The Internal Revenue Code of 1986, as amended (“Code”), generally provides that for purposes of the “tax qualification” requirements of the Code all employees of all companies which are members of a “controlled group of employers” are treated as employed by a single employer. In addition, the Code generally provides that a controlled group of employers can be a “brother-sister controlled group” and “parent-subsidiary controlled group”.
A. Brother-sister Controlled Group
A Brother-sister Controlled Group will exist between two or more organizations if the following requirements are satisfied: (1) the same five or fewer persons who are individuals own a “controlling interest” in each organization; and (2) after taking into account the ownership of each such person, only to the extent such ownership is identical with respect to each such organization, such persons are in “effective control” of each organization. In determining whether a Brother-sister Controlled Group exists, certain attribution rules are applied.
After the attribution rules of the Code are applied, the next step in determining whether a Brother-sister Controlled Group exists is to determine if the same five or fewer persons who are individuals own a controlling interest in each organization. A controlling interest is defined as ownership of at least 80 percent of the total value of the entity.
An example of the application of the controlling interest rule is as follows. Assume Company ABC is owned 33 percent each by individuals A, B and C. Further assume that Company XYZ is owned 25 percent each by individuals A, B, C and D. When the controlling interest test is applied to the facts of this example; individuals A, B and C only own 75 percent of XYZ Company. Thus, the controlling interest test is failed.
In addition to a controlling interest in one or more organizations, a Brother-sister Controlled Group also requires the same persons who own such controlling interests to be in effective control of such organizations. Under the Code, effective control of a business entity is defined as such individuals owning more than 50 percent of the total value of the entity. The same individuals whose ownership is considered in determining a controlling interest must be the same individuals whose ownership is considered for purposes of determining effective control of a business entity. In addition, the ownership interest of each individual that is taken into account for purposes of determining effective control is limited to the extent that such individual’s ownership interest is identical with respect to each organization.
An example of the application of the effective control test is as follows. Assume Company ABC, from the example above, is now owned 10 percent by individual A, 10 percent by individual B and 80 percent by individual C. Further assume that Company XYZ is owned 45 percent by individual A, 40 percent by individual B, 10 percent by individual C and 5 percent by individual D. When the controlling interest test is applied to the facts of this example; individuals A, B and C own 100 percent of ABC Company and 95 percent of XYZ Company. Thus, the controlling interest test is satisfied. However, when their lowest percentage interest owned in either entity is examined; individual A owns 10 percent, individual B owns 10 percent and individual C owns 10 percent. This totals to 30 percent. Since 30 percent does not exceed 50 percent, the effective control test is failed.
B. Parent-subsidiary Controlled Group Rules
The Parent-subsidiary Controlled Group rules requires one company to own directly or indirectly 80 percent or more of another company. In determining whether this group exists, the same attribution rules are applied that concern a Brother-sister Controlled Group.
An example of a Parent-subsidiary Controlled Group is as follows. Assume Company A owns 85 percent of Company B. In this example, a company directly owns 80 percent or more of another company. Thus, a Parent-subsidiary Controlled Group exists between Company A and Company B.
Another example of a Parent-subsidiary Controlled Group is as follows. Assume Company A owns 70 percent of Company B. Further assume that Company A owns 100 percent of Company C and Company C owns the remaining 30 percent of Company B. In this example, Company A indirectly owns 100 percent of Company B because of Company C’s ownership by Company A and Company C’s ownership of Company B.
If you have any questions regarding the Controlled Group of Employers rules, please contact The Law Firm of Anthony L. Scialabba at (609)352-4663