Controlled and Affiliated Service Group Rules for Retirement and Cafeteria Plans Controlled and Affiliated Service Group Rules for Overview service organizations Retirement and This article presents an overview of the as a single employer for Cafeteria Plans controlled group and affiliated service retirement and cafeteria group rules as they apply to qualified plan purposes. The ownership retirement plans (defined benefit, cash thresholds triggering application balance, profit sharing, 401(k), SEP, SIMPLE) of these rules are much lower for and cafeteria plans, a.k.a. Section 125 plans. this type of group than for controlled These rules are extremely important, as groups. they must be followed in order to maintain Background the tax favored status of a plan. For plan The rule basically states that, if two or more sponsors with U.S.-based operations and corporations, trades, or businesses are part exclusively U.S. controlled groups, there is, of a controlled group of businesses, then generally, a healthy awareness of the rules, the controlled group members are treated as operations are typically centralized in as a single employer when applying certain the U.S., and frequently a single third-party employee benefit plan requirements under administrator is used for all retirement plans the Internal Revenue Code (“IRC”). Similarly, of the controlled group. For foreign based two or more employers who are members of corporations with U.S. subsidiaries, the level an affiliated service group are also treated as of awareness and compliance with these a single employer for purposes of satisfying rules is frequently not very high. The primary the IRC controlled group requirements. The reason is that a foreign-based corporation affected requirements are: (or group of individuals) may have wholly owned subsidiaries in other countries that in • The general nondiscrimination rules under turn have wholly owned subsidiaries in the IRC section 401(a)(4), U.S., which are in fact part of a controlled • The compensation dollar limitations under group. Most often, these U.S. controlled IRC section 401(a)(17), groups do not have centralized operations • The minimum participation requirements and are not even aware that there are other under IRC section 401(a)(26), related entities in the U.S. As a result, each • The eligibility requirements under IRC company in the U.S. controlled group sections 401(a)(3) and 410(a), may have their own retirement plan and cafeteria plan with completely • The minimum coverage rules under IRC different benefits and separate third- section 410(b), party administrators, and none • The vesting requirements under IRC of the parties are aware that a sections 401(a)(7) and 411, controlled group exists. • The contribution limits under IRC section 415, • The top-heavy rules under IRC section 416, Less familiar to many service-type companies • The rules applicable to SEP and SIMPLE (discussed below) are the plans under IRC section 408, and rules treating affiliated • The nondiscrimination rules applicable to (through ownership) cafeteria plans under IRC section 125 and 2 Controlled and Affiliated Service Group Rules for dependent care under IRC section 129. or more corporations Retirement and in the group; and Cafeteria Plans Plans that do not satisfy the applicable The parent corporation requirements, when taking into account all must own 80 percent of at the members of the controlled group, could least one other corporation. be disqualified resulting in additional taxable income, loss of tax deductions, and possible Brother-sister Controlled Group penalties. A brother-sister controlled group is a group of two or more corporations, in which Overview of Controlled Groups five or fewer common owners (a common The definition of a controlled group is found owner must be an individual, a trust, or an in IRC sections 414(b) and (c). IRC section estate) own directly or indirectly a “controlling 414(b) covers a controlled group consisting interest” of each entity and have “effective of corporations and defines a controlled control.” group as a combination of two or more corporations that are under common control • A “controlling interest” generally means 80 within the meaning of IRC section 1563(a). percent or more of the total control or value of each entity (but only if such common IRC section 414(c) applies to a controlled owners own equity in each entity); and group of trades or businesses (whether or • “Effective control” generally means more not incorporated), such as partnerships than 50 percent of the voting power or and proprietorships. Since IRC section 1563 value of each entity, but only to the extent was written only for corporations, Treasury such stock ownership is identical with Regulations 1.414(c)-1 through 1.414(c)-5 respect to each entity. apply the section 1563 controlled group principles to unincorporated businesses. Combined Group A combined group consists of three or more Types of Controlled Groups organizations that are organized as follows: A control group relationship exists if the businesses have one of the following • Each organization is a member of either a relationships: parent-subsidiary or brother-sister group; and • Parent-subsidiary, • At least one corporation is the common • Brother-sister, or parent of a parent-subsidiary; and is also a • Combination of the above types. member of a brother-sister group. Parent-subsidiary Controlled Group Ownership Attribution Rules A parent-subsidiary controlled group exists Family member constructive ownership rules when one or more chains of corporations are for controlled groups are covered under IRC connected through stock ownership with a section 1563(e), as outlined below. It should common parent corporation; and also be noted that there are constructive 80 percent of the stock of each corporation ownership rules for stock options owned and (except the common parent) is owned by one attribution from partnerships, estates, trusts 3 Controlled and Affiliated Service Group Rules for and corporations under IRC sections 1563(e) Adult Children, Retirement and (1), (2), (3) and (4), which are beyond the Parents and Cafeteria Plans scope of this article, but must be considered if Grandparents applicable to a specific situation. An individual who owns more than fifty percent of the voting Spouses power or fifty percent of the value An individual is considered as owning stock in of a corporation shall be considered a corporation owned directly or indirectly by as owning the stock in such corporation or for his/her spouse except for a corporation owned, directly or indirectly, by or for his/ where all of the following conditions are her parents, grandparents, grandchildren and satisfied for a taxable year: children who have attained age twenty-one. 1. The individual does not own directly any stock in the corporation; Overview of Affiliated Service Group 2. The individual is not a director or The affiliated service group rules of IRC employee and does not participate in the section 414(m) are very complex and management of such corporation; are intended to preclude an entity from 3. Not more than fifty percent of such establishing an employee benefit plan for corporation’s gross income for such taxable just one entity if there are two or more year was derived from royalties, rents, organizations that constitute an affiliated dividends, interest and annuities; and service group which, for employee benefit 4. Such stock is not subject to conditions that plan purposes, would be aggregated into a substantially restrict or limit the spouse’s single employer. An affiliated service group right to dispose of such stock and that run is an entity (incorporated or unincorporated) in favor of the individual or his children who that is either a service or management-type have not attained the age of twenty-one group (see below). It consists of a First Service years. Organization (“FSO”) plus an ‘A organization’, a ‘B organization’ or, A and B organizations. Minor Children A parent is considered as owning stock An ‘A organization’ is a shareholder or partner owned, directly or indirectly, by or for in the FSO and regularly performs services his/her children who have not attained for the FSO, or is associated with the FSO the age of twenty-one. Conversely, if in performing services for third parties. For the individual has not attained age purposes of the ownership test, it is sufficient twenty-one, s/he is considered as for the ‘A organization’ to have any ownership owning stock owned, directly regardless of how small the percentage. or indirectly, by or for his/her A ‘B organization’ is an organization (does parents. not have to be a service organization) that provides services to the FSO or an ‘A organization’, which provides services their employees would normally perform. Additionally, at least ten percent or more of 4 Controlled and Affiliated Service Group Rules for the interest in the ‘B organization’ must be Management-Type Retirement and owned by officers or highly compensated Affiliated Service Cafeteria Plans employees of the FSO or ‘A organization’. Group Defined A management-type affiliated Service Organization Defined service group exists under IRC The principal business of an organization section 414(m)(5) when: will be considered the performance of • An organization performs services if capital is not a material income- management functions, and producing factor for the organization, even • The management organization’s principal though the organization is not engaged in a business is performing management field listed in proposed Treasury Regulation functions on a regular and continuing basis section 1.414(m)-2(f)(2). Whether capital is for a recipient organization. a material income-producing factor must be determined by reference to all the facts There does not need to be any common and circumstances of each case. In general, ownership between the management capital is a material income-producing organization and the organization for which factor if a substantial portion of the gross it provides service.