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Checkpoint Contents
Pension & Benefits Library
Pension & Benefits Editorial Materials
EBIA Benefits Compliance Library
Cafeteria Plans
XXVIII. Nondiscrimination Rules—The Core Concepts
XXVIII.I. Identifying the Employer: Controlled Groups and Affiliated Service Groups
I. Identifying the Employer: Controlled Groups and
Affiliated Service Groups
Particularly for the various eligibility tests, employers must “take into account” all employees of the employer.
For example, if the employer has 100 non-HCEs during a plan year and 60 of them are eligible for the
cafeteria plan, then for eligibility-testing purposes, the plan “takes into account” all 100 non-HCEs by including
them in the denominator of a fraction used to determine whether the plan covers a sufficient number of the
employer's non-HCEs for that plan year. The numerator of that fraction is 60 (the non-HCEs who are eligible).
To pass the various eligibility tests, a specified minimum percentage of non-HCEs must be eligible.
Identifying the employees that must be included in this calculation also requires knowing who the employer is
and what employees can be disregarded (excluded) for testing purposes. Congress has indicated that some
businesses are so closely connected that they should be considered a single employer for purposes of the
various nondiscrimination tests, and so all employees of those employers must be included in the
denominator (less certain employees that the rules specifically permit the employer to exclude for testing
purposes). This subsection describes the principles that apply when determining which employees and which
employers must be included—and may be excluded—when running the nondiscrimination tests.
Caution: Complex and Detailed Rules. Confirming who the employer is and whose employees must be
counted is very complex and requires careful application of detailed rules. This subsection I is intended
only to provide a broad overview of these rules, not to provide a comprehensive description or analysis.
Anyone seeking to interpret these rules for a specific fact situation should consult with experienced
benefits counsel.
1. Mandatory Inclusions and Permissive Exclusions of
Employees
In performing nondiscrimination tests, certain individuals must be included in the testing group (mandatory
inclusions) because of their relationship with the plan sponsor. Many nondiscrimination tests require that each
plan sponsor consider not only its own employees, but also certain other individuals employed by related
entities and (if applicable) employee leasing entities. Therefore, if a company is related to another company
(whether through stock ownership, a partnership, or otherwise) or utilizes leased employees, the plan sponsor
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must determine which employees to include in its nondiscrimination testing. While in many circumstances,
plan participation may not need to be extended to all individuals, failure to consider them could lead to
inaccurate test results. Likewise, certain employees may be excluded on a uniform basis (permissive
exclusions) from the testing group because of their age, limited service, etc. The mandatory inclusions are
discussed in this subsection I. The permissive exclusions from the testing group are discussed for the
applicable benefits plans in Sections XXIX through XXXII.
2. Treating Multiple Employers as a Single Employer
For plan-testing purposes (among others), the Code treats two or more employers as a single employer if
there is sufficient common ownership or a combination of joint ownership and common activity. These rules
are described in Code §§414(b), (c), and (m), which are directly incorporated into the cafeteria plan rules. 47
The concept of aggregating multiple employers because of common ownership applies to corporations,
partnerships, sole proprietorships, and all other forms of business entities. When these rules are applied to a
group of commonly owned corporations, the group is referred to as a “controlled group of corporations.” 48
When the rules are applied to a mixed group of corporations, partnerships, proprietorships, and other
business entities, the group is referred to as “trades or businesses under common control.” 49 In addition, the
“affiliated service group” rules link certain types of groups based on joint activity or a combination of joint
activity and common ownership. 50
The following two examples illustrate how the controlled group rules apply to related corporations and related
unincorporated business entities. Following the examples is a discussion of the different types of business
relationships that must be analyzed to answer the question: “Who is the employer?” Those relationships are
as follows:
• controlled group of corporations;
• trades or businesses under common control; and
• affiliated service groups.
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3. Controlled Group of Corporations
A controlled group of corporations may be composed of a parent-subsidiary controlled group, a brother-sister
controlled group, or a combined group. 51
Caution: Definitions of Controlled Group May Differ for Different Tax Purposes. The definition of a
controlled group of corporations for various employee benefit plan purposes is set forth in Code §414(b),
which refers to the rules in Code §1563(a) with certain limitations. Employers that determine the
members of their corporate controlled group for certain tax purposes under Code §1563(a) need to be
aware that not all of the controlled group rules under that Code section apply in the context of the
controlled group rules for benefit plans under Code §414(b).*
*
See, e.g., Code §414(b) (referencing Code §1563(a), but without regard to Code §§1563(a)(4) (relating to
special rules for certain insurance companies) and 1563(e)(3)(C) (relating to stock owned by qualified
plans)). See also Code §1563(f)(5) (applying different rule for brother-sister corporations for certain
purposes).
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a. Parent-Subsidiary Controlled Group of Corporations
A parent-subsidiary controlled group is one or more chains of corporations connected through stock
ownership with a common parent if—
• 80% or more of the total combined voting power of all classes of stock entitled to vote (or 80% or more of
the total value of all shares of all classes of stock) of each of the corporations, except the common parent
corporation, is owned, directly or indirectly, by one or more of the other corporations; and
• the common parent corporation owns, directly or indirectly, 80% or more of the total combined voting
power of all classes of stock entitled to vote (or 80% or more of the total value of shares of all classes of
stock) of at least one of the other corporations. 52
In determining whether a common parent owns the requisite stock in at least one subsidiary, stock held by
other subsidiaries is disregarded. 53 This exclusion reduces the total number of shares considered to be
outstanding and increases the percentage of total shares owned by the common parent.
The following examples illustrate some typical combinations of parent-subsidiary relationships that are treated
as a single employer for nondiscrimination testing. As the examples illustrate, the ownership analysis
frequently is complicated.
b. Brother-Sister Controlled Group of Corporations
A brother-sister controlled group of corporations is a group where five or fewer persons who are individuals,
estates, or trusts own, directly or indirectly, stock possessing—
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• 80% or more of the total combined voting power of all classes of stock entitled to vote (or 80% or more of
the total value of all shares of all classes of stock) of each corporation; and
• more than 50% of the total combined voting power of all classes of stock entitled to vote (or more than
50% of the total value of all shares of all classes of stock) of each corporation, taking into account the
stock ownership of each owner only to the extent that the level of ownership interest is identical with
respect to each corporation. 54
The five or fewer individuals, estates, or trusts with respect to whom stock ownership is considered for
purposes of determining whether the 80% requirement is satisfied must be the same individuals, estates, or
trusts whose stock ownership is considered for purposes of the greater-than-50% requirement. Thus, the
brother-sister controlled group should be of concern where five or fewer shareholders (who are individuals,
estates, or trusts) (1) own at least 80% of each corporation; and (2) own more than 50% of all corporations,
taking into account identical ownership interests with respect to each corporation.
Ownership in Brother-Sister Analysis Does Not Include Corporations. A brother-sister controlled
group of corporations can only result if the shareholders are individuals, estates, or trusts. Sometimes, in
the analysis, there can be confusion over whether a corporation’s partial ownership is included in the
ownership analysis. It is not.
The following two examples explain how to identify brother-sister controlled groups that are treated as a
single employer for nondiscrimination testing.
Example 1: Identifying a Brother-Sister Controlled Group of Corporations.
Individual
Corp. A
Corp. B
Identical Ownership
1
20%
20%
20%
2
15%
15%
15%
3
10%
10%
10%
4
30%
25%
25%
5
25%
30%
25%
Total
100%
100%
95%
Analysis:
•Do five or fewer individuals, estates, or trusts own at least 80% of each corporation in the group? Yes. Between
them, Individuals 1, 2, 3, 4, and 5 own 100% of Corp. A and 100% of Corp. B, which is more than 80% of each
corporation.
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• Do five or fewer individuals, estates, or trusts own more than 50% of the group of corporations to the extent
that their ownership is identical with respect to each corporation? Yes. Together, Individuals 1, 2, 3, 4, and 5
have 95% identical ownership of Corps. A and B, which is more than 50%.
Answer: A and B are a brother-sister controlled group of corporations. This is because (1) five or fewer
individuals own 80% of each corporation; and (2) the same five or fewer individuals own more than 50% of both
corporations, taking into account identical ownership interests with respect to each corporation.
Example 2: Identifying a Brother-Sister Controlled Group of Corporations.
Individual
Corp. A
Corp. B
Identical Ownership
1
12%
12%
12%
2
12%
12%
12%
3
12%
12%
12%
4
12%
12%
12%
5
13%
13%
13%
6
13%
13%
13%
7
13%
13%
13%
8
13%
13%
13%
Total
100%
100%
100%
Analysis:
• Do five or fewer individuals, estates, or trusts own at least 80% of each corporation in the group? No. The most
that any five individuals own in each corporation is 64% (13% + 13% + 13% + 13% + 12% = 64%), which is less
than the requisite 80%.
• Do five or fewer individuals, estates, or trusts own more than 50% of the group of corporations to the extent
that such ownership is identical with respect to each corporation? Yes. There are several configurations that
meet this test. For example, Individuals 1, 2, 3, 4, and 5 hold 61% (12% + 12% + 12% + 12% + 13% = 61%),
which is more than 50%.
Answer: A and B are not a brother-sister controlled group of corporations. Although at least one group of five
individuals controls more than 50% of a group of corporations on an identical ownership basis, no group of five
or more individuals controls 80% of the stock of each corporation. Both the 80% and 50% tests must be
satisfied.
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c. Combined Group of Corporations
A controlled group also may be composed of an overlapping parent-subsidiary controlled group of
corporations and a brother-sister controlled group of corporations. This occurs if—
• each corporation is a member of either a parent-subsidiary controlled group or a brother-sister controlled
group; and
• at least one of the corporations is the common parent of the parent-subsidiary controlled group and is a
member of a brother-sister controlled group. 55
d. Constructive Ownership Rules
In determining ownership for purposes of the controlled group rules, constructive ownership is taken into
account. 56 “Constructive ownership” is an ownership interest attributed to a party other than the actual
owner. The most common of these rules attributes stock ownership to a related party, but the rules also take
into account interests other than stock. In application, constructive ownership can be complex. The following
is only a general description of the constructive ownership rules.
For corporations, an interest owned, directly or indirectly, by a corporation is considered as owned by any
person who owns 5% or more in value of the corporation's stock in that proportion which the value of the
stock that such person owns bears to the total value of all the stock in the corporation. 57 Ownership of an
option to acquire an outstanding interest in an organization is treated as actual ownership. 58
For partnerships, an organization owned, directly or indirectly, by a partnership is treated as being owned by
its partners that have an interest of 5% or more in the partnership, in proportion to the partner's interest in the
profits or capital, whichever is greater. 59
For estates and trusts, an interest in an organization owned, directly or indirectly, by an estate or trust is
considered to be owned proportionately by beneficiaries who have actuarial interests of 5% or more in the
estate or trust. For estates, property of a decedent is considered to be owned by the decedent's estate if the
property is subject to an executor's administration for the purpose of paying claims against the estate and
expenses of administration. 60
With certain limited exceptions, an individual is considered to own any interest owned by the individual's
spouse as well as any interest owned by the individual's children under age 21. If the individual is in effective
control of an organization, then the individual also is considered to own an interest in the organization owned,
directly or indirectly, by the individual's parents, grandparents, grandchildren, and children who have attained
the age of 21. 61
Exception for Certain Spouses. Although generally a spouse is considered to own the other spouse’s
interest, there is an exception to this rule if certain requirements are met.*
*
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(5), and 1.414(c)-4(b).
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e. Exclusion and Attribution of Interests
If a controlling interest in another entity is found, the next question is whether any of the interests in or stock
of that entity should be excluded—that is, whether the interest is held by a related party and should be
disregarded. 62 For example, in a parent-subsidiary group, certain interests can be excluded if a parent
organization owns directly, or indirectly under the constructive ownership rules, an interest of at least 50% in
the subsidiary. 63 In particular, the following should be excluded:
• interests in a subsidiary held by certain employees; 64
• an interest in a subsidiary owned by a 5% owner, an officer, a partner, or a fiduciary of the parent
organization; 65
• an interest in the subsidiary held by a deferred compensation plan for the benefit of the subsidiary or
parent organization's employees; 66 and
• an interest held by an organization (other than the parent organization) organized under Code §501
(generally, qualified plans and tax-exempt organizations) if the organization is controlled, directly or
indirectly, by (1) the parent; (2) a subsidiary; (3) an individual or an estate or trust that is a principal owner
of the parent; (4) an officer, partner, or fiduciary of the parent; or (5) any combination of the above. 67
Even if an interest would normally be excluded, there is an exception to this rule. An interest otherwise
excludable will not be excluded if, by applying that rule, two entities (which would otherwise have been part of
the same controlled group) are treated as separate employers that are not in the same controlled group. In
other words, the exclusion rules generally will only apply to increase (not decrease) the percentage of
ownership by an individual, estate, trust, or parent corporation in another entity. 68
Similar rules to those for parent-subsidiary controlled groups apply, with some modifications, to brother-sister
controlled groups. 69
Example: Constructive Ownership. Alice is a 50% shareholder of Shore Corporation. Shore owns 50%
of Beach Corporation. Under the constructive ownership rules, Alice is deemed to own 25% of Beach
because 50% of the Beach stock that is owned by Shore is attributed to Alice.
Caution: Different Constructive Ownership Rules. The constructive ownership rules discussed in this
subsection I are only applicable for determining who is the employer. Different rules may apply in
determining who is an HCE or Key, and the rules differ from one plan to the next. See the plan-specific
nondiscrimination Sections of this manual.
4. Trades or Businesses Under Common Control
The Code's aggregation rules also apply to business entities other than corporations, including partnerships,
sole proprietorships, and other non-corporation business entities. When referring to a combination of
corporate and non-corporate entities, the Code uses the term “trades or businesses.” 70 The tests for
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determining common control of multiple trades or businesses are substantially the same as the tests for
determining controlled groups of corporations. Trades or businesses under common control may be made up
of:
• a parent-subsidiary group of trades or businesses under common control;
• a brother-sister group of trades or businesses under common control; or
• a combined group of trades or businesses under common control.
The common-control tests parallel the tests discussed in connection with corporations. The principal
difference is that, instead of stock ownership, the tests look at the control that an entity or individual has over
another entity. This is necessary because the analysis considers trades or businesses that are not exclusively
corporations; therefore, the concept of stock ownership is not always applicable. For example, control of a
partnership generally is determined by the capital or profits interest in the partnership. 71
Determining the Partnership Interest. A partnership might distribute its profits based on criteria other
than each partner’s capital interest so it can be important to understand a partnership’s capital and profits
interests when determining control.
a. Parent-Subsidiary Group of Trades or Businesses Under Common Control
Similar to a parent-subsidiary controlled group of corporations, a parent-subsidiary group of trades or
businesses under common control is found to exist if:
• 80% or more of the ownership interest of each of the organizations (except the common parent
organization) is owned, directly or indirectly, by one or more of the other organizations; and
• the common parent organization owns, directly or indirectly, an 80% or more interest in at least one of the
other organizations. 72
b. Brother-Sister Group of Trades or Businesses Under Common Control
Similarly, the rules for determining whether a brother-sister group of trades or businesses are under common
control mirror the rules for determining a brother-sister controlled group of corporations. Essentially, five or
fewer individuals, estates, or trusts must own directly or indirectly in the aggregate:
• 80% or more of the ownership interest in each business entity; and
• more than 50% of the ownership interest in each entity, considering ownership only to the extent that it is
identical with respect to each entity being considered. 73
c. Combined Group of Trades or Businesses Under Common Control
Finally, a combined group of trades or businesses under common control exists for any group of three or
more business entities if:
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• each business entity is a member of either a parent-subsidiary group of trades or businesses under
common control, or a brother-sister group of trades or business under common control; and
• at least one of the business entities is the common parent organization of a parent-subsidiary group of
trades or businesses under common control and is also a member of a brother-sister group of trades or
businesses under common control. 74
5. Affiliated Service Groups
Another way that the Code aggregates employers is to link them together through joint activity or a
combination of common ownership and joint activity, which the Code refers to as an affiliated service group.
Joint activity may be services rendered back and forth between two or more entities, or it may be entities
joining forces to render services for third parties. 75 Under these rules, aggregation is contingent upon one or
more of the business entities constituting a “service organization,” which is defined in the Code as an
organization “the principal business of which is the performance of services.” 76
An organization is a service organization if capital is not a material income-producing factor for the
organization or if it is engaged in a specified service field. The proposed regulations list the following as
service fields: health, law, engineering, architecture, accounting, actuarial science, performing arts,
consulting, and insurance. 77 A service organization may be a sole proprietorship, partnership, corporation, or
any other type of entity regardless of its ownership format. 78 An affiliated service group is found in three
types of business combinations, each of which is discussed in greater detail below.
a. Combination of First Service Organization and A-Organization
The first type of affiliated service group is a combination of a service organization, referred to as the first
service organization (FSO), and another service organization, which proposed regulations refer to as an AOrganization (A-Org). 79
i. First Service Organization (FSO)
An FSO may be a sole proprietorship, partnership, corporation, or any other type of entity, regardless of its
ownership format, which is engaged in professional services so long as capital is not a material-income
producing factor for the organization. 80 If the FSO is a corporation, it must be a professional service
corporation. A “professional service corporation” is a corporation that is organized under state law for the
purpose of providing professional services and that has at least one shareholder who is licensed or legally
authorized to provide that service. Professional services include those performed by accountants, actuaries,
architects, attorneys, chiropodists, chiropractors, medical doctors, dentists, professional engineers,
optometrists, osteopaths, podiatrists, psychologists, and veterinarians. 81
ii. A-Organization (A-Org)
An A-Org is a service organization that is a partner or shareholder in the FSO and that regularly performs
services for the FSO or is regularly associated with the FSO in performing services for third parties. 82 In
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determining whether a potential A-Org is a partner or shareholder, the extent of the partnership interest or of
the stockholding does not matter. Ownership is determined, however, with regard to the constructive
ownership rules. 83
Example: FSO and A-Org Combination. Ebenezer is an attorney who has incorporated as a
professional corporation; the professional corporation is a partner in a law firm. Ebenezer and his
corporation are regularly associated with the law firm in performing services for third parties.Treating the
law firm as the FSO, Ebenezer's corporation is an A-Org because it is a partner in the law firm and is
regularly associated with the law firm in performing services for third parties. Accordingly, the corporation
and the law firm constitute an affiliated service group.*
*
See Prop. Treas. Reg. §1.414(m)-2(b)(3), Example 1.
The determination of whether a service organization regularly performs services for the FSO or is regularly
associated with the FSO in performing services for third parties is made on the basis of the facts and
circumstances. One factor is the amount of income derived by the service organization from performing
services for the FSO or for third parties in association with the FSO. 84
b. Combination of First Service Organization and B-Organization
The second type of affiliated service group is a combination of an FSO and another organization, which
proposed regulations refer to as a B-Organization (B-Org). 85 An organization may be a B-Org even though it
is not a service organization. 86 An organization is a B-Org if it satisfies these three tests:
• a significant portion of the B-Org's business consists of performing services for the FSO, for an A-Org of
that FSO, or for both the FSO and the A-Org;
• those services are of a type historically performed by employees in the service field of the FSO or the AOrg; and
• 10% or more of the interests in the B-Org is held, in the aggregate, by HCEs (as defined in Code §414
(q)) of the FSO or of an A-Org of the FSO. 87
Example: FSO and B-Org Combination. Doc-n-Box, Ltd. is a medical clinic with 11 physician-owners.
Each of the physician-owners owns 5% of the stock in Nurses, Inc., a corporation that provides nursing
services to multiple medical clinics in the metropolitan area. A significant portion of the business of
Nurses is providing services to Doc-n-Box that are of a type historically performed by employees of Doc-n
-Box.
Treating Doc-n-Box as an FSO, Nurses is a B-Org because a significant portion of its business is the
performance of services of a type historically performed by employees in the medical services field, and
because more than 10% of the interests in Nurses is held, in the aggregate, by HCEs of Doc-n-Box. As a
result, Doc-n-Box and Nurses constitute an affiliated service group.*
*
See Prop. Treas. Reg. §1.414(m)-2(c)(8), Example 1, as modified by Code §414(m)(2)(B).
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c. Group Performing Management Services
The third type of affiliated service group is based on the performance of management services. Under this
test, two business entities constitute an affiliated service group if the principal business of one entity is the
regular and continuing performance of management services for the second entity, or the performance of
regular and ongoing management services for the second entity and other entities related to the second
entity. 88
Example: Management Services Combination. The managing executives of Go-Getters, Inc. desire
greater contributions to their cafeteria plan. The shareholders of Go-Getters, however, do not want to
make additional contributions to all employees participating in Go-Getters' cafeteria plan. The executives
propose to form Money, Inc.—a separate corporation that will contract with Go-Getters and perform all of
its management services. The proposal is that Money would adopt a separate cafeteria plan for the
executives, without having to extend a similar plan to the other employees of Go-Getters.
This solution will not work. Because Money's principal business will be performing, on a regular and
continuing basis, management functions for Go-Getters, the two entities will be treated as an affiliated
service group on the basis of management functions.
d. Authority to Prevent Avoidance of Affiliated Service Group Rules
In 1983, the IRS released proposed regulations interpreting the affiliated service group rules. For example,
the regulations listed the type of business entities that would constitute a service organization. 89 The IRS
released further proposed regulations in 1987, including guidance on whether an entity's “principal business”
was the performance of management services. 90 The IRS withdrew most of the 1987 regulations in 1993,
however, and has never finalized the 1983 regulations. 91
Code §414(o) gives the Treasury Department the authority to issue regulations to prevent business entities
from avoiding the purpose of the affiliated service group rules. As was the case with the affiliated service
group rules, in 1987 the IRS issued proposed regulations under Code §414(o) but then in 1993 withdrew most
of them. The portions not withdrawn are still in proposed form. 92 As a result, there is little guidance under the
broad authority of Code §414(o). Nevertheless, Code §414(o) continues to authorize the Treasury
Department to issue regulations, should it find that employers have come up with creative business
arrangements that have the effect of circumventing the affiliated service group rules.
e. MEWA Risks for Affiliated Service Groups
Due to ERISA's preemption rules, state law generally does not apply to self-funded welfare plans, including
self-funded health plans. On the other hand, when unrelated employers participate in a self-funded plan, a
multiple employer welfare arrangement (MEWA) is created and ERISA's preemption rules do not shield that
arrangement from state laws. For example, state-law-mandated benefit requirements, reserve requirements,
or premium taxes might apply. 93 As a general matter, ERISA incorporates tax law concepts for purposes of
determining whether employers are under common control. While this incorporation of tax law concepts
generally picks up employers in the same controlled group, it does not pick up employers in an affiliated
service group. 94 Thus, while applicable tax law would permit participation in a self-funded medical plan
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(including a health FSA) by employers in an affiliated service group, such participation could cause the selffunded plan to be a MEWA, potentially subject to undesirable state-law regulation.
Looking for More Information About MEWAs? See ERISA Compliance for Health & Welfare Plans
(Thomson Reuters/EBIA, 1992-present, updated quarterly).
6. Limited Liability Companies
Although the rules discussed in this subsection I address the aggregation of corporations, in certain
circumstances an unincorporated business entity may be treated as a corporation or part of a controlled group
of corporations. Limited liability companies (LLCs) are hybrid business entities that possess the ability of a
corporation to insulate the owners from liability, while at the same time offering greater flexibility than a
corporation with respect to taxation. Specifically, IRS rules allow an LLC to elect to be taxed as a corporation,
or if no election is made, it will be treated as a partnership, which means taxable gains and losses are passed
through to the owners, thereby avoiding a second layer of tax at the corporate level. 95 If an election is made
to be taxed as a corporation, the LLC will be treated as a corporation for all tax purposes.
Another unique characteristic of an LLC, as opposed to a partnership, is that an LLC can be formed with a
single member. If this is the case, then the LLC may elect to be treated as a pass-through conduit entity,
disregarded for tax purposes and treated as an unincorporated division of the single member. 96
7. Tax-Exempt Organizations
Tax-exempt organizations do not have stock or other ownership interests, which has made the controlled
group rules difficult to apply to related groups of these organizations. Regulations provide that tax-exempt
organizations are under common control if at least 80% of the directors or trustees of one organization are
either representatives of, or directly or indirectly controlled by, the other organization. 97 These rules allow
certain organizations to be permissively aggregated or disaggregated under specified circumstances.
47
Code §125(g)(4) provides that “All employees who are treated as employed by a single employer under
subsection (b), (c) or (m) of section 414 shall be treated as employed by a single employer for purposes of
this section.” See also Code §414(t) (applying the controlled group provisions to various benefits including
Code §125 plans).
48
Code §414(b) (referencing the term “controlled group of corporations” within the meaning of Code §1563
(a), determined without regard to Code §§1563(a)(4) and 1563(e)(3)(C)). Thus, both Code §§414 and 1563
are relevant to a controlled group analysis.
49
Code §414(c); Treas. Reg. §§1.414(c)-1 and -2.
50
Code §414(m).
51
Code §414(b) (referencing Code §1563(a)).
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Code §1563(a)(1). See Code §414(b) (referencing Code §1563(a)). See also Hermes Consol., Inc. v.
United States, 14 Cl. Ct. 398, 61 AFTR 2d 88-823 (Cl. Ct. 1988) (“[v]oting power is not merely the holding of
voting stock shares…the ultimate expression of voting power is the ability to approve or disapprove of
fundamental changes in the corporate structure, and the ability to elect the corporation's board of directors”).
53
See Treas. Reg. §§1.414(b)-1 and 1.1563-2(b).
54
See Code §414(b) (referencing Code §1563(a)). For plan years beginning after October 22, 2004, the
ownership rule in Code §1563(a)(2) for brother-sister controlled groups was changed, but Code §1563(f)(5)
retains the prior brother-sister controlled group rule for plan-related purposes.
55
Code §1563(a)(3). See Code §414(b) (referencing Code §1563(a)); Treas. Reg. §§1.414(b)-1 and 1.1563-
1(a)(4).
56
Code §1563(e) (as limited by Code §414(b)). See Treas. Reg. §§1.414(b)-1, 1.1563-3(a), and 1.414(c)-4
(a).
57
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(4), and 1.414(c)-4(b).
58
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(1), and 1.414(c)-4(b).
59
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(2), and 1.414(c)-4(b).
60
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(3), and 1.414(c)-4(b).
61
See Treas. Reg. §§1.414(b)-1, 1.1563-3(b)(5), 1.1563-3(b)(6), and 1.414(c)-4(b).
62
The regulations use the phrase “not outstanding” to describe stock or interests that are held by related
parties. See Treas. Reg. §§1.414(b)-1, 1.1563-2(b), and 1.414(c)-3(a).
63
See Treas. Reg. §§1.414(b)-1, 1.1563-2(b), and 1.414(c)-3(a).
64
Employee interests are excluded if the stock or other interest is owned by an employee and is subject to
conditions that (a) run in favor of the parent or subsidiary organization and (b) substantially restrict or limit the
employee's right to dispose of the stock or interest. See Treas. Reg. §§1.414(b)-1, 1.1563-2(b)(2), 1.414(c)-3
(b)(5) and 1.414(c)-3(c)(3). A corporation's right of first refusal has been held to be a substantial restriction of
the employee's rights. Also, any other legally enforceable condition that prevents the employee from
disposing of the stock or interest without the consent of the parent or subsidiary will be considered a
substantial restriction. For brother-sister groups, these same rules generally apply, with the exception that
here is not a substantial restriction for such groups if a restriction on the stock held by an employee applies
equally to all common owners.
65
See Treas. Reg. §§1.414(b)-1, 1.1563-2(b)(2), and 1.414(c)-3(b)(4). These interests are not excluded for
brother-sister controlled groups.
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See Treas. Reg. §§1.414(b)-1, 1.1563-2(b)(2), and 1.414(c)-3(b)(3). These interests are not excluded for
brother-sister controlled groups.
67
See Treas. Reg. §§1.414(b)-1, 1.1563-2(b)(2), 1.414(c)-3(b)(6), and 1.414(c)-3(c)(4).
68
See Treas. Reg. §§1.414(b)-1, 1.1563-2(c), and 1.414(c)-3(f).
69
See Treas. Reg. §§1.414(b)-1, 1.1563-2(b), and 1.414(c)-3(c).
70
Code §414(c) and Treas. Reg. §1.414(c)-2.
71
Treas. Reg. §1.414(c)-2(b)(2).
72
Code §414(c); Treas. Reg. §1.414(c)-2(b).
73
Code §414(c); Treas. Reg. §1.414(c)-2(c).
74
Code §414(c); Treas. Reg. §1.414(c)-2(d).
75
Code §414(m)(2).
76
Code §414(m)(3).
77
Prop. Treas. Reg. §1.414(m)-2(f).
78
Prop. Treas. Reg. §1.414(m)-2(e).
79
Code §414(m)(2); Prop. Treas. Reg. §1.414(m)-2(a)(1).
80
Code §414(m)(3); Prop. Treas. Reg. §1.414(m)-2(f). Generally, capital is a material income-producing
factor if a substantial portion of the gross income is attributable to the employment of capital, such as a
substantial investment in inventories, plant, or equipment. Capital is not a material income-producing factor if
the gross income of the business consists principally of fees, commissions, or other compensation for
personal services. Prop. Treas. Reg. §1.414(m)-2(f)(1).
81
Prop. Treas. Reg. §1.414(m)-1(c).
82
Code §414(m)(2)(A); Prop. Treas. Reg. §1.414(m)-2(b)(1).
83
Code §414(m)(2)(B).
84
Prop. Treas. Reg. §1.414(m)-2(b)(2).
85
Code §414(m)(2); Prop. Treas. Reg. §1.414(m)-2(a)(2).
86
Prop. Treas. Reg. §1.414(m)-2(c)(7).
87
Code §414(m)(2)(B).
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88
Code §414(m)(5).
89
Prop. Treas. Reg. §1.414(m)-2.
90
See Preamble to Prop. Treas. Reg. §1.414(m)-5, 52 Fed. Reg. 32502 (Aug. 27, 1987).
91
58 Fed. Reg. 25587 (Apr. 27, 1993); IRS Notice 92-12, 1992-16 I.R.B. 35.
92
Prop. Treas. Reg. §1.414(o)-1.
93
See, e.g., ERISA §514(b)(6).
94
See, e.g., ERISA §3(40)(B)(ii) (incorporating ERISA §4001(b), which in turn incorporates Code §414(c)
but not the affiliated service group provisions contained in Code §414(m)). See also DOL Information Letter
(May 24, 2004) (cautioning that affiliated service group status, in and of itself, does not support a conclusion
that a group of two or more trades or businesses is a single employer for purposes of ERISA §3(40)),
available at http://www.dol.gov/ebsa/regs/ILs/il052404.html (as visited Feb. 25, 2010).
95
Treas. Reg. §301.7701-1.
96
Treas. Reg. §301.7701-3(b)(1).
97
Treas. Reg. §1.414(c)-5 (effective for plan years beginning after December 31, 2008).
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