What Are Section 52 Controlled Group Rules?

Internal Revenue Code Section 52 establishes rules to prevent business owners from dividing a single enterprise into multiple smaller entities to gain duplicative tax benefits. These regulations ensure that related companies, known as controlled groups, are treated as a single employer for specific tax purposes. The primary function is to aggregate the activities and financial data of these entities, limiting them to the same tax advantages they would have if they operated as one company.

Defining a Controlled Group

A controlled group is a set of corporations connected through common ownership. The Internal Revenue Code, primarily in Section 1563, outlines three classifications for these groups based on ownership tests. For the purposes of Section 52, the standard “at least 80%” ownership threshold is lowered to “more than 50%.” This change broadens the scope of what constitutes a controlled group. These definitions rely on precise calculations of stock ownership, measured by either voting power or the total value of the shares.

Parent-Subsidiary Controlled Group

A parent-subsidiary controlled group exists when one corporation, the parent, directly owns stock in another, the subsidiary. For this relationship to be established, the parent company must own more than 50% of the total combined voting power or more than 50% of the total value of all classes of stock of the subsidiary. This can create a chain of ownership linking multiple tiers of subsidiaries to a single common parent.

Brother-Sister Controlled Group

A brother-sister controlled group involves two or more corporations owned by a small group of common shareholders. This determination requires satisfying two separate ownership tests. The first is the 50% total ownership test, which is met if five or fewer individuals, estates, or trusts own more than 50% of the voting power or value of each corporation. The second is the 50% identical ownership test, met if the same five or fewer owners possess more than 50% of the voting power or value of each corporation, considering an owner’s stock only to the extent it is identical across each entity.

For example, consider two corporations, Corp A and Corp B, with two shareholders, Sam and Pat. Sam owns 70% of Corp A and 30% of Corp B, while Pat owns 30% of Corp A and 70% of Corp B. Together, they own 100% of both corporations, satisfying the total ownership test. Sam’s identical ownership is 30% (the smaller of his two stakes), and Pat’s is also 30%. Their combined identical ownership is 60%, which is more than 50%, so Corp A and Corp B form a brother-sister controlled group.

Combined Group

A combined group is a hybrid of the other two forms, consisting of three or more corporations. Each entity must be a member of either a parent-subsidiary or a brother-sister group. A key requirement is that one corporation must serve as the common parent of a parent-subsidiary group while also being a member of a brother-sister group. This links the groups into a single, larger aggregated entity.

Ownership Attribution Rules

Determining whether the ownership tests are met involves more than just direct stock holdings. The Internal Revenue Code’s constructive ownership rules require that stock owned by certain related parties be attributed to other individuals or entities. These attribution rules ensure that ownership is viewed comprehensively, preventing business owners from using indirect arrangements to avoid controlled group status.

Family Attribution

Ownership is often attributed between close family members. An individual is considered to own the stock held directly or indirectly by their spouse, children, grandchildren, and parents. For instance, if a person owns 50% of a corporation, their spouse is also treated as owning that 50%. Stock attributed from one family member to another cannot then be re-attributed to a third family member, which prevents an endless chain of attribution.

Option Attribution

The rules also account for potential ownership through stock options. A person who holds an option to acquire stock is treated as already owning that stock for the controlled group tests. This provision prevents shareholders from deferring official ownership to manipulate the tests. The option rule takes precedence over family attribution rules.

Entity Attribution

Ownership can also be attributed from entities like partnerships, estates, and trusts to their owners or beneficiaries. Stock owned by a partnership is considered owned proportionally by its partners. Stock held by an estate or trust is attributed to its beneficiaries based on their interests. For C corporations, attribution from the entity to a shareholder occurs if that shareholder owns 50% or more of the corporation’s stock value.

Tax Consequences of Controlled Group Status

Classification as a controlled group carries significant tax implications, as member companies are treated as a single taxpayer for many tax benefits and limitations. This aggregation prevents the businesses from each claiming separate, full tax advantages. The result is that tax credits, deductions, and other provisions must be calculated for the group as a whole and then allocated among the members.

Some of the most common tax items applied at the group level include:

• The Work Opportunity Tax Credit (WOTC), which incentivizes hiring individuals from certain groups, must be calculated on a group-wide basis with the members sharing a single credit.
• The Credit for Increasing Research Activities (R&D tax credit), which requires all members to aggregate their qualified research expenses and gross receipts to compute one credit for allocation.
• The Section 179 expense deduction, which allows businesses to deduct the cost of qualifying equipment, is limited for the entire group, not each individual company.
• The accumulated earnings credit, which permits companies to accumulate up to $250,000 of earnings without a penalty tax, is limited to one credit for the entire group to be divided among the members.