The passage of the Tax Reform and Jobs Act (“TRJA”) in 2018 made entity selection an important part of tax planning. The TRJA made fundamental changes affecting individual and entity tax rates. Combined with corporate transactions for strategic reasons and business owners acquiring interests in other companies, we’re seeing businesses and owners using multiple entities.
And that’s where the elephant in the room gets into the act. The elephant is the complex set of IRS rules that must be considered regarding retirement benefits offered to employees. Consider the following:
Background
During the mid-1980s, control group rules were incorporated into the Internal Revenue Code (the “Code”) to prevent employers from using multiple entities to escape coverage or nondiscrimination rules. In other words, business owners could not subdivide their businesses into separate entities to favor Highly Compensated Employees (“HCEs”).
What is a Control Group?
It can get very complicated very quickly. Depending on the entity structures and ownership, it could be either:
- Parent-Subsidiary Control Group, or
- Brother-Sister Control Group, or
- Combined Group
Or an “Affiliated Service Group”.
Why does it matter?
In qualified retirement plan terms, this means that the control group rules determine whether all employees of commonly controlled corporations, trades, or businesses must be treated as employees of a single corporation for the following purposes:
- General qualification under Internal Revenue Code (“Code”) Section 401;
- Coverage under Code Section 410;
- Vesting under Code Section 411;
- Limits under Code Sections 401(a)(17), 401(a)(30), and 415;
- Top-heavy rules under Code Section 416.
In practical terms, all of these Code sections must be satisfied to demonstrate that the plans(s) do not discriminate in favor of owners and other highly compensated employees; and, thus qualify for tax-favored treatment.
What should be the starting point?
Whether or not a Control Group or an Affiliated Service Group exists begins with answering these questions:
- Does the plan sponsor have ownership in any other entity?
- If the plan sponsor is privately owned, do the shareholders, or partners, or LLC members have ownership in any other entity?
- Does a spouse, children, or other relatives have ownership in any other entity directly or indirectly by family attribution?
- What types of stock are owned, e.g., treasury stock, nonvoting preferred stock, restricted stock held by an employee, etc.?
- Are any of the entities providing services for any other entity?
What should be considered?
When common ownership in business entities is involved with retirement plans, there are four key considerations:
- All members of a control group could be jointly and severally liable for liabilities under a defined benefit pension plan.
- Control group considerations can be an important consideration in a corporate transaction.
- Even though certain entities may be disregarded for tax and financial reporting purposes does not mean they can be disregarded for control group purposes.
- The control group rules must also be considered for welfare benefit plans and non-qualified deferred compensation plans.
Whether a Control Group or Affiliated Service Group exists and it’s impact on a retirement plan should be discussed with plan sponsor advisors.
