What Is an IRC 414 Controlled Group?

The concept of a controlled group under Internal Revenue Code (IRC) Section 414 aggregates separate businesses that share common ownership. The purpose of these rules is to treat related companies as a single employer for specific regulatory requirements, preventing owners from dividing operations to circumvent rules on fair employee benefit offerings. For instance, without these regulations, a company could place highly compensated employees in an entity with a generous retirement plan and other employees in an entity with a lesser plan.

Types of Controlled Groups

The Internal Revenue Code defines specific types of controlled groups based on ownership structures, with distinct tests to determine if businesses must be aggregated. These rules apply to various business entities, including corporations, partnerships, and sole proprietorships.

A parent-subsidiary controlled group exists when there is a chain of ownership flowing from a common parent entity. For this group to be formed, a parent company must own at least 80% of the stock, measured by either voting power or total value, of another corporation. The group can extend through multiple tiers so long as at least 80% of each subsequent corporation in the chain is owned by other members of the group.

A more intricate arrangement is the brother-sister controlled group, which involves two distinct but simultaneous ownership tests applied to a group of five or fewer common owners. The first test is the 80% controlling interest test, which is met if these five or fewer individuals, estates, or trusts collectively own at least 80% of each business in the group. The second requirement is the 50% effective control test. This test is met only if the same five or fewer owners have more than 50% identical ownership across the companies, meaning you only count an owner’s smallest ownership percentage in any of the companies being tested.

For example, consider two companies, A Corp and B Corp, with two owners, Ann and Bob. Ann owns 70% of A Corp and 30% of B Corp, while Bob owns 30% of A Corp and 70% of B Corp. Together, they own 100% of both companies, satisfying the 80% test. For the 50% identical ownership test, Ann’s identical ownership is 30% (the smaller of her 70% and 30% stakes), and Bob’s is also 30% (the smaller of his 30% and 70% stakes). Their combined identical ownership is 60%, which exceeds the 50% threshold, making A Corp and B Corp a brother-sister controlled group.

A third category, the combined group, is a hybrid of the other two types. This group exists when a company is both the parent in a parent-subsidiary group and also a member of a brother-sister group. All companies in both the parent-subsidiary and brother-sister groups are then treated as one single controlled group.

Integral to these ownership tests are the stock attribution rules, which treat a person as owning stock that is actually owned by a related party. Ownership is generally attributed between spouses, but the SECURE 2.0 Act created an exception for plan years starting after December 31, 2023. Spousal attribution is waived if all of the following conditions are met:

• The non-owner spouse has no direct ownership.
• The non-owner spouse is not an employee, director, or officer and does not participate in the management of the business.
• No more than 50% of the company’s gross income is from passive sources.
• The owner’s stock has no restrictions favoring the non-owner spouse or their minor children.

Attribution rules also apply between parents and children. Stock is generally attributed from parents to their minor children under age 21. For attribution to occur between a parent and an adult child age 21 or older, the party whose stock would be attributed must own more than 50% of the business. The same greater-than-50% ownership threshold applies for attribution between grandparents and grandchildren. Beyond family, ownership can also be attributed from entities like partnerships, estates, and trusts to their partners or beneficiaries.

Affiliated Service Groups

Beyond direct ownership, the tax code also aggregates businesses through affiliated service group rules. These rules were established to address business structures, common in service industries, that might not meet the strict 80% ownership tests of controlled groups but still function as a single economic unit. The focus here is on the interplay of services provided between entities, combined with a degree of cross-ownership.

One type of affiliated service group is the “A-Org.” This structure involves a First Service Organization (FSO) and an “A-Organization.” The A-Org is any entity that is a shareholder or partner in the FSO and that regularly performs services for the FSO or is regularly associated with the FSO in performing services for third parties. For example, a partnership of medical corporations would be an FSO, and each individual medical corporation that is a partner would be an A-Org.

Another arrangement is the “B-Org.” A B-Organization is an entity where a significant portion of its business involves performing services for an FSO or for members of an A-Org. The services must be of a type historically performed by employees in that service field. A component of this test is that 10% or more of the B-Org must be owned, in aggregate, by individuals who are highly compensated employees of the FSO or A-Org. A classic example is a law firm (the FSO) that outsources its administrative work to a separate company (the B-Org) that is partially owned by the law firm’s partners.

A third category is the management function group. An organization is considered part of a management group if its principal business is performing, on a regular and continuing basis, management functions for one other organization. The recipient organization and all of its related entities are included in the group. This rule prevents a company from spinning off its management team into a separate entity to avoid providing them with the same benefits as other employees.

Consequences of Controlled Group Status

Being classified as a controlled or affiliated service group carries consequences that primarily impact the administration of employee benefit plans. The fundamental outcome is that all employees of the aggregated entities are treated as working for a single employer for a wide range of compliance tests and statutory limits.

The impact is most apparent on qualified retirement plans, such as 401(k)s. These plans are subject to annual tests to ensure they do not unfairly benefit high-income earners over the broader employee population. Under controlled group rules, these tests must be performed on a group-wide basis. This includes coverage testing, which requires the plan to benefit a sufficient ratio of non-highly compensated employees, and nondiscrimination testing, which examines the contributions and benefits provided to different employee classes.

Furthermore, the annual statutory limit on contributions applies to all additions made on behalf of an employee by any member of the group. Top-heavy testing, which determines if a plan disproportionately benefits key employees, must aggregate the accounts of all employees across all related companies. Service with any member of the group must also be counted for purposes of determining an employee’s eligibility to participate in a plan and their vesting schedule.

Beyond retirement plans, controlled group status affects other tax and benefit areas. The determination of who is a Highly Compensated Employee (HCE) is made by looking at the compensation and ownership across all member companies. This can cause an individual who would not be an HCE at a single small company to become one when their compensation is aggregated. The rules also impact certain tax deductions, like the Section 179 deduction for expensing business property, which has a dollar limit that must be shared among all members of the controlled group. The Affordable Care Act (ACA) also relies on these rules to determine if an employer is an “applicable large employer” (ALE) subject to the employer mandate.