IMPACT OF AFFILIATION IN COMPLEX BUSINESS WORLD (Affiliated Service Groups) Jane Armstrong, Esq., Phelps Dunbar LLP Avaneesh Bhagat, Group Manager, IRS 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. 1
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. AGGREGATION RULE Employees of an affiliated service group (ASG) are treated as if employed by a single employer Code Sec. 414(m) 2
BACKGROUND Kiddie v. Commissioner, 69 TC 1055 (1978) Garland v. Commissioner, 73 TC 5 (1979) AUTHORITIES Code Sec. 414(m) Enacted in 1980 Amended in 1982 (TEFRA) Added (m)(5) to address management functions Proposed Regulations 1.414(m), subsections (1) - (4) February 28, 1983 3
AUTHORITIES Prop. Regs. Sec. (1) (4): Reliance until adoption of final regs. (preamble) Final regs. have NOT been issued/prop. Regs. have not been withdrawn Prop. Regs. Sec. (5) - (6): Concerned management functions Issued in 1987; withdrawn in 1993 AUTHORITIES Rev. Rul. 81-105: Not affected or superseded by Prop. Reg. 1.414(m) 4
DETERMINING AFFILIATED SERVICE GROUPS AFFILIATED SERVICE GROUP First service organization (FSO) and A organization(s) (A-Org); or B organization(s) (B-Org); or Both Management groups 5
ORGANIZATION Corporations C corp S corp LLC whether taxed as a partnership or corporation Sole Proprietorship Partnership SERVICE ORGANIZATIONS FSO and A-Org must be a service organization Facts and circumstances Regardless of nature of trade or business, capital cannot be a material income producing factor Capital = substantial investment in inventory, plant, equipment 6
SERVICE ORGANIZATIONS Capital always material factor for banks Capital not material factor if gross income primarily from fees, commissions, compensation for personal services Organizations engaged in deemed services per se service organizations Management organization, B-Org need not be service organization DEEMED TO BE SERVICE ORGANIZATIONS Deemed Service Health Engineering Accounting Performing Arts Consulting Deemed Service Law Architecture Actuarial Science Insurance 7
FSO If FSO is a corporation, for purposes of an ASG that includes an A-Org, FSO MUST also be a professional service corporation Organized under state law for the purpose of providing professional services At least one shareholder licensed to render professional services for which the professional service organization is organized ASG with B-Org does not require that FSO be a professional service corporation FSO PROFESSIONAL SERVICES (Exclusive List) Professional Services CPA Architect Chiropodists Medical Doctors Professional Engineers Osteopaths Phycologists Professional Services Actuary Attorney Chiropractors Dentists Optometrists Podiatrists Veterinarians 8
FSO/A-ORG 3 PART TEST: 1. FSO must be professional service organization 2. A-Org must be shareholder or partner in FSO In any amount, determined using attribution under Code Sec. 318 If a tax-exempt, control over appointment of directors and officers sufficient FSO/A-ORG 3. A-Org must: Regularly perform services for FSO or regularly associate with FSO to perform services for third parties Regularly = facts and circumstances Amount of earned income Separate billing would be disregarded 9
BASIC A-ORG EXAMPLES Partnership of PC s Sole employee of each PC is lawyer Law firm bills and collects for each lawyer s services Law firm provides common law employees and facilities Law firm = FSO Each PC = A-ORG Each PC separately bills for services Issue is whether the law firm is simply a mechanism to share cost of facilities or whether each PC may be deemed to regularly derive income from performance of services for law firm clients BASIC A-ORG EXAMPLES Real estate agency is partnership Broker is incorporated and corporation is a partner in agency Agency = FSO Service organization because capital NOT a material income producing factor Because agency is a partnership, NEED NOT also be a professional service organization Broker = A-ORG Owns part of agency through attribution Regularly joins with agency to provide services to third-parties 10
A-ORG EXAMPLE Dr. A is an incorporated surgeon with no employees Surgery Center is owned by 12 physicians, including Dr. A, who owns 8% Surgery Center bills and collects fees for Dr. A for procedures performed by Dr. A at center Dr. A pays a fee to Surgery Center for billing and collection services Surgery Center employees may assist Dr. A during surgery and are billed separately by Surgery Center ARE DR. A AND SURGERY CENTER AN ASG USING A-ORG RULES? MAY BE Dr. A cannot be FSO and Surgery Center an A-Org because Surgery Center does not possess an ownership interest in Dr. A Surgery Center may be an FSO and Dr. A an A-Org IF: Surgery Center and Dr. A are service organizations Surgery Center is a professional service organization Dr. A owns any amount of Surgery Center using attribution Dr. A is regularly associated with Surgery Center to provide services to third parties Facts and Circumstances 11
WOULD DR. A AND NETWORK ORGANIZATION BE AN ASG USING A-ORG RULES? Assume a network organization instead of the Surgery Center; network organization: Negotiates pricing contracts Group malpractice insurance Risk management Legal advice Billing and collection services FSO/B-ORG 4 PART TEST: 1. FSO must be a service organization (need not be professional service organization) 2. Significant % of business of B-Org must be performance of services for FSO or A-Org associated with FSO, or both Facts and circumstances 12
FSO/B-ORG Safeharbors (define significant ): Receipts from performance of services less than 5% - NOT a significant percentage Receipts 10% or more IS a significant percentage Calculated as ratio for current year or 3-year period including current year (whichever is greater) FSO/B-ORG 3. B-Org services of a type historically performed by employees in the service field of FSO 4. 10% or more of B-Org owned by members of designated group Officers, HCEs, common owners of FSO or A-Org Ownership aggregated to reach 10% threshold 13
FSO/B-ORG Aggregation under Code Sec. 318 Common owners included only if the owners own (in the aggregate) at least 3% of the FSO or A-Org FSO/B-ORG EXAMPLE Are Dr. A and Surgery Center an ASG Using B-Org Rules? MAY BE Dr. A = FSO Surgery Center = B-Org Dr. A must be service organization Significant portion of Surgery Center revenue must be derived from billing and collection for Dr. A (potentially more 5% of receipts using safeharbors) Services performed by Surgery Center must be by historical employees At least 10% of Surgery Center owned by Dr. A ( designated group (of FSO)) 14
FSO/B-ORG EXAMPLE Are Dr. A and Network Organization an ASG Using B-Org Rules? MAY BE Dr. A = FSO Network Org. = B-Org Dr. A must be service organization Significant portion of Network Org. revenue must be derived from billing and collection for Dr. A (potentially more 5% of receipts using safeharbors) Services performed by Network Org. must be by historical employees At least 10% of owned by Dr. A ( designated group (of FSO)) FSO/B-ORG EXAMPLE Are Dr. A and Surgery Center an ASG Using B-Org Rules? NO Surgery Center = FSO Dr. A = B-Org Surgery Center must be service organization Significant portion of Dr. A s revenue must be derived from Surgery Center Services performed by Dr. A must be by historical employees At least 10% of Dr. A must be owned by designated group (of Surgery Center) 15
Combined Groups Under Prop. Reg. 1.414(m)-2(g)(3): ASG determined with reference to a FSO All A- and B-Orgs identified with same FSO aggregated and treated as single ASG COMBINED GROUPS EXAMPLE Three doctors, A, B, and C practice through professional corporations Clinic is a medical practice equally owned by the three professional corporations Drs. B and C, individually, own 50% of a billing and coding corporation that is employed by Clinic Dr. A owns, with others, Nurse Staffing, which provides nurses to the Clinic 16
COMBINED GROUPS EXAMPLE FSO/A-Org: Clinic is FSO Professional corporations of Drs. A, B, and C are each A-Orgs because they regularly join with Clinic to provide services to third parties FSO/B-Org: Clinic is FSO Billing and Coding is B-Org because Significant portion of revenue derived from Clinic 10% or more owned by Clinic s designed group COMBINED GROUPS EXAMPLE FSO/B-Org: Clinic is FSO Nurse Staffing may be B-Org if: Significant portion of revenue derived from Clinic 10% or more owned by Dr. A Combined group consists of: FSO Clinic Any A-Org with respect to Clinic Drs. A, B, and C Any B-Org with respect to Clinic - Billing and Collection and Nurse Staffing 17
MANAGEMENT ORGANIZATIONS Third type of ASG: Principal business of an organization is performance of management functions on a regular and continuing basis for an FSO or for an FSO and organizations related to FSO Rules of interpretation: Management org NOT required to be a service organization Principal business and regular and continuing not defined Definitions included in withdrawn Prop. Regs. MANAGEMENT ORG. EXAMPLE XYZ Corp. is restaurant consulting and management company owned by A and B XYZ Corp. enters into a 3-year management contract with Jeff, who owns (100%) five restaurants 18
MANAGEMENT ORG. EXAMPLE Are XYZ Corp. and Jeff s restaurants an ASG under the management org. rules? MAY BE Can Jeff s restaurants be considered FSO? Is capital a material income producing factor? Professional service rules do not apply Is management contract principal business of XYZ corp? Under withdrawn Prop. Reg., principal = 50% of gross revenue Contingent on number of contracts and fees charged APPLICATION 19
APPLICATION WHEN RULE APPLIES There is no specific day on which affiliated service 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 APPLICATION WHEN RULE APPLIES Code Sec. 403(b) Universal availability Code Sec. 408(k) SEP Code Sec. 408(b) SIMPLE Code Sec. 404 - deductions Code Sec. 410 (a) minimum age and service (b) minimum coverage 20
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 OTHER APPLICATIONS WHEN RULE APPLIES (welfare) Code Sec. 79 group term insurance Code Sec. 106 MSAs, HSAs, HRAs (health plan savings accounts) Code Sec. 117(d) tuition reduction plans Code Sec. 120 group legal services Code Sec. 125 cafeteria plans Code Sec. 127 education assistance Code Sec. 129 dependent care assistance Code Sec. 132 fringe benefits 21
OTHER APPLICATIONS WHEN RULE APPLIES (welfare) Code Sec. 137 adoption assistance Code Sec. 274(j) limits on employee achievement awards Code Sec. 505 VEBA Code Sec. 4980B - COBRA Code Sec. 4980H applicable large employer under ACA OTHER APPLICATIONS 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 22
RELIEF Code Sec. 410(b)(5)(C) Applies in the event of merger and acquisition until the last day of the first plan year following year in which transaction occurs Jane Armstrong Phelps Dunbar LLP armstroj@phelps.com 23