Controlled group

What a controlled group is

Section 414 of the tax code combines related businesses so an owner cannot put favored employees in one company with a rich plan and everyone else in another. The two main types are:

• Parent-subsidiary: one business owns at least 80% of another.

• Brother-sister: the same five or fewer individuals, estates or trusts own at least 80% of each business, and their identical ownership across the businesses adds up to more than 50%.

Ownership can be attributed from spouses, children and certain entities. A related concept, the affiliated service group, combines service businesses that work together even with less shared ownership.

Why it matters to employers

All employees of a controlled group are treated as working for a single employer. That affects who must be covered by the plan, the ADP, ACP and top-heavy tests, the annual additions limit, vesting service and eligibility for the small employer startup tax credit. A plan that ignores a related company can fail coverage testing without anyone noticing for years.

Example

A founder owns 100% of a software company with 12 employees and 90% of a consulting firm with 30 employees. The two are a controlled group. If the software company sponsors a 401(k) only for its own staff, the plan must still pass coverage testing counting all 42 employees.

Common mistakes

• Not telling your provider about other businesses you or your family own.

• Assuming separate EINs or separate payrolls mean separate employers.

• Missing a change after an acquisition, sale or new investment round. A transition period applies after some transactions, but it ends.

• Guessing. Determining controlled group status is a legal analysis, and the result should be documented by an ERISA attorney or qualified TPA.