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 being the complex set of IRS rules that must be considered regarding retirement benefits offered to employees. Consider the following:
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”).
Impact on Qualified Retirement Plans
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 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.
The Starting Point
So what’s a control group? It can get very complicated very quickly. It could be either:
- Parent-Subsidiary Control Group, or
- Brother-Sister Control Group, or
- Combined Group
Or an “Affiliated Service Group”.
Here are some questions with which to begin:
- 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?
- 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?
Failure to follow the control group and affiliated service group rules can result in significant compliance issues with the Internal Revenue Service (“IRS”) and the Department of Labor (“DOL”). The good news is that both the IRS and DOL have correction programs.
Here are some important takeaways when common ownership in business entities are involved:
- 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 it can be disregarded for control group purposes.
- The control group rules must be considered for welfare benefit plans and non-qualified deferred compensation plans.
And here is the most important takeaway of all:
It doesn’t take very long to realize that a through and detailed understanding of the facts is necessary to make a determination if a control group or affiliated service group exists and what impact there is on retirement and other benefit plans; and that determination should be made by an experienced professional.