IRC 1563: What Are the Rules for Controlled Groups?

The tax code prevents a business from splitting into multiple corporations to claim tax benefits multiple times. The Internal Revenue Code (IRC) establishes rules that treat legally separate but related corporations as one entity for certain tax purposes. When specific ownership links exist, they are viewed collectively, preventing owners from creating, for example, ten corporations to claim ten sets of tax credits. These regulations define the structures and tests for when multiple corporations are treated as a single taxpayer.

The Three Types of Controlled Groups

The Internal Revenue Code identifies three ways corporations can be linked to form a controlled group. Each type is defined by a specific ownership structure that determines how the corporations are related for tax purposes.

Parent-Subsidiary Controlled Group

A parent-subsidiary controlled group exists when chains of corporations are connected through stock ownership with a common parent. The parent corporation must own at least 80% of the voting power or stock value of at least one other corporation, the subsidiary. For instance, if Parent Corp owns 80% of Subsidiary A, and Subsidiary A owns 80% of Subsidiary B, all three form a parent-subsidiary controlled group. The 80% ownership test applies to each link in the chain.

Brother-Sister Controlled Group

A brother-sister controlled group involves two or more corporations where five or fewer individuals, estates, or trusts have a controlling interest in each. This structure is defined by a common set of non-corporate owners who hold power across the companies. For example, if the same small group of individuals owns a controlling interest in both Ocean Corp and Mountain Corp, they may form a brother-sister group.

Combined Group

A combined group is a hybrid structure that links the other two types of controlled groups. To form a combined group, at least one corporation must be the common parent of a parent-subsidiary group while also being a member of a brother-sister group. For example, imagine Parent Corp owns 80% of Subsidiary Corp, forming a parent-subsidiary group.

If Parent Corp and a third company, Valley Corp, are also owned by the same small group of individuals, they form a brother-sister group. In this scenario, Parent Corp, Subsidiary Corp, and Valley Corp all become members of a single combined group.

Applying the Ownership Tests

To formally determine if a controlled group exists, the IRS applies specific ownership percentage tests outlined in IRC Section 1563. These tests measure stock ownership in terms of both voting power and total value. Passing these tests is what legally establishes the controlled group relationship.

The 80% Ownership Test for Parent-Subsidiary Groups

The test for a parent-subsidiary relationship requires the parent corporation to directly own stock possessing at least 80% of the total combined voting power or at least 80% of the total value of all classes of stock of the subsidiary. This creates a clear, hierarchical link.

The “More Than 50%” Identical Ownership Test for Brother-Sister Groups

The sole test for a brother-sister group is the “more than 50%” identical ownership test. This test requires that five or fewer common owners must own more than 50% of the voting power or stock value of each corporation, but it only considers the identical ownership of each common owner. Identical ownership is the smallest percentage of stock that a person owns in any of the corporations being compared.

For example, assume Shareholder A owns 40% of Corp X and 50% of Corp Y, and Shareholder B owns 30% of Corp X and 20% of Corp Y. Shareholder A’s identical ownership is 40% (the lower of 40% and 50%). Shareholder B’s identical ownership is 20% (the lower of 30% and 20%). The total identical ownership is the sum of these amounts, 60%. Since this sum is more than 50%, Corp X and Corp Y would form a brother-sister controlled group.

Stock Excluded from Tests

When applying these ownership tests, certain types of stock are disregarded by the rules. This excluded stock includes non-voting preferred stock and treasury stock, which is stock the corporation has repurchased. By excluding these, the tests focus on the stock that holds genuine voting power and equity value, providing a more accurate picture of control.

Understanding Stock Attribution Rules

The ownership tests are not limited to the stock a person owns directly. The rules are expanded by “constructive ownership” or attribution rules, which treat a person as owning stock that is legally owned by a related person or entity. These rules prevent owners from circumventing the controlled group tests by simply distributing ownership among family members or related entities.

Family Attribution

The family attribution rules are specific and do not include all relatives. An individual is considered to own the stock owned by their spouse, their children under the age of 21, and their grandchildren. Ownership is also attributed from parents to their minor children. However, stock is not attributed between adult siblings, from an adult child to a parent, or between in-laws. For example, if a wife owns 40% of a company, her husband is also treated as owning that 40%, but her brother is not.

A spousal attribution exception applies under certain conditions. Stock owned by one spouse is not attributed to the other if the non-owning spouse meets all of the following criteria:

• Owns no stock directly in the corporation.
• Is not a director or employee of the corporation.
• Does not participate in the management of the corporation.
• The corporation’s income from passive sources, like royalties or interest, is 50% or less of its total.

This exception helps prevent attribution between spouses who are genuinely uninvolved in each other’s separate businesses.

Option Attribution

A person who has an option to acquire stock is treated as already owning that stock for the controlled group tests. This prevents shareholders from using stock options to delay formal ownership to avoid meeting the ownership thresholds. The existence of the option itself is enough to trigger attribution.

Entity-to-Owner Attribution

Ownership can also be attributed from entities like partnerships, estates, and trusts to the individuals who own them. Stock owned by a partnership is attributed proportionately to any partner who has a 5% or more interest in either the capital or profits of the partnership. Similarly, stock owned by an estate or trust is attributed to any beneficiary who has at least a 5% actuarial interest in the entity.

Owner-to-Entity Attribution

Attribution can also work in the other direction, from an owner to an entity. If a person owns 5% or more of the stock in a corporation, any stock they own in other corporations is attributed to the first corporation. Likewise, stock owned by a partner or trust beneficiary can be attributed to the partnership or trust. This rule primarily impacts the parent-subsidiary test by creating ownership links that may not exist on paper.

Key Tax Implications of Controlled Group Status

Being classified as a controlled group carries tax consequences. The rules require members of the group to share certain tax benefits as if they were a single company, preventing them from multiplying tax breaks across multiple entities. Because the U.S. uses a flat 21% corporate income tax rate, the main impact is not on tax brackets but on the allocation of various tax benefits.

Various tax credits and deductions are limited and must be shared. The accumulated earnings credit of $250,000, or $150,000 for certain service corporations, must be divided among all members of the controlled group. The Section 179 expense deduction, which allows businesses to expense the cost of qualifying property, also has a single limit that must be shared. For 2025, that limit is $1,250,000.

The impact extends to employee benefit plans as well. Under related code sections, such as IRC Section 414, members of a controlled group are treated as a single employer for retirement plan rules. This is important for non-discrimination testing, which ensures that retirement plans do not unfairly favor highly compensated employees. All employees across all corporations in the group must be considered together for these tests.