IS YOUR CLIENT S PLAN OUT OF CONTROL? (Controlled Groups) Jane Armstrong, Esq., Phelps Dunbar LLP Avaneesh Bhagat, Group Manager, IRS

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1 IS YOUR CLIENT S PLAN OUT OF CONTROL? (Controlled Groups) Jane Armstrong, Esq., Phelps Dunbar LLP Avaneesh Bhagat, Group Manager, IRS

2 Jane Armstrong, Esq., Partner, Phelps Dunbar, LLP Jane Armstrong is a partner at Phelps Dunbar LLP, a regional law firm that is headquartered in New Orleans. She has practiced exclusively in the areas of employee benefits and executive compensation for more than 30 years. Jane has been listed in all editions of the Best Lawyers in America and "Louisiana Super Lawyers," and is listed in Chambers U.S.A. as a leading practitioner in the employee benefits field. She is a frequent speaker and author on retirement plan issues. Jane graduated from Vanderbilt University School of Law, where she was elected to the Order of the Coif.

3 Avaneesh Bhagat, Group Manager, IRS Avaneesh is the Group Manager for the Voluntary Compliance Group in El Monte, California. His responsibilities include assisting with the resolution of applications made under VCP, assisting with the development of the revenue procedure relating to the correction programs for qualified plans, providing information on correction programs, and responding to inquiries relating to plan corrections and potential VCP applications. Avaneesh has worked with the examination, determination letter and voluntary compliance functions of the IRS' Employee Plans Division since 1988.

4 BASICS

5 BASIC RULE Employees of a controlled group or trades or businesses under common control treated as if employed by a single employer Code Sec. 414(b) Code Sec. 414(c) Code Sec. 1563

6 APPLICATION WHEN RULE APPLIES There is no specific day on which controlled group is tested (continuous; NOT last day snap shot) Code Sec. 401 general qualification rules 401(a)(17) - compensation limit 401(a)(4) non-discrimination testing 401(k) Separation from employment Deferral limits ADP/ACP

7 APPLICATION WHEN RULE APPLIES Code Sec. 403(b) Universal availability Code Sec. 408(k) SEP Code Sec. 408(b) SIMPLE Code Sec deductions Code Sec. 410 (a) - minimum age and service (b) minimum coverage

8 APPLICATION WHEN RULE APPLIES Code Sec. 411 vesting Code Sec. 414 HCE determination Code Sec. 415 annual additions Code Sec. 416 top heavy Testing Key employee determination

9 Relief Under Code Sec. 410 Code Sec. 410(b) coverage testing Merger and acquisition relief during transition period Code. Sec. 410(b)(6)(C) Applies until the last day of the plan year following the year in which the closing date occurs Establish qualified separate lines of business ( QSLOB rules) Code Sec. 410(b)(5) (line of business exception) Code Sec. 414(r) (definition of QSLOB)

10 APPLICATION WHEN RULE APPLIES (Other Issues) Code Sec. 409A deferred compensation Plan termination Separation from service ERISA Sec 4201 et seq. Liability for withdrawal from multiemployer plan ACA - large employer determination Code Sec. 4980H

11 TYPES OF ENTITIES Corporations C corp S corp LLC whether taxed as a partnership or corporation Sole Proprietorship Partnership Trust/Estate

12 DETERMINING CONTROLLED GROUPS

13 THREE TYPES Parent-Subsidiary Brother Sister Combination

14 PARENT SUBSIDIARY Parent owns, directly or indirectly, controlling interest in subsidiary Controlling interest: At least 80% (50% for purposes of 415 limits) For corporation, measure using: Combined voting power of all classes of stock; or Total value of shares For sole proprietorship, ownership of business

15 PARENT SUBSIDIARY For partnership: Capital interests; or Profits interests For trust/estate, measured by actuarial interest

16 PARENT SUBSIDIARY Example 1 Parent C Corp 100% Sub LLC % Sub LLC % Sub LLC - 3

17 PARENT SUBSIDIARY Example 2 A - Parent C Corp 75% Sub - B 100% Sub - C 100% Sub - C

18 BROTHER-SISTER Same 5 or fewer individuals, estates or trusts satisfy 2 tests: Applies to natural persons 80% common ownership test 50% identical ownership test

19 BROTHER-SISTER 80% controlling interest test Include only individuals who are common owners (own an interest in each entity in group) PLLC LAB Dr. Bob 100% 75% Frank 0% 12% Larry 0% 13% NOT a controlled group because Frank and Larry do not own an interest in the PLLC

20 BROTHER-SISTER 50% identical ownership test same 5 individuals (or fewer) own more than 50% using only identical holdings Take into account ownership only to the extent identical in each organization Assume A owns: 100% of a sole proprietorship 33% of LLC 1 20% of LLC 2 A is considered to own only 20% of all three entities for identical ownership test

21 BROTHER-SISTER Example 1 Assume A, B, C, D, E, and F own two businesses as follows: OWNERS A B C D E F 1 16% 16% 17% 17% 17% 17% 100% 2 15% 20% 0% 15% 30% 20% 100%

22 BROTHER-SISTER Example 1 C is not considered because he does not own any interest in 2 A, B, D, E and F are considered to own the following interests in each business under the identical ownership rule: A B D E F 15% 16% 15% 17% 17% The two businesses ARE a brother-sister controlled group because: A, B, D, E and F own more than 50% (identical ownership) A, B, D, E, and F own at least 80% (controlling interest)

23 BROTHER-SISTER Example 2 A owns four restaurants through LLC-A B, C, D, and E each manage a restaurant and acquire the following interests in A s business: LLC A LLC 1 LLC 2 LLC 3 LLC 4 A 96% 51% 65% 65% 95% B 1% 49% 10% 5% 5% C 1% 0% 15% 5% 0% D 1% 0% 10% 20% 0% E 1% 0% 0% 5% 5% Total 100% 100% 100% 100% 100%

24 BROTHER-SISTER Example 2 LLC A and LLC 4 are a controlled group because A alone satisfies the identical ownership and controlling interest tests LLC 2 and LLC 3 are a separate controlled group: A, B, C, and D as common owners: E is disregarded A B C D Total LLC 2 65% 5% 5% 10% 85% LLC 3 65% 5% 5% 10% 85%

25 COMBINED GROUPS When parent in parent-subsidiary group is also part of a brother-sister group, the entities in both groups are treated as a single controlled group

26 COMBINED GROUP C D A B A is an individual A owns 100% of B and C C owns 80% of D B and C are Brother- Sister C and D are Parent Subsidiary Combined Group

27 ATTRIBUTION

28 ATTRIBUTION Attribution - stock actually owned by one person deemed owned by another ( constructive ownership ) Parent-subsidiary group: From corporation or partnership To corporation or partnership Brother-sister group: Family attribution From corporation or partnership To corporation or partnership

29 ATTRIBUTION PARENT-SUBSIDIARY Stock owned by a corporation or partnership owned proportionately by shareholders or partners Example: LLC is owned 30% by A and 70% by B LLC holds a 50% interest in a joint venture A constructively owns 15% of the JV B constructively owns 35% of the JV

30 ATTRIBUTION PARENT-SUBSIDIARY Stock owned by a partner constructively owned by partnership Stock owned by a shareholder constructively owned by corporation ONLY IF shareholder owns 50% or more in value of the corporation Example: LLC is owned 30% by A and 70% by B Stock owned by B will be constructively owned by LLC

31 Attribution Example 1 Sub 1 Parent Sub 2 Parent Owns: 100% of Sub 1 100% of Sub 2 Sub 1 and Sub 2 Own: 40% of ABC ABC Partnership

32 BROTHER-SISTER GROUP FAMILY ATTRIBUTION An individual constructively owns stock owned by: Spouse, exception for legal separation Children who are under 21 If the individual is under 21, owned by parents Grandchildren and parents, BUT only if in effective control (facts and circumstances) Count shares only once

33 BROTHER-SISTER GROUP FAMILY ATTRIBUTION Corp A Corp B Roger 40% 60% Bob 30% 40% Bob s Mother Bob s Minor Child 25% 0% 5% 0% NOT a brothersister group IF mother s interest not attributed to Bob Pass identical ownership (70%) Fail controlling interest (75%)

34 FAMILY ATTRIBUTION Corp A Corp B Roger 40% 60% Bob 30% 40% Bob s Mother Bob s Minor Child Common Ownership 0% 0% 30% 0% 100% 100% IS a Brother-sister group IF the interest of Bob s minor child attributed to Bob Bob constructively owns 60% Pass identical ownership (80%) Pass controlling interest (100%)

35 SPECIAL SITUATIONS

36 GOVERNMENTAL CONTROLLED GROUPS Governmental entities generally subject to controlled group rules. IRS Notice Reasonable good faith compliance permitted Should be consistently applied Check interlocking boards May apply when one entity controls another IRM Sec IRS General Info. Ltr. (8/20/1991)

37 NOT FOR PROFIT CONTROLLED GROUPS Applies to tax-exempt entities under Code Section 501 Church plans not subject to rules The controlled group includes: Not for profit whose employees participate in plan Any other organization under common control Two organizations that coordinate day-to-day activities may be electively aggregated if employees from both participate in plan

38 NOT FOR PROFIT CONTROLLED GROUPS Common Control: At least 80% of directors or trustees of one organization are representative of or controlled by the other organization Representative means a trustee, director, officer, agent or employee of the other entity Example: Officer of hospital serves on the board of the separate foundation formed to raise funds Controlled by means the power to appoint or remove trustees Example: Clinic s board is appointed by hospital

39 NOT FOR PROFIT CONTROLLED GROUPS Coordinate Activities Facts and Circumstances Share mission Periodic transfer of employees Common fund raising Common sources of income Coordinate operational goals or budget

40 FOREIGN CONTROLLED GROUPS Foreign entities NOT excluded from controlled groups Two approaches: Exclude if entity has only FDAP income that is not effectively connected to the U.S. Taxed at 30% rate Limitation generally refers to all types of income, except income derived from the conduct of business in U.S. Commonly, passive income, such as rents, royalties, dividends from U.S. sources Exclude from participation nonresident aliens with no U.S. Source income

41 DISCUSSION OF BEST PRACTICES

42 Jane Armstrong Phelps Dunbar LLP