What Is a Controlled Group for Tax Purposes?

The Internal Revenue Code (IRC) uses the concept of a controlled group to regulate how related companies are treated for tax purposes. These rules prevent owners from dividing a business into multiple smaller entities to gain tax advantages intended for small businesses. By aggregating related entities, the IRS looks at the economic reality of the business structure rather than just its legal form. For many tax-related calculations, controlled group rules treat these separate but related entities as a single employer.

The rules can apply to corporations, partnerships, sole proprietorships, and other business forms. This single-employer treatment has implications for employee benefits, tax credits, and various deductions, requiring business owners to carefully analyze their ownership structures.

Types of Controlled Groups

A parent-subsidiary controlled group exists when one corporation (the parent) owns at least 80% of the total voting power or 80% of the total stock value of another corporation (the subsidiary). For example, if Corporation A owns 85% of the voting stock of Corporation B, they form this type of group.

This ownership chain can extend through multiple tiers. If Corporation A owns 80% of Corporation B, and Corporation B owns 80% of Corporation C, all three corporations are members of the same parent-subsidiary controlled group.

A brother-sister controlled group involves two or more corporations where five or fewer individuals, estates, or trusts hold a significant ownership stake in each entity. This structure is defined by the common ownership of non-corporate entities. For this group to exist, two specific ownership tests must be met simultaneously.

For example, if two individuals are the sole owners of two separate companies, Corp Alpha and Corp Beta, their combined ownership may qualify the companies as a brother-sister controlled group.

A combined group includes elements of both parent-subsidiary and brother-sister controlled groups. This group consists of three or more corporations where one corporation is the common parent in a parent-subsidiary group and is also a member of a brother-sister group.

For instance, imagine Corporation P owns 80% of Corporation S, forming a parent-subsidiary group. If Corporation P and another company, Corporation B, also qualify as a brother-sister group, then Corporations P, S, and B form a combined group.

Determining Ownership and Control

A brother-sister controlled group is determined by two ownership tests, both of which must be met.

The Two Ownership Tests

The first is the 80% total ownership test. The same five or fewer common owners must collectively own at least 80% of the total voting power or value of the stock of each corporation in the group. This test establishes that a small group has significant control over each entity.

The second requirement is the 50% identical ownership test, which focuses on effective control. The same five or fewer owners must own more than 50% of the voting power or value of each corporation. For this test, ownership is only counted to the extent that it is identical across all corporations. For example, if Shareholder A owns 30% of Corp X and 60% of Corp Y, their identical ownership is 30%.

Constructive Ownership Rules

Ownership extends beyond shares held directly. The IRC uses constructive ownership, or attribution, rules to prevent owners from circumventing the tests by distributing ownership among related parties. These rules treat a person as owning stock that is legally owned by another person or entity.

These rules are complex and include several forms of attribution:

• Family attribution: An individual is considered to own the stock owned by their spouse, children, grandchildren, and parents. There are narrow exceptions, such as for spousal attribution if the spouse has no direct ownership and is not involved in the business.
• Partnership attribution: Stock owned by a partnership is attributed proportionally to any partner with a 5% or greater interest in the partnership’s capital or profits.
• Estate or trust attribution: Stock owned by an estate or trust is attributed to its beneficiaries.
• Corporate attribution: If a corporation is a shareholder in another corporation, the stock can be attributed to any shareholder who owns 5% or more of the parent corporation’s stock.
• Stock option attribution: A person who has an option to acquire stock is treated as already owning that stock.

The combination of direct and attributed ownership requires a detailed analysis to determine if a controlled group exists.

Key Tax Consequences

When a group of businesses is classified as a controlled group, they are treated as a single employer for many purposes, which has several tax consequences. For employee benefit plans, such as 401(k)s and health insurance, all employees across all member companies must be aggregated when performing required nondiscrimination tests under the IRC and the Employee Retirement Income Security Act of 1974 (ERISA). These tests ensure that plans do not unfairly favor highly compensated employees.

This aggregation means a plan must satisfy coverage requirements by looking at the entire workforce of the controlled group. If one company in the group has a 401(k) plan but another does not, the plan may fail testing because it does not cover a sufficient percentage of the total employee base. This can force all members of the group to adopt comparable benefit plans to avoid plan disqualification and significant penalties.

This single-employer principle also applies to numerous business tax credits. The limit on the amount of the Research and Development (R&D) tax credit, for example, is calculated on a group-wide basis. The total credit is computed for the group as a whole and then allocated among the members, reducing the potential benefit compared to what would be available to separate companies.

Certain tax deductions and credits subject to annual dollar limits must also be aggregated and shared. A prominent example is the Section 179 expense deduction, which allows businesses to deduct the purchase price of qualifying equipment. For 2025, the maximum deduction is $1.25 million, and this limit applies to the entire controlled group, not each company. Similarly, the accumulated earnings tax credit, which allows a business to accumulate up to $250,000 without penalty, must be divided among all member corporations.