they aren't a controlled group for testing (like coverage testing) purposes?  

I fully admit controlled group rules aren't a strength of mine so I wouldn't mind learning a bit here.   

They are only a controlled group for the limited purpose of the ESOP rules, and are not a controlled group for any other purposes.