What Are Affiliated Service Group Rules?

An affiliated service group (ASG) is a collection of related businesses that the IRS treats as a single employer for employee benefit plan rules. These regulations prevent business owners from creating separate legal entities to exclude employees from retirement plan participation. By grouping these entities, the rules ensure benefit plans like 401(k)s are tested on a broader employee population.

Determining if a group of businesses is an ASG depends on the specific facts and relationships between them, requiring an analysis of ownership and service structures. This status directly impacts how retirement plans must be administered to maintain their tax-favored status.

The A-Organization Test

The A-Organization (A-Org) test identifies an ASG by evaluating a First Service Organization (FSO) and one or more A-Orgs. An FSO is an organization whose principal business is performing services, such as professional corporations in health, law, engineering, and consulting.

For an entity to be classified as an A-Org, it must satisfy a two-part test. The first part is an ownership test, requiring the A-Org to be a partner or shareholder in the FSO. Any percentage of ownership is sufficient, and constructive ownership rules apply, meaning ownership can be attributed between related individuals or entities.

The second part is a working relationship test. This is met if the A-Org either regularly performs services for the FSO or is regularly associated with the FSO in performing services for third parties. The term “regularly” is based on a facts-and-circumstances analysis of the ongoing nature and frequency of the shared work.

A common example involves a law practice operating as a partnership (the FSO) where each attorney has their own professional corporation (PC). The PCs are partners in the law firm, satisfying the ownership test. Since the attorneys, through their PCs, provide legal services to the firm’s clients, they are regularly associated with the FSO in performing services for third parties, meeting the relationship test.

The B-Organization Test

The B-Organization (B-Org) test identifies another type of ASG, consisting of an FSO or an A-Org, and at least one B-Org. The B-Org itself does not need to be a service organization. A B-Org relationship exists if three requirements are met.

• A significant portion of the B-Org’s business must be performing services for the FSO or its related A-Orgs. If service receipts from the FSO/A-Org are less than 5% of the B-Org’s total revenue, the portion is not significant, but if they are 10% or more, it is considered significant.
• The services provided by the B-Org must be of a type historically performed by employees in that service field. For instance, if a medical practice outsources patient billing to a separate company, those services are ones that would historically be handled by the practice’s own employees.
• At least 10% of the B-Org must be held, in aggregate, by individuals who are highly compensated employees (HCEs) of the FSO or A-Org. The IRS defines an HCE as an individual who either owned more than 5% of the business in the current or preceding year or received compensation over a certain threshold in the preceding year.

The Management Organization Test

The Management Organization test identifies an ASG using a framework that does not require a service organization or specific ownership percentages. The structure involves a Management Organization and a Recipient Organization.

The test’s main condition is that the Management Organization’s principal business must be the regular performance of management functions for one Recipient Organization, including any related organizations. The “principal business” requirement is met if more than 50% of the Management Organization’s business activities are for the recipient.

Management functions include activities related to the daily operations, administration, and strategic direction of the recipient company. This can encompass personnel management, financial oversight, and operational planning. The relationship must be ongoing and continuous, not temporary.

For example, Company A may be established for the sole purpose of providing all executive and administrative oversight for Company B. If Company A’s employees handle daily operations and strategic planning for Company B, Company A is the Management Organization and Company B is the Recipient Organization. This forms an ASG even without a direct ownership link.

Consequences of Affiliated Service Group Status

When businesses form an ASG, all employees of all member companies are treated as working for a single employer for retirement plan qualification. This has several consequences for administering plans like 401(k)s. Failure to account for the entire group can lead to plan disqualification and costly corrective actions. The primary effects of ASG status include:

• Coverage Testing: A retirement plan must cover a certain percentage of non-highly compensated employees. For an ASG, this test must be performed by aggregating all employees across all member entities, not on a company-by-company basis.
• Nondiscrimination Testing: These tests, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, ensure that contributions do not disproportionately favor HCEs. The contributions of all employees within the ASG must be combined for these calculations.
• Employee Service History: An employee’s service with any member of the ASG must be counted for plan purposes like vesting. An employee moving from one company to another within the group will continue to accrue service for vesting without interruption.
• Annual Contribution Limits: The limits on employee contributions and benefits apply to the employee across all plans sponsored by any member of the ASG. An employee cannot exceed the annual deferral limit by contributing to separate 401(k) plans at each company.