Chapter 7- Controlled and affiliated service groups
Page 7-1
Controlled and Affiliated Service Groups
Chapter 7
Controlled and Affiliated Service Groups
By
Larry Lawson (Cincinnati)
Reviewer:
Jeff Nelson (Cincinnati)
INTERNAL REVENUE SERVICE
TAX EXEMPT AND GOVERNMENT ENTITIES
Overview
Introduction
The Internal Revenue Code established its Controlled Groups Provisions as
part of the Revenue Act of 1964. They were initially issued as part of a tax
reform package intended to encourage small businesses, which operated in
the corporate form. Over time some medium and large businesses began
taking advantage of the lower tax rates afforded small businesses by
organizing their structure into multiple corporate forms.
The Employee Retirement Income Security Act of 1974 (ERISA) added
sections 414(b) and (c). These sections required that all employees of
commonly controlled corporations, trades or businesses be treated as
employees of a single corporation, trade or business. These Code provisions
used the statutory definition of controlled groups found in section 1563(a) of
the Code.
Section 1563(a) provides mechanical ownership tests, which are used in
determining if a controlled group situation exists.
Sections 414 (b) and (c) did not cover many of the arrangements devised by
employers who attempted to avoid coverage of employees. Congress enacted
section 414(m) pursuant to section 201 of the Miscellaneous Revenue Act of
1980. Section 414 (m) addresses employees of an affiliated service group,
which will be discussed later in this chapter.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-2
Controlled and Affiliated Service Groups
Overview, Continued
Objectives
At the end of this chapter you will be able to:
• Define a controlled group and identify the three forms of controlled
groups.
• Apply section 1563(a) in conjunction with section 414(b) and (c) to
determine if a controlled group is in existence.
• Identify the effect of the attribution rules on controlled groups.
• Determine the impact of sections 414(b) and (c) on the determination
letter process and qualified plans.
In This
Chapter
This chapter contains the following topics:
OVERVIEW ------------------------------------------------------------------------------------------------------------------------1
DEFINITION: CONTROLLED GROUP-------------------------------------------------------------------------------------4
ATTRIBUTION RULES ------------------------------------------------------------------------------------------------------- 11
DETERMINATION LETTER PROGRAM: CONTROLLED GROUP PLANS----------------------------------- 20
CONTROLLED GROUP: EXERCISES------------------------------------------------------------------------------------ 34
SUMMARY ----------------------------------------------------------------------------------------------------------------------- 37
OVERVIEW: AFFILIATED SERVICE GROUP------------------------------------------------------------------------- 38
AFFILIATED SERVICE GROUP ------------------------------------------------------------------------------------------- 40
AFFILIATED SERVICE GROUP: PERFORMANCE OF SERVICE ----------------------------------------------- 49
MULTIPLE AFFILIATED SERVICE GROUP--------------------------------------------------------------------------- 58
ATTRIBUTION RULES FOR AFFILIATED SERVICE GROUPS -------------------------------------------------- 62
MANAGEMENT ORGANIZATIONS -------------------------------------------------------------------------------------- 72
EXERCISES – MANAGEMENT ORGANIZATIONS ------------------------------------------------------------------ 83
DETERMINATION LETTER PROGRAM: AFFILIATED SERVICE GROUPS -------------------------------- 86
THE IMPACT OF SECTION 414(M) ON QUALIFIED PLANS------------------------------------------------------ 90
PROFESSIONAL EMPLOYEE ORGANIZATIONS (PEOS) --------------------------------------------------------- 90
LEASED EMPLOYEES-------------------------------------------------------------------------------------------------------102
INDEPENDENT CONTRACTORS-----------------------------------------------------------------------------------------104
EXERCISES – AFFILIATED SERVICE GROUPS---------------------------------------------------------------------105
AFFILIATED SERVICE GROUP SUMMARY--------------------------------------------------------------------------108
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group
Section 414(b)
and (c)
The controlled group definition is found in section 414(b) & (c). Section
414(b) covers controlled group consisting of corporations and defines a
controlled group as a combination of two or more corporations that are under
common control within the meaning of section 1563(a).
All employees of companies in the controlled group must be considered to
determine if a plan maintained by a controlled group member meets the
requirements of sections 401, 408(k), 408(p), 410, 411, 415, and 416.
Section 414(c) applies to controlled group of trades or businesses (whether or
not incorporated), such as partnerships and proprietorships. Since section
1563 was written only for corporations, Treasury Regulations 1.414(c)-1
through 1.414(c)-5 mirror the section 1563 controlled group principles.
The definitions and examples used in this chapter refer to both section 414(b)
and 414(c) controlled groups.
Three Types of
Controlled
Groups
A control group relationship exists if the businesses have one of the following
relationships:
− Parent-subsidiary,
− Brother-sister, and
− Combination of the above
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Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
Parent-
subsidiary
Group
A parent-subsidiary controlled group exists when one or more chains of
corporations are connected through stock ownership with a common parent
corporation; and
− 80 percent of the stock of each corporation, (except the common parent)
is owned by one or more corporations in the group; and
− Parent Corporation must own 80 percent of at least one other corporation.
Sections 1563(a) and 414(b) and (c).
Sections
1563(a) and
414(b) and (c)-
Example 1
The following examples illustrate the parent-subsidiary rules:
Example 1
Redwood Corporation owns:
− 90% of the stock of Bond Corporation,
− 80% of the stock of Greene Corporation, and
− 65% of the stock of Teller Corporation.
Unrelated persons own the percentage of stock not owned by Redwood
Corporation.
Redwood Corporation owns 80% or more of the stock of the Bond and
Greene Corporations. Therefore, Redwood Corporation is the common
parent of a parent-subsidiary group consisting of Redwood, Bond, and
Greene. Teller Corporation is not a member of the group because Redwood
Corporation’s ownership is less than 80%.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
Sections
1563(a) and
414(b) and (c)-
Example 1
(continued)-
Example 2
Example 2
Assume the same facts as in the previous example and assume further that
Greene Corporation owns 80% of the profits interest in XYZ Partnership.
Redwood Corporation is the common parent of a parent-subsidiary group
consisting of Redwood, Bond, Greene and XYZ. The results would be same
if Redwood Corporation, rather than Greene Corporation owned the 80%
interest in XYZ.
Brother- Sister
Group
A brother-sister controlled group is a group of two or more corporations, in
which five or fewer common owners (a common owner must be an
individual, a trust, or an estate) own directly or indirectly a controlling
interest of each group and have “effective control”.
− Controlling interest - 1.414(c)-2(b)(2) – generally means 80 percent or
more of the stock of each corporation (but only if such common owner
own stock in each corporation); and
− Effective control – 1.414(c)-2(c)(2) – generally more than 50 percent of
the stock of each corporation, but only to the extent such stock ownership
is identical with respect to such corporation.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
Example-
Brother-Sister
Ownership Test
Adams Corp and Bell Corp are owned by four shareholders, in the following
percentages:
Percentage of Ownership
Shareholder Adams Corp Bell Corp
A 80% 20%
B 10 50
C 5 15
D 5 15
TOTAL 100% 100%
To meet the first part of the test in section 1563(a)(2)(A), the same five or
fewer common owners must own more than 80% of stock or some interest in
all members of the controlled group.
In this example, the four shareholders together own 80% or more of the stock
of each corporation, the first test is met, since the shareholders own 100%
percent of the stock.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
50 Percent
Test-Example
Shareholder Identical Ownership Percentage in both Corps.
A 20%
B 10
C 5
D 5
TOTAL 40%
To meet the second part of the test in Section 1563(a)(2)(B), the same five or
fewer common owners must own more than 50% of each corporation, taking
into account the stock ownership of each person only to the extent such stock
ownership is identical with respect to each such corporation.
In this example, although the four shareholders together own 80% or more of
the stock of each corporation, they do not own more than 50% of the stock of
each corporation, taking into account only the identical ownership in each
corporation as demonstrated above.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
Example-
Brother-Sister
Group not
established
The following individuals each own 12% to 13% of the stock in Tate Corp
and also Ward Corp.
Individual Percentage of Tate Corp Percentage of Ward
Corp
A 12 12
B 12 12
C 12 12
D 12 12
E 13 13
F 13 13
G 13 13
H 13 13
Any grouping of five of the shareholders will own more than 50% of the
stock in each corporation and all shareholders in any of the groupings will
own identical amounts.
But, Tate and Ward are not members of a brother-sister group because, the
same five or fewer individuals do not own at lease 80% of each corporation’s
stock.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-10
Controlled and Affiliated Service Groups
Definition: Controlled Group, Continued
Combined
Group
A combined group consists of three or more organizations that are organized
as follows:
− Each organization is a member of either a parent-subsidiary or brother-
sister group; and
− At least one corporation is the common parent of a parent-subsidiary; and
is also a member of a brother-sister group.
Combined
Group-
Example
A is an individual owning:
− 80% in York Partnership; and
− 90% in Sharp Corporation
York Partnership owns 85% of Tripp Corporation
York Partnership, Sharp Corporation and Tripp Corporation are each members
of the same combined group of trades or businesses under common control
because
• York Partnership, Sharp Corporation, and Tripp Corporation are each
members of either a parent-subsidiary or a brother–sister group, and
• York is:
Ø the common parent of the parent-subsidiary group consisting of
York and Tripp; and
Ø A member of a brother-sister group consisting of York and Sharp.
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Attribution Rules
Introduction
Attribution is the concept of treating a person as owning an interest in a
business that is not actually owned by that person. Attribution may result
from family or business relationships. Section 1563 attribution is used in
determining a controlled group of businesses, under section 414(b) and (c).
Important Note
Although the following attribution rules are written in terms of stock
ownership, the same principles are applied for organizations that are not
incorporated.
In the case of a:
Ownership relates to the:
Trust or estate Actual interest
Partnership Capital or profits
Sole proprietorship Sole proprietorship
When calculating ownership interests, use the greater of:
− Corporate ownership – voting stock or value of stock
− Partnership ownership – capital or profits
Section 1563
Attribution
Section 1563 contains the rules of attribution used to determine “control” for
the following:
− Controlled groups of corporations (section 414 (b)); and
− Trades or businesses, whether or not incorporation, which are under
common control (section 414 (c)).
Also see Treas. Reg. § 1.414(c)-4.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Attribution Rules, Continued
General Rules
for Family
Attribution
The following table is a general description of how the family attribution
rules are applied to controlled groups.
Note: the following family attribution rules only apply to a brother-
sister controlled group and do not apply to a parent-subsidiary controlled
group.
THE OWNERSHIP
INTERESTS OF:
Are attributed to:
Spouse Spouse EXCEPTION:
No attribution between
spouses if there is no:
• direct ownership,
• participation in
company, and
• no more than 50%
of business gross
income is passive
investments. See
1.414(c)-4(b)(5)(ii).
Minor child (under age 21) Parent
Parent Minor child (under
age 21)
Parent Adult child (age 21
or older)
ONLY IF: Adult child
owns greater than 50%
of that business.
Adult child Parent ONLY IF: Parent owns
greater than 50% of
that business.
Grandparent Minor or Adult
child
ONLY IF: Minor/Adult
child owns greater than
50% of that business.
Minor or Adult child Grandparent ONLY IF: Grandparent
owns greater than 50%
of that business.
Sibling None None
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Attribution Rules, Continued
Examples-
family
attribution
The following examples illustrate the family attribution rules:
Example 1-
family
attribution
Ada and Barton are married. Barton is a doctor owning 100% of his medical
practice. Ada is also a doctor and owns 50% of a separate medical practice
(the other 50% is owned by an unrelated doctor).
Barton is not an employee or owner of a direct interest in Ada’s practice and
less than 50% of the gross income in Ada’s practice is from passive
investments. Barton, however, is in charge of significant management
activities for his wife’s practice.
Ada does not directly own an interest or participate in Barton’s practice and
less than 50% of the gross income from Barton’s practice is from passive
investments.
− Barton is attributed the 50% interest that Ada owns in her practice (due to
his participation in Ada’s practice).
− Ada is not attributed any ownership interest in Barton’s practice.
Example 2
Clare, age 25 is the daughter of Dana. Dana owns 75% of XYZ Corporation
and Clare own the remaining 25%.
Since Dana owns more than 50% of XYZ, her ownership is attributed to
Clare.
Since Clare does not own more than 50% of XYZ, her ownership is not
attributed to Dana.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-14
Controlled and Affiliated Service Groups
Attribution Rules, Continued
General Rules
for
Organizational.
Attribution
The following table is a general description of how the attribution rules for
organizations are applied to controlled groups.
The ownership interest: Are attributed to:
From a corporation to its
shareholder
• Applicable to brother-sister
controlled group only.
Corporate ownership interests
attributed, proportionately *, to
shareholders (owning at least 5% of
corporate stock).
From a partnership to its partners
• Applicable to brother-sister
controlled group only.
Partnership ownership interests
attributed, proportionately *, to
partners having at least 5% or more
capital or profits interest.
From a trust to its beneficiaries
• Applicable to brother-sister and
parent-subsidiary controlled
groups.
Trust ownership interests attributed,
proportionately *, to beneficiaries
having 5% or more actuarial
interest.
To an organization None
General Rules –
Orginazational
Attribution
* The interest owned is proportionate to the individual’s share of the
organization’s value.
For example, a shareholder’s interest in a corporation is proportionate share
of the total stock value of the corporation.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-15
Controlled and Affiliated Service Groups
Attribution Rules, Continued
Organizational
Attribution
Rules
The following examples illustrate the organizational attribution rules:
Example 1
Elliott owns 70% of the stock in the Fairfield Corporation. Grant owns 20%
of the stock and four other individuals who each own less than 5% own the
remaining 10%. The Fairfield Corporation has a 30% stock ownership in the
Hale Corporation.
The Hale stock is attributed to Elliott and Grant in proportion to their
ownership interests in the Fairfield Corporation as follows:
Elliott is treated as a 21% owner of Hale Corporation.
• 70% (interest in Fairfield) x 30% (Fairfield’s interest in Hale)
Grant is treated as a .06 % owner of Hale Corporation.
• 20% (interest in Fairfield) x 30% (Fairfield’s interest in Hale)
Since each of the four remaining shareholders of Fairfield Corporation own
less than 5%, they are not treated as owning any interest in Hale Corporation.
Example 2
The Isanti Group is a partnership. Jay owns a 70% interest in Isanti, and
Kendall owns a 30% interest. The Isanti Group owns 50% of the stock of
Lake Investments Corporation.
The Lake stock is attributed to Jay and Kendall in proportion to their
partnership interests in Isanti as follows:
Jay is treated as a 35% owner of Lake Corporation (70% x 50%).
Kendall is treated as a 15% owner of Lake Corporation (30% x 50%).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-16
Controlled and Affiliated Service Groups
Attribution Rules, Continued
Other Rules
under Section
1563
After an individual is attributed the ownership of a family member, the
interest does not get attributed from the individual to another family member.
However:
1. The ownership interests of an individual may be attributed to more
than one family member.
2. After an individual is attributed the ownership of a corporation,
partnership or trust, the interest may then be taken into account under
other attribution rules.
Options to acquire stock are, generally, treated as stock ownership under IRC
section 1563. Refer to Rev. Rul. 68-601 and North American Industries, Inc.
v. Commissioner, 33 TCM 1275 (1974) for further information.
Example-
Attribution to
More than One
Family
Member-facts
The following example illustrate attribution to more than one family member
DAD
40 %
30 % 20 %
An unrelated person owns the remaining interest in XYZ.
Continued on next page
SON
A
(Age 20)
SON B
(Age 30)
X
YZ
PARTNERSHIP
Chapter 7- Controlled and affiliated service groups
Page 7-17
Controlled and Affiliated Service Groups
Attribution Rules, Continued
Dad-Ownership
percentage
Dad is considered to own a total of 90% of the profits interest in XYZ
Partnership as follows:
• He directly owns 40% of XYZ Partnership,
• He is considered as owning the 30% interest owned by minor Son A, and
• He is also considered as owning the 20% interest of XYZ that is owned by
his adult son. Note that generally, the stock ownership of family members
who are 21 or older are not attributed to an individual. However, such
attribution is required if the individual has effective control. Dad has
more than a 50% ownership of XYZ. See 1.414(b)-4(b)(6).
Son A
Son A is considered to own a total of 70% of the profits interest in XYZ:
− He directly owns 30%, and
− He is considered to own the 40% profits interest owned directly by Dad.
Son A is not, however, considered to own the 20% owned directly by Son B
(and attributed to Dad).
Son B
− Son B is considered to own a total of 20% of the profits interest in XYZ:
− He directly owns 20%, and
− He is not considered to own the 40% interest of XYZ that is owned by his
father. This is because Son B owns only 20% and he would have to own
more than 50% in order for his father’s interest to be attributed to him.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-18
Controlled and Affiliated Service Groups
Attribution Rules, Continued
Other Rules for
Spousal
Attribution
under Section
1563
The following examples illustrate other spousal attribution rules
Example 1
Marian and Mitchell are the parents of Norton, age 25, and Oliver, age 20.
Mitchell has a 45% interest in the Pitkin Corporation and his son, Norton, has
a 55% interest.
ATTRIBUTION BETWEEN SPOUSES:
Marian is treated as owning Mitchell’s 45% interest in Pitkin, assuming the
spousal exception described above is not applicable.
FAMILY ATTRIBUTION IS NOT FURTHER ATTRIBUTED TO
ANOTHER FAMILY MEMBER:
The 45% interest attributed to Marian is not further attributed to Oliver.
This rule would not prevent Mitchell’s interest from being attributed to Oliver
(see below).
Example 2
FAMILY ATTRIBUTION RULES MAY BE APPLIED TO MORE
THAN ONE FAMILY MEMBER:
In addition to attributing Mitchell’s 45% interest in Pitkin to his wife, Marian,
using the rule for attribution between spouses, Mitchell’s 45% interest is also
attributed to Norton. Since Norton is over age 21 and owns more than 50% of
Pitkin, Mitchell’s ownership is attributed again to Norton under the family
attribution rule for parents and adult children.
Since Oliver is under age 21, Mitchell’s 45% interest may be attributed again
to Oliver under the family attribution rule for parents and minor children.
NO ATTRIBUTION BETWEEN SIBLINGS:
The 55% interest owned by Norton is not treated as owned by Oliver.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-19
Controlled and Affiliated Service Groups
Attribution Rules, Continued
Example -
Other Rules for
Organizational
Attribution
under Section
1563
Assume the same facts as in Example 2. In addition, the Pitkin Corporation
has a 50% interest in Rich and Riley, Inc. and Norton is married to Shannon.
ATTRIBUTION RULES APPLIED AFTER ORGANIZATIONAL
ATTRIBUTION:
Norton is considered to own a 50% (100% x 50%) interest in Rich and Riley,
Inc.
• Norton is treated as owning 100% of Pitkin (55% directly and 45%
attributed from his father).
• Shannon is attributed the 50% interest in Rich and Riley, Inc.
Chapter 7- Controlled and affiliated service groups
Page 7-20
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans
Background
The Employee Plans (EP) Determination Letter Program provides a means
whereby plan sponsors may submit their plans to the Service for review. The
Service reviews the form of the plan and, if the plan sponsor elects, reviews
certain operational features as well. If the plan meets the qualification
requirements under 401(a) of the Internal Revenue Code (Code), a favorable
determination letter is issued to the plan sponsor. The letter gives the
employer reliance on the form of plan.
Controlled
Group Pension
Plans
When the sponsor of a qualified retirement plan is part of a controlled group,
all employers of the group must be treated as a single employer to determine
if a plan meets the requirements of sections 401, 408(k), 408(p), 410, 411,
415, 416, and 417.
Rev. Proc 2004-
6 : Required
Information
When a plan sponsor submits a determination letter application (Forms 5300,
5307, 5310 and 6406), question 6 on the applications, asks if the employer is
a member of a controlled group or affiliated service group.
If question 6 is answered “Yes”, Rev. Proc. 2004-6 provides certain
information about the controlled group. The EP Specialist should secure for
review the following information (if not present with the application):
1. All members of the group;
2. Their relationship to the plan employer;
3. The type(s) of plan(s) each member has; and
4. Plans common to all members.
Continued on next page
Chapter 7- Controlled and affiliated service groups
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Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Example-
Determination
Letter
Application for
a Controlled
Group Plan-
Facts
Corporation A submits a Form 5307 Prototype Application for a
Determination Letter for a Profit Sharing Plan, which indicates that
Corporation A is a member of a controlled group. Along with the application,
the plan sponsor provides a controlled group statement with the following
information.
Example-
Controlled
group
statement
Corp A owns:
− 90% of Corp B,
− 85% of Corp C, and
− 50% of Corp X.
There is only one plan, sponsored by Corp A and members will adopt the
sponsor’s plan.
Plan effective date 1-1-1997
Corp A has 56 employees, Corp B has 20 employees, Corp C has 30
employees and Corp X has 90 employees.
Plan sponsor paid no user fee per EGTRRA section 620, which exempts
small plans from user fees on determination letter requests.
Continued on next page
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Page 7-22
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Application and
controlled
group
statement
review
Since the Service doesn’t rule on the controlled group status of qualified
plans, the analysis performed by the EP Specialist, regarding the controlled
group status of an employer, must include the following:
− Review the controlled group information to determine if the employer’s
status meets the requirements of a controlled group, under sections
1563(a) and 414(b) & (c). If the requirements are met, the employer has
declared that are a member of a controlled group.
− If the requirements of sections 1563(a) and 414(b) & (c) are not met, the
EP Specialist should notify the employer or their representative that based
on sections 1563(a) and 414(b) & (c), the employer status is not a
controlled group member.
The specialist should secure a revised application (with question 6, answered
“No”) or notate the case file with the correct employer status.
Application and
Controlled
Group
Statement
Analysis
Based on the information provided, a controlled group exists between
Corporation A, Corporation B and Corporation C. This is a parent-subsidiary
group, due to the 80% rule. Corporation X is excluded as a member (less
than 80%).
In this example, once the controlled group status is determined, the EP
Specialist should secure the appropriate user fee for a Form 5307 Application.
Since all employees of a controlled are treated as employed by a single
employer, the number of employees exceeds 100 (total # of employees for
Corporations A, B, and C equals 106).
The application is not eligible for user fee exclusion, under EGTRRA section
620.
Once the user fee is received, the application should be reviewed for general
qualification requirements, which are discussed later in this chapter.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-23
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Specific
Instructions
Form 5310
Application for
Controlled
Group Plans
Form 5310, Application or Determination for Terminating Plans, is used by
any plan sponsor or administrator of the pension plan to request a
determination letter on the plan’s qualified status at the time it terminates.
Rev. Proc. 2004-6 states that an application for a determination letter
involving plan termination must also include any supplemental information or
schedules required by the forms or form instructions. For example, the
application must include copies of all records of actions taken to terminate the
plan (such as a board of directors resolution) and a schedule providing certain
information regarding employees who separated from vesting service with
less than 100% vesting.
The Form 5310 application is the last opportunity for the Service to review
the qualified status of the plan before termination. When a Form 5310 is filed
for a plan sponsor who is a member of a controlled group.
The EP specialist should ensure that the controlled group members are treated
as a single employer when applying certain employee plan benefits
requirements.
Also when analyzing the application for employees separated without 100%
vesting, reversion issues, spin-off termination/change in funding and any
other issues addressed in (IRM) 7.12.1, Plan Terminations.
Example-
Termination
Application for
a Controlled
Group Plan-
Assume the same facts in previous example except the application submitted
is a Form 5310 and the application indicated that the termination date is 12-
31-2003. In addition the application states that in 2001, 6 participants were
separated without 100% vesting
The plan document has a 3-year cliff vesting schedule and immediate
participation upon employment.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-24
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Example-
coverage
information
Also the following coverage information was provided:
A B C Total
Total
Employees
56 20 30 106
Highly
Comp.
Employees
4
2
5
11
Highly
Comp.
Employees
Benefiting
4
1
5
10
Ineligible
Employees
9
0
1
10
Total 43 18 24 85
Other
NHCEs not
benefiting
10
2
4
16
NHCEs
Benefiting
33
16
20
69
Application
review for
Form 5310
In addition to the determination made in the previous example (Corporations.
A, B and C are members of a controlled group), the EP Specialist should
secure (if not provided) the following information:
A schedule with the following information for each participant who has
separated from vesting service with less than 100% vesting:
1. Name of participant,
2. Date of hire,
3. Date of termination,
4. Years of participation,
5. Vesting percentage,
6. Account balance/account benefit at the time of separation from
service,
7. Amount of distribution,
8. Date of distribution, and
9. Reason for termination.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-25
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Analysis of
Form 5310
Application for
a Controlled
Group Plan
The analysis should review the information to ensure that the participants,
who separated without 100% vesting, were cashed out properly. Also
investigate if there was any previous service with other members of the
controlled group, and
Consider whether the form requirements of the plan are met and coverage is
adequate. If the facts have materially changed or new legislation has affected
the entity, sufficient information should be requested from the employer to
determine whether all eligible employees are considered for purposes of
coverage.
Results of
Performing
Coverage
Testing for a
Controlled
Group
The coverage information was included to illustrate controlled group
coverage testing under section 410(b).
Results:
The percentage of HCEs benefiting is 91% (HCEs benefiting/total HCEs).
The NHCEs benefiting is 81% (total NHCEs benefiting/total NHCEs)
The final step in the coverage test is to calculate the coverage percentage,
which is 89% (percentage of NHCEs benefiting/Percentage of HCEs
benefiting, which passes coverage).
The application should be reviewed for general qualification requirements,
which are discussed later in this chapter.
Chapter 7- Controlled and affiliated service groups
Page 7-26
Controlled and Affiliated Service Groups
Impact of Section 414(b) and (c) on Qualified Plans
Code Sections
Effected by
Controlled
Group Plans
If two or more corporations, trades or businesses are part of a controlled
group of businesses, the controlled group members are treated as a single
employer when applying certain employee plan benefits requirements.
These requirements are:
1 – Nondiscrimination, IRC 401(a)(4),
2 – Compensation dollar limit under IRC 401(a)(17),
3 – Minimum participation test under IRC 401(a)(26),
4 – Eligibility, IRC 401(a)(3) and 410(a),
5 – Coverage, IRC 410(b),
6 – Vesting, IRC 401(a)(7) and IRC 411,
7 – Section 415 limits,
8 – Top heavy rules IRC 416, and
9 – SEP’s under 408(k) and SIMPLE-IRA plans under IRC 408(p).
Section
401(a)(4)
Section 401(a)(4) requires that contributions under the plan may not
discriminate in favor of those who are highly compensated (as defined in
section 414(q)).
An employee is a highly compensated employee if the employee meets one of
two tests:
− the five-percent owner test ,or
− the compensation test. Section §414(q)(1)
Since all employees of a controlled group are treated as employed by a single
employer, any employee of the related business, who is (or was) a five
percent owner, will be a highly compensated employee.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-27
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Nondiscriminat
ion
The following examples illustrate the impact of section 401(a)(4) on qualified
plans:
Example 1
Tucker Computing, Inc., Smith Mainframe, Inc. and Yuma Software, Inc. are
a controlled group of corporations.
Jack is a participant in the Tucker Computing, Inc. Profit Sharing Plan. Jack
has never had any ownership in Tucker Computing, Inc. and is not a highly
compensated employee.
Prior to the buy out of Smith Mainframe, Inc. by Tucker Computing, Inc.,
Jack was a 30% owner in Smith Mainframe.
Solely as a result of the controlled group relationship, Jack would be deemed
to be a highly compensated employee in the Tucker Computing plan.
Similar issues may result in determining if an employee is highly
compensated under IRC sections 414(q)(1)(B), (C), and (D). See next
Example.
Example 2
Tabor Equipment Co, Inc and Wells Supplies, Inc are members of a
controlled group of corporations.
Wanda is a participant in the Tabor Equipment Co, Inc Profit Sharing Plan.
Wanda’s compensation from Travis is $45,000 and from Wells is $35,000.
Wanda would not be deemed a highly compensated employee based upon her
compensation from Tabor Equipment Co, Inc alone.
However, because all of her compensation from both employers would be
aggregated to determine the “Top Paid Group”, she would be a highly
compensation employee.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-28
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Section
401(a)(17)
Section 401(a)(17) limits the amount of compensation that may be considered
under a qualified plan to $200,000
All of the employees in the controlled group must be considered as if there
were one employer.
Compensation
Limits-
Example
Gordon, Inc. and Bacon, Inc. are unrelated employers who have two separate
money purchase pension plans. Both plans have a 10 percent of compensation
contribution formula.
Bob is an employee of both employers and earns $150,000 from each of
them. In 2000, he received an allocation of $15,000 under each plan.
In 2001, Gordon, Inc. and Bacon, Inc. became members of a controlled group.
For subsequent allocation purposes, Bob’s compensation is limited to
$200,000 (not the $300,000 if counted separately), because one employer
pays his entire compensation. Therefore, the amount that may be allocated to
his account under both plans is limited to $20,000 (not the $30,000 he was
entitled to previously).
Failure to limit Bob’s compensation will result in a violation of section
401(a)(17).
Section
401(a)(26
Section 401(a)(26) requires that a plan must benefit the lesser of 50
employees or 40 percent or more of all employees.
In testing a plan for section 401(a)(26), all employers required to be aggregated
under sections 414(b) and (c), must be treated as a single employer.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-29
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Additional
Participation
Requirements-
Example
Alma and her husband, Clay jointly own 100% of the Caldwell Corporation.
Alma also owns 100% of the capital and 50% of the profits of A & B
Partnership. Clay owns the other 50% profit interest in A & B. Alma is the
only employee in the Caldwell Corporation and there are no common law
employees in A & B Partnership. Alma wants to set up a defined benefit plan
for Caldwell. A & B does not maintain a retirement plan. There are only two
employees, Alma and Clay, in the controlled group.
Caldwell Corporation and A & B Partnership are a controlled group of
businesses under section 414(c) because Alma owns:
• 100% of A & B (the greater of her ownership in the capital or profits), and
• 100% of Caldwell (due to attribution from Clay).
Alma could not set up a defined benefit plan for only the Caldwell
Corporation.
Since both businesses must be treated as a single employer and section
401(a)(26) applies, she would have to cover both employees of the controlled
group in order to have 40% or more employee participation.
Section
401(a)(3)
Section 401(a)(3) requires that a qualified plan satisfy section 410, coverage
and eligibility.
In general, all years of service with an employer must be counted.
Sections 414(b) and (c) require the consolidation of all employees in the
group as if employed by one employer.
Therefore years of service with the following entities must be counted:
− Any member of a controlled group of corporations, or
− A commonly controlled entity, whether or not incorporated.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-30
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Coverage
Creek Manufacturing, Inc. and Dunn, Inc. are members of a controlled group.
Creek maintains a qualified plan in which only their employees may
participate. Dunn employees are not eligible to participate in the plan.
The Creek plan has a one-year service requirement. It must recognize service
with all employers in the controlled group and otherwise meet the coverage
requirements of section 410(b) with reference to the entire group.
You determine that one employee, Mary, had completed three years of service
with Dunn prior to her transfer to Creek. The plan administrator required
Mary to complete a year of service with Creek before including her in the
plan.
In this instance, Mary should have become a participant in the plan as soon as
she started to work for Creek, because she had already completed her year of
service under Dunn.
Failure to have Mary participate immediately in the plan means the plan
violates sections 401(a)(3) and 410(a)(1)(A).
Section
401(a)(7) &
Section 411
Section 401(a)(7) requires that a qualified plan satisfies section
411, vesting.
In general, all years of service with an employer must be counted.
Sections 414(b) and (c) require the consolidation of all employees in the
group as if employed by one employer.
Therefore years of service with the following entities must be counted:
− Any member of a controlled group of corporations, or
− A commonly controlled entity, whether or not incorporated.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-31
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Vesting-
example
Teton corporation is the parent company of subsidiary L. Carmen works for
subsidiary L and commenced employment on September 1, 2000. Teton
corporation maintains a profit sharing plan. The plan only covers employees
of Teton.
On May 1, 2004, Carmen transfers to Teton corporation. In determining
Carmen’s vesting percentage under Tech’s plan, Carmen’s service with
subsidiary L must be counted.
Teton’s plan prescribes a 5-year cliff vesting schedule. Therefore, as of the
vesting period in which Carmen transferred, she already has three years of
service for vesting purposes under L’s plan (although no accrued benefit to
vest in).
Sections 414(b) and (c) require the consolidation of all employees in the
group as if employed by one employer.
Section 415
Section 401(a)(16) requires that a qualified plan must meet the requirements
of Section 415.
Sections 414(b) and (c) require the consolidation of all employees in the
group as if employed by one employer.
Benefits and contributions under all plans maintained by employers in the
group must be aggregated to determine the maximum amount allowed by
section 415.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-32
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
Section 415
Limits-
Example
Starr, Inc. and Upson Ltd. are a controlled group. Each maintains an identical
money purchase plan.
During the 2003 plan year, Sue earns $100,000 from each employer and is a
participant in each plan. She receives an allocation of $25,000 in each.
Since the employers are members of a controlled group, the limitation of
section 415(c)(1)(A) should have been applied by aggregating the allocations
under both plans. This would have limited the total allocations to the lesser
of 25% of compensation or $40,000.
The allocations in this instance result in a disqualification of either one or the
other of the plans due to a violation of sections 401(a)(16) and 415(c)(1)(A).
The actual plan to be disqualified is determined pursuant to Treas. Regulation
section 1.415-9(b)(3)(iii).
Section 416
Section 416, special rules for top-heavy plans
Aggregate all years of service and compensation earned by organizations
within a controlled group for purposes of:
− Minimum contributions and benefits,
− Minimum vesting,
− Determining if a plan is top-heavy.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-33
Controlled and Affiliated Service Groups
Determination Letter Program: Controlled Group Plans,
Continued
SEPs &
SIMPLE-IRA
Section 408(k) establishes the rules for simplified employer plans (SEPs). In
many ways, the rules for SEPs mirror those for qualified plans.
Sections 414(b), (c) and (m) require the consolidation of all employees in the
group as if employed by one employer for the purposes of section 408(k).
Such items as the minimum service requirement of subsection (2)(B) and the
non-discrimination requirements of subsection (3) would have to be applied
as if all the employers in the group constituted a single employer.
Chapter 7- Controlled and affiliated service groups
Page 7-34
Controlled and Affiliated Service Groups
Controlled Group: Exercises
Exercise 1
A Corp owns:
• 90% of the stock of B Corp,
• 80% of the stock of C Corp, and
• 50% of the stock of D Corp.
Unrelated persons own the percentage of stock not owned by A Corp.
C Corp. owns 80% of the profits interest in the XYZ Partnership.
Which of the following constitutes the controlled group and what type of
group?
a. B Corp, C Corp and XYZ Partnership
b. A Corp, B Corp and C Corp
c. A Corp, B Corp, C Corp and XYZ Partnership
d. A Corp, B Corp, C Corp, D Corp and XYZ Partnership
e. B Corp and C Corp
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-35
Controlled and Affiliated Service Groups
Controlled Group: Exercises, Continued
Exercise 2
Assume the same facts as in exercise 1, except C Corp and D Corp are owned
by three unrelated shareholders in the following percentages:
Percentage of Ownership
Shareholder C Corp D Corp
A 80 % 20 %
B 10 50
C 10 30
TOTAL 100 % 100 %
C Corp and D Corp not considered to be a controlled group, Why?
a. To be a controlled group, each of the three shareholders would have to
own 80% or more of the stock of each corporation.
b. Although the three shareholders together own 80% or more of the stock of
each corporation, they do not own more than 50% of the stock of each
corporation taking into account only the identical ownership.
c. To be a controlled group, each of the three shareholders would have to
own 50% or more of the stock of each corporation.
d. In order to satisfy the requirements of section 414(c), there must be a
chain of corporations, connected through stock ownership with a common
parent that owns 80% or more of at least one other organization.
e. C Corp and D Corp constitute an affiliated service group.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-36
Controlled and Affiliated Service Groups
Controlled Group: Exercises, Continued
Exercise 3
X Corp and Y Corp are owned by five unrelated shareholders in the following
percentages:
Percent of Ownership
Shareholder X Corp Y Corp
A 40% 30%
B 20 40
C 35 15
D 5 0
E 0 15
Total 100% 100%
Do X Corp and Y Corp constitute a controlled group of corporations? Why?
a. Yes. All shareholders, together, own at least 80% of each corporation and
no individual shareholder owns more than 50% of either corporation.
b. No. Neither corporation owns at least 80% of the other.
c. No. No individual shareholder owns more than 50% of either
corporation.
d. No. Since D and E do not have ownership in both X Corp and Y Corp,
there cannot be any combined identical ownership.
e. Yes. A, B and C, together, own more than 80% of X Corp and more than
80% of Y Corp and their combined identical ownership is more than 50%.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-37
Controlled and Affiliated Service Groups
Controlled Group: Exercises, Continued
Exercise 4
What are the three types of controlled groups?
a. Parent-subsidiary, Brother-brother and Combined group.
b. Brother-sister, Combined and Parent-child group.
c. Parent-subsidiary, Brother-sister and Combined groups.
d. Husband -wife, Brother-sister and Combined groups.
Summary
Summary
IRC sections 414(b) & (c) were added to the Code because, in the words of
the Senate Committee Report on ERISA: “ The Committee, by this provision,
intends to make it clear that the coverage and nondiscrimination provisions
cannot be avoided by operating through separate corporations instead of
separate branches of one corporation.”
A plan that is maintained by an employer, within a group of employers that
are under common control, must meet the requirements of IRC section 401(a)
as if a single employer employed all employees of the group.
This chapter explains how to recognize a controlled group and the impact on
qualified plans and the Determination Letter process.
In the next section of this chapter, we will discuss Affiliated Service Groups.
Chapter 7- Controlled and affiliated service groups
Page 7-38
Controlled and Affiliated Service Groups
Overview: Affiliated Service Group
Introduction
As you have learned, section 414(b) and (c) require that all employees of
commonly controlled corporations or trades or businesses be treated as
employees of a single corporation or trade or business.
By arranging the ownership of related business entities in an artificial manner,
the definition of "control" under section 414(b) and (c) and the aggregation
rules established by ERISA could be circumvented. In addition, the basic rule
that employee plans provide an exclusive benefit for employees or their
beneficiaries could be violated.
Section 414(m) was enacted to prevent such circumvention by expanding the
idea of control to separate, but affiliated, entities. Proposed Treas. Reg. §
1.414(m) provides that all employees of the members of an affiliated service
group shall be treated as if a single employer employed them.
Objectives
At the end of this section, you will be able to identify situations where the
plan sponsor is a member of an affiliated service group and recognize the
impact on qualified plans. Therefore, you will be able to:
1. Describe the relationship between employers and determine if an
affiliated service group exists.
2. Describe the relationship between a first service organization and an
A-Organization and determine whether an affiliated service group
exists.
3. Describe the relationship between a first service organization and a B-
Organization and determine whether an affiliated service group exists.
4. Describe a management organization situation and determine whether
an affiliated service group exists.
5. Determine how these relationships affect the status of qualified plans.
6. Describe the procedure for processing a affiliated service group
determination letter request.
Describe other employer/employee relationships, such as leased employees,
impendent contractors, professional employee organization and management
organization
Chapter 7- Controlled and affiliated service groups
Page 7-39
Controlled and Affiliated Service Groups
Chapter 7- Controlled and affiliated service groups
Page 7-40
Controlled and Affiliated Service Groups
Affiliated Service Group
History
The Kiddie v. Commissioner 69 T.C. 1055 (1978)) and Garland v.
Commissioner 73 T.C. 5 (1979)) cases addressed the issue of control. The Tax
Court held that where a controlled group situation did not exist, it would not be
necessary to aggregate employees for purposes of testing for coverage and
discrimination.
IRC § 414(m) was enacted to expand the idea of control to separate, but
affiliated, entities. Proposed Treas. Reg. § 1.414(m) provides that all
employees of the members of an affiliated service group shall be treated as if
they were employed by a single employer.
Definition
An affiliated service group is one type of group of related employers and
refers to two or more organizations that have a service relationship and, in
some cases, an ownership relationship, described in IRC section 414(m). An
affiliated service group can fall into one of three categories:
1. A-Organization groups (referred to as “A-Org”), consists of an
organization designated as a First Service Organization (FSO) and at
least one “A organization”,
2. B-Organization groups (referred to as “B-Org”), consists of a FSO and
at least one “B organization”, or
3. Management groups.
First Service
Organization
An FSO must be a "service organization":
− Performance of services is the principal business of the organization as
defined in section 414(m)(3), and Proposed Treas. Reg. § 1.414(m)-2(f) .
− “Organization” refers to a corporation, partnership, or other organization.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-41
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
A-Org
To be an A-Org, an organization must satisfy a two-part test:
− Ownership Test
The organization is a partner or shareholder in the FSO (regardless of
the percentage interest it owns in the FSO) determined by applying the
constructive ownership rules as specified in section 318(a), and
− Working Relationship Test
• The organization "regularly performs services for the FSO," or
• Is "regularly associated with the FSO in performing services for
third parties.
Facts and circumstances are used to determine if a working
relationship exists. See Proposed Treas. Reg. § 1.414(m)-2(b).
See section 414(m)(2)(A).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-42
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
B-Org
To be a B-Org, the organization must meet the following requirements:
− A significant portion of its business must be the performance of services
for a FSO, for one or more A-Org’s determined with respect to the FSO,
or for both,
− The services must be of a type historically performed by employees in the
service field of the FSO or the A-Org’s, and
− Ten percent or more of the interests in the organization must be held, in
the aggregate, by persons who are highly-compensated employees
(pursuant to IRC § 414(q)) of the FSO or A-Org.
A B-Org need not be a service organization.
See IRC § 414(m)(2)(B).
Performance of
Services
The principal business of an organization will be considered the performance
of services if capital is not a material income-producing factor for the
organization, even though the organization is not engaged in a field listed in
Proposed Treas. Reg. § 1.414-(m)-2(f)(2) .
Whether capital is a material income-producing factor must be determined by
reference to all the facts and circumstances of each case. In general, capital is
a material income-producing factor if a substantial portion of the gross
income of the business is attributable to the employment of capital in the
business as reflected, for example, by a substantial investment in inventories,
plant, machinery or other equipment.
Capital is a material income-producing factor for banks and similar
institutions.
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 performed by an individual.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-43
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
Specific fields
Regardless of whether the above subparagraph applies, an organization
engaged in any one or more of the following fields is a service organization:
− Health,
− Law,
− Engineering,
− Architecture,
− Accounting,
− Actuarial science,
− Performing arts,
− Consulting, and
− Insurance.
An
organization
will not be
considered as
performing
services
An organization will not be considered as performing services merely
because:
• It is engaged in the manufacture or sale of equipment or supplies used
in the above fields,
• It is engaged in performing research or publishing in the above fields,
or
• An employee provides one of the enumerated services to the
organization or other employees of the organization, unless the
organization is also engaged in the performance of the same services
for third parties.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-44
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
Commissioner
may determine
other specific
fields
The Commissioner may determine that a specific business field, not
enumerated in the proposed regulations, is engaged in performing services.
In this case, the above list will be expanded, but only prospectively.
“Organization”
defined
The term "organization" includes a sole proprietorship, partnership,
corporation or any other type of entity, regardless of its ownership format.
A bona fide expense-sharing arrangement, in which the parties involved share
the cost of the office overhead but are not working in unison for common
business purposes, would not be considered an organization. These costs
would include rent, supplies, maintenance and employees' salaries.
Historically
Performed
Services will be considered of a type historically performed by employees in
a particular service field if it was not unusual for the services to be performed
by employees of organizations in that service field (in the United States) on
December 13, 1980.
Professional
Service
Corporations
All the employees of professional service corporations that are members of an
affiliated services group shall be aggregated together and treated as if they
were employed by a single employer for purposes of the employee benefit
requirements.
A professional service corporation:
− Is a corporation that is organized under state law for the principal purpose
of providing professional services,
− Has at least one shareholder who is licensed or otherwise legally
authorized to render the type of services for which the corporation is
organized, and
− Provides the services performed by certified or other public accountants,
actuaries, architects, attorneys, chiropodists, chiropractors, medical
doctors, dentists, professional engineers, optometrists, osteopaths,
podiatrists, psychologists and veterinarians. The Commissioner may
expand the list of services.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-45
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
Flowchart
Is the organization a
partner or shareholder
in the first service
organization?
Is this an organization,
the principal business
of which is performing
services?
Does it regularly
perform services for
the FSO?
Is capital NOT a
material income-
producing factor?
Is it
associated with the
FSO in performing
services for third
persons?
regularly
This organization
qualifies as a First
Service
Organization.
This organization is
NOTpartofan
Affiliated Service
Group.
This is an
Affiliated
Service Group.
YES
NO
NO
YES
YES
YES
YES
NO
NO
YES
NONO
A-Organization First Service Organization
(FSO)
Affiliated Service Group
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-46
Controlled and Affiliated Service Groups
Flowchart
Is a of
the business of the
organization the
performance of services for
the FSO or the
A-Organization?
significant portion
Is this an organization,
the principal business
of which is performing
services?
Are the services of a type
historically performed by
employees in the service
field of the FSO or the
A-Organization?
Is capital NOT a
material income-
producing factor?
Is ten percent or more of
the interest in the
organizations held, in the
aggregate, by persons
who are designated group
members of the FSO or
the A-Organization?
This organization
qualifies as a First
Service
Organization.
This organization is
NOT part of an
Affiliated Service
Group.
This is an
Affiliated
Service Group.
NO
NO YES
YES
YES
YES
NO
NO
YES
NONO
B-Organization First Service Organization
(FSO)
Affiliated Service Group
Chapter 7- Controlled and affiliated service groups
Page 7-47
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
Section 414(m)-
Example
Allen Averett, a doctor, is incorporated as Allen Averett, P.C. and this
professional corporation is a partner in the Butler Surgical Group. Allen
Averett and Allen Averett, P.C., are regularly associated with the Butler
Surgical Group in performing services for third parties.
The Butler Surgical Group is an FSO. Allen Averett, P.C. is an A-Org
because it is a partner in the medical group and is regularly associated with
the Butler Surgical Group to perform services for third parties.
Accordingly, Allen Averett, P.C. and the Butler Surgical Group would
constitute an affiliated service group.
As a result, the employees of Allen Averett, P.C. and the Butler Surgical
Group must be aggregated and treated as if they were employed by a single
employer per section 414(m).
First Service
Organization
and an A-Org-
Example
The Everett, Furman and Guilford Partnership is a law partnership with
offices in numerous cities. EFG of Capital City, P.C., is a corporation in
Capital City that is a partner in the law firm. EFG of Capital City, P.C.
provides paralegal and administrative services for the attorneys in the law
firm. All of the employees of the corporation work directly for the
corporation, and none of them work directly for any of the other offices of the
law firm.
The law firm is an FSO. The corporation is an A-Org because it is a partner
in the FSO and is regularly associated with the law firm in performing
services for third parties.
The corporation and the partnership would together constitute an affiliated
service group. Therefore, the employees of EFG of Capital City, P.C. and the
employees of The Everett, Furman and Guilford Partnership must be
aggregated and treated as if they were employed as a single employer per
section 414(m).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-48
Controlled and Affiliated Service Groups
Affiliated Service Group, Continued
First Service
Organization
and a B-Org-
Example
Reinhardt & Associates is a financial services organization that has 11
partners. Each partner of Reinhardt owns one percent of the stock in Asbury
Corporation. Asbury provides services to the partnership of a type
historically performed by employees in the financial services field. A
significant portion of the business of Asbury consists of providing services to
Reinhardt.
Considering Reinhardt &Associates as an FSO, the Asbury Corporation is a
B-Org because:
1. A significant portion of its business is in the performance of services
for the partnership of a type historically performed by employees in
the financial services field. And,
2. More than 10% of the interests in the Asbury Corporation is held, in
the aggregate, by the highly-compensated employees of the FSO
(consisting of the 11 common owners of Reinhardt and Associates).
Accordingly, the Asbury Corporation & Reinhardt and Associates constitute
an affiliated service group. Therefore, the employees of the Asbury
Corporations and Reinhardt and Associates must be aggregated and treated as
if they were employed by a single employer per section 414(m).
Non Service
Organization-
Example
Dade Properties, Inc. sells land that it has purchased and developed.
Craig is a 25% shareholder of Dade and a 50% shareholder of Craig and Son
Construction Company, Inc. Dade Properties regularly engages the services
of Craig and Son. Although it appears that Dade Properties could be an FSO,
the affiliated service group rules do not apply because Dade Properties is not
a service organization.
Chapter 7- Controlled and affiliated service groups
Page 7-49
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service
Significant
Portion
Proposed Treas. Reg. § 1.414(m)-2(c)(2) specifies that whether providing
services (for the FSO, for one or more A-Org’s or for both,) is a "significant
portion" of the business of an organization will be based on the facts and
circumstances.
The following tests may be used to substantiate the facts and circumstances:
− Service Receipts Safe Harbor Test, and
− Total Receipts Threshold Test.
For additional information, see Proposed Treas. Reg. § 1.414(m)-(2)(c)(2).
Service Receipts
Safe Harbor
The performance of services for the FSO, for one or more A-Org’s, or for
both, will not be considered a significant portion of the business of an
organization if the "service receipts percentage" is less than five percent.
− The "service receipts percentage" is the ratio of:
1. Gross receipts of the organization derived from performing services
for the FSO, for one or more A-Org’s, or for both, to
2. Total gross receipts of the organization derived from performing
services.
− This ratio is the greater of:
1. the ratio for the year for which the determination is being made, or
2. the ratio for the three-year period including that year and the two
preceding years (or the period of the organization’s existence, if less).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-50
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Total Receipts
Threshold Test
The performance of services for the FSO, for one or more organizations, or
for both, will be considered a significant portion of the business of an
organization if the "total receipts percentage" is ten percent or more.
The "total receipts percentage" is calculated in the same manner as the service
receipts percentage, except that gross receipts in the denominator are
determined without regard to whether they were derived from performing
services.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-51
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Service
receipts-
Example
The income of Cascade Corporation is derived from performing both services
and other business activities. The amount of its total receipts and its receipts
derived from performing services and its total receipts from Starr Corporation
and from all customers is provided below:
Origin of Income All Customers Starr Corp.
Year 1
Services $ 100 $ 4
Total $120
Year 2
Services 150 9
Total 180
Year 3
Services 200 42
Total 240
Service
Receipts
Percentage
In Year 2, the services receipts percentage is the greater of:
1. The ratio for that year ($9/$150, or 6%), or
2. For Years 1 and 2 combined ($13/$250, or 5.2 %).
= 6%
The total receipts percentage is the greater of:
1. The ratio for that year ($9/$180, or 5%), or
2. For Years 1 and 2 combined ($13/$300, or 4.3%).
= 5%
The services receipts percentage is greater than 5% and, therefore, the Service
Receipts safe harbor is not met.
The total receipts percentage is less than 10% and, therefore, the Total
Receipts threshold test is not met.
As a result, for Year 2, facts and circumstances is used to determine whether
performing services for Starr Corporation constitutes a significant portion of
the business of Cascade Corporation.
Chapter 7- Controlled and affiliated service groups
Page 7-52
Controlled and Affiliated Service Groups
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-53
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Total Receipts
Percentage
In Year 3, the services receipts percentage is the greater of:
1. the ratio for that year ($42/$200, or 21%), or
2. for Years 1, 2, and 3 combined ($55/$450, or 12.2%).
= 21%.
The total receipts percentage is the greater of:
1. the ratio for that year ($42/$240, or 17.5%), or
2. for Years 1, 2, and 3 combined ($55/$540, or 10.2%).
= 17.5%
Because the total receipts percentage is greater than 10% and the services
receipts percentage is not less than 5%, a significant portion of the business of
Cascade Corporation is considered to be the performances of services for
Starr Corporation.
For Year 3, therefore, the Cascade Corporation and the Starr Corporation are
part of an affiliated service group within the meaning of section 414(m), and the
employees of both corporations must be aggregated and treated as if they were
employed by a single employer.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-54
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Example-Total
Receipts,
Percentage Test
Marsha Mesa owns one-third of an employee benefits consulting firm,
Benefits by Marsha. Marsha also owns one-third of an insurance agency,
Mesa, Long and Toole Insurance Agency. A significant portion of the
business of Benefits by Marsha consists of assisting the Mesa, Long and
Toole Insurance Agency in developing employee benefit packages for sale to
third persons and providing services to the insurance company in connection
with employee benefit programs sold to other clients of the Mesa, Long and
Toole Insurance Agency.
Additionally, Benefits by Marsha frequently provides services to clients who
have purchased insurance arrangements from the Mesa, Long and Toole
Insurance Agency for the employee benefit plans they maintain. Mesa, Long
and Toole Insurance Agency frequently refer clients to Benefits by Marsha to
assist them in the design of their employee benefit plans. Twenty percent of
the total gross receipts of Benefits by Marsha represent gross receipts from
the performance of these services for the Mesa, Long and Toole Insurance
Agency.
Considering Mesa, Long and Toole Insurance Agency as a FSO, Benefits by
Marsha is a B-Org because:
− A significant portion of the business of Benefits by Marsha (as
determined under the total receipts percentage test) is the performance of
services for Mesa, Long and Toole Insurance Agency of a type
historically performed by employees in the service field of insurance, and
− More than 10% of the interests in Benefits by Marsha is held by owners
of the Mesa, Long and Toole Insurance Agency.
Thus, Mesa, Long and Toole Insurance Agency and Benefits by Marsha
constitute an affiliated service group, and the employees of both companies
must be aggregated and treated as if they were employed by a single
employer.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-55
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Example-Gross
Receipts
Derived from
Performing
Services
Calvin Cameron is a 60% partner in Decatur, a service organization, and
regularly performs services for Decatur. Cameron is also an 80% partner in
Fleming Brothers. A significant portion of the gross receipts of Fleming
Brothers is derived from providing services to Decatur of a type historically
performed by employees in the service field of Decatur.
If Decatur is an FSO, then Fleming Brothers would be a B-Org because:
− A significant portion of gross receipts of Fleming Brothers is derived
from performing services for Decatur of a type historically performed by
employees in that service field, and
− More than 10% of the interests in Fleming Brothers is held by a highly-
compensated employee, Calvin Cameron (who is a common owner of
Decatur).
Accordingly, Decatur and Fleming Brothers constitute an affiliated service
group. Additionally, the employees of Decatur and Fleming Brothers are
aggregated under the rules of section 414(c). Thus, any plan maintained by a
member of the affiliated service group must satisfy the aggregation rules of
section 414 (c) and 414 (m).
The aggregation rules of section 414(c) and 414(m) require all employees of the
“employer” to be aggregated and treated as if they were employed by a single
employer. The “employer” is Decatur and Fleming Brothers.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-56
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Example-FSO
with an A-Org
and a B-Org
− Karen King, incorporated as Karen King Corporation, is a partner in the
management consulting firm of King & Ferris and she regularly performs
services for King & Ferris.
− Morehead Corporation provides secretarial services for King & Ferris.
This constitutes a significant portion of Morehead's business. Karen King
owns all of the stock of the Morehead Corporation.
− King & Ferris, is an FSO. Karen King Corporation is an A-Org because it
is a partner in King & Ferris and regularly performs services for the firm or
is regularly associated with the firm in performing services for third persons.
− Under the attribution rules of section § 318(a) (attribution rules are
discussed in the next section), Karen King owns the partnership interest in
the consulting firm, King & Ferris, which is held by Karen King
Corporation. Thus, Karen King is an owner of the consulting firm.
− King & Ferris is an FSO. The secretarial corporation, Morehead
Corporation, is a B-Org because:
a. a significant portion of its business consists of performing
services for the consulting firm, King & Ferris, or for the
Karen King Corporation, of a type historically performed by
employees in the service field of management consulting, and
b. at least 10% of the interests in Morehead Corporation is held
by Karen King, an owner of the consulting firm.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-57
Controlled and Affiliated Service Groups
Affiliated Service Group: Performance of Service, Continued
Example-FSO
and a B-Org
Jasper Jay is the office manager and a highly compensated employee of an
accounting partnership, Hickory & Holmes. Woodruff Corporation provides
the secretarial services for the partnership. Jasper Jay owns 50% of the stock
of the secretarial corporation. A significant portion of the business of the
secretarial corporation consists of providing services to the partnership.
Considering the partnership as a FSO, Woodruff Corporation is a B-Org
because:
− A significant portion of the business of the secretarial corporation is the
performance of services for the partnership, Hickory & Holmes, of a type
historically performed by employees of accounting firms, and
− More than 10% of the interests in the corporation is held by a highly-
compensated employee of the partnership, Hickory & Holmes.
Under the principles of section 318(a), the result would be the same, for
example, if the stock were held, instead of by Jasper Jay, by his spouse,
children, parents, grandparents or a combination of such relatives.
Chapter 7- Controlled and affiliated service groups
Page 7-58
Controlled and Affiliated Service Groups
Multiple Affiliated Service Group
Introduction
FSOs
Two or more affiliated service groups will not be aggregated simply because an
organization is an A-Org or a B-Org with respect to each affiliated service
group.
If an organization is an FSO with respect to two or more A-Org’s or two or
more B-Org’s, or both, all of the organizations shall be considered to constitute
a single affiliated service group.
For additional information, see Proposed Treas. Reg. § 1.414(m)-2(g)
Example-
Multiple FSOs
Pfeiffer Corporation provides secretarial service to numerous dentists in a
medical building, each of whom maintains a separate unincorporated practice.
Tina Temple, D.D.S., owns 20% of the secretarial corporation and accounts
for 20% of its gross receipts. Paula Pomona, D.D.S., owns 25% of the
corporation and accounts for 25% of its gross receipts.
REMEMBER: Two or more affiliated service groups will not be
aggregated simply because an organization is an A-Org or a B-Org with
respect to each affiliated service group.
Since the secretarial corporation, Pfeiffer Corporation, is a B-Org with respect
to both dentists, there are two separate affiliated service groups as follows:
1. Tina Temple, D.D.S. is an FSO and
Pfeiffer Corporation is a B-Org.
2. Paula Pomona, D.D.S., is an FSO and
Pfeiffer Corporation is a B-Org.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-59
Controlled and Affiliated Service Groups
Multiple Affiliated Service Group, Continued
Example-
Multiple FSOs
(continued)
Pfeiffer Corporation is a B-Org for each FSO because:
− A significant portion of its business is the performance of services for
each FSO,
Ø 20% of the gross receipts of the corporation are derived from
performing services for Tina Temple, D.D.S., and 25% of the
gross receipts of the corporation are derived from performing
services for Paula Pomona, D.D.S.
− The services are of a type historically performed by employees in the
service field of the FSO, and
− Ten percent or more of the interests in Pfeiffer Corporation are held, in
the aggregate, by persons who are highly-compensated employees of the
FSO.
Again, using the attribution rules of section 318(a) (discussed in the next
section), Tina Temple and Paula Pomona are each considered to own the
interests in Pfeiffer that is held by their respective dental practices.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-60
Controlled and Affiliated Service Groups
Multiple Affiliated Service Group, Continued
Multiple B-
Org-Example-
Facts
The following examples illustrate a multiple B-Org :
Dr. Neil Northland is incorporated as Dr. Northland, M.D., P.C. His
secretarial services are provided by Quincy Corporation. Dr. Northland,
M.D., P.C., owns 20 percent of the interests in the secretarial corporation and
provides 20 percent of its gross receipts.
Redwood Corporation provides nursing services to Dr. Northland, M.D., P.C.
Neil Northland, M.D., P.C., owns 25 percent of the interests in the nursing
corporation and provides 25 percent of its gross receipts.
Example-
Analysis-Dr.
Northland is an
FSO and
Quincy is a B
org.
Dr. Northland, M.D., P.C. is an FSO. The secretarial corporation, Quincy
Corporation, is a B-Org because:
− 20 percent of the gross receipts of the secretarial corporation, Quincy
Corporation, are derived from performing services for Neil Northland,
M.D., P.C., of a type historically performed by employees of doctors, and
− 20 percent of the secretarial corporation is owned by the owner of Neil
Northland, M.D., P.C.
Accordingly, Neil Northland, M.D., P.C., and the secretarial corporation,
Quincy Corporation, constitute an affiliated service group.
Redwood corp.
is a B org.
Considering Neil Northland, M.D., P.C., as a FSO, the nursing corporation,
Redwood Corporation, is a B-Org because:
• 25 percent of the gross receipts of the nursing corporation, Redwood
Corporation, are derived from performing services for Neil Northland,
M.D., P.C., of a type historically performed by employees of doctors,
and
• 25 percent of the nursing corporation is owned by the owner of Neil
Northland, M.D., P.C.
Accordingly, Neil Northland, M.D., P.C. and the nursing corporation
constitute an affiliated service group.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-61
Controlled and Affiliated Service Groups
Multiple Affiliated Service Group, Continued
Redwood corp.
is a B org.
(continued)
REMEMBER: If an organization is an FSO with respect to two or more A-
Org’s or two or more B-Org’s, or both, all of the organizations shall be
considered to constitute a single affiliated service group.
For purposes of section 414(m), there will be considered to be one affiliated
service group consisting of Neil Northland, M.D., P.C., the secretarial
corporation, Quincy Corporation, and the nursing corporation, Redwood
Corporation.
Chapter 7- Controlled and affiliated service groups
Page 7-62
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups
Introduction
You have been introduced to situations in which an individual is treated as
owning an interest in a business, even though the individual does not actually
own such interest. This concept, known as “attribution”, may result from
family or business relationships. In this section, we will discuss attribution as
it relates to affiliated service groups.
Section 318
Section 318 contains the rules of attribution to determine “control” for
affiliated service groups (section 414(m)).
Note 1
Affiliated service group proposed regulations were issued in 1983 and, Prop.
Treas. Reg. § 1.414(m)-2(d)(1) referred to section 267(c) attribution rules.
Section 414(m)(6)(B) was amended in 1984 and refers to section 318
attribution rules. At this time, the proposed regulations have not been
updated or finalized.
Note 2
Attribution rules for management-type affiliated service groups are
determined under IRC §§ 267 and 1563. These rules are discussed later in
this chapter.
General Rules –
Family
Attribution
The following table is a general description of how the family attribution
rules are applied to affiliated service groups (other than management
organizations).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-63
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Family
Attribution,
Section 318
The ownership
interests of:
Are attributed to
Spouse Spouse N/A
Parent Child Child’s age is
irrelevant
Child Parent Child’s age is
irrelevant
Grandchild Grandparent Grandparent’s interest
is not attributed to
grandchild
Siblings None N/A
Section 318-
Example-
Married
Dana and Drew are married. Dana is a 50% partner in a medical practice.
Drew is treated as owning 50% of the medical practice.
NOTE: For controlled group purposes, section 1563 provides an exception
for spouses under certain conditions. This exception does not apply to
affiliated service groups.
Example-
General Rules,
Family
Attribution
Hope is the daughter of Howard. Howard owns 75% of H Company, Inc. and
Hope owns the remaining 25%. Howard’s ownership is attributed to Hope
and Hope’s ownership is attributed to Howard.
NOTE: For controlled group purposes, IRC § 1563 provides that the child’s
age and the ownership percentages of the parent or child are considered in
determining attribution. For affiliated service groups, there are no exceptions
for attribution between parent and child.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-64
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
The following table is a general description of how the attribution rules for
organizations are applied to affiliated service groups (other than management
organizations):
The ownership interests Are attributed to:
From a corporation to its
shareholders
Corp ownership interests attributed,
proportionately *, to shareholders
(owning at least 50% of corp stock).
From a partnership to its partners Partnership ownership interest
attributed proportionately *, to all
parties
From a trust to its beneficiaries Trust’s ownership interests
attributed proportionately *, to all
beneficiaries.
To a corporation Interest owned by individual owning
at least 50% of corporation is
attributed to the corporation
To a partnership Interest owned by partner is
attributed to the partnership.
To a trust Interest owned by trust beneficiaries
is attributed to the trust.
General Rules -
Org Attribution
* The interest owned is proportionate to the individual’s share of the
organization’s value. For example, a shareholder’s interest in a corporation is
his proportionate share of the total stock value of the corporation.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-65
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Example-Org
Attribution
Alvin owns 80% and Alfred owns 20% in the Butler Corporation. Butler
Corporation owns a 40% interest in Cornell Corporation. Since Alvin owns
at least 50% of Butler, he is considered to own a proportionate share of the
Cornell stock owned by Butler. Alvin is attributed 32% (80% and 40%) of
Cornell; Alfred is not considered to own an interest in Cornell because he
does not own at least 50% of Cornell.
Example-Org
Attribution,
Partnerships
If, in the previous example, Butler and Cornell were a partnership, rather than
corporations, Alfred would be considered to own a .08% (20% and 40%)
interest in Cornell.
For partnerships and trusts, under section 318, the ownership interests are
attributed to all partners and beneficiaries. The “at least 50%” rule applies
only to corporations under section 318.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-66
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Example-Org
Attribution for
an FSO
Trimble Corporation is a service organization. The sole function of Worth
Corporation is to provide services to Trimble Corporation of a type
historically performed by employees in the service field of Trimble
Corporation. Wallace Wheeler owns all of the stock of Worth Corporation
and 2.5 % of Trimble Corporation. He is not a highly-compensated employee
of Trimble Corporation.
If Trimble is
considered to
be an FSO
Worth Corporation is not an A-Org because the corporation does not have an
interest in Trimble, and
Worth Corporation is not a B-Org because highly-compensated employees do
not own at least 10% of it.
If Worth
Corporation is
considered to
be an FSO
Trimble Corporation is an A-Org because:
• It has an ownership interest in Worth due to attribution from its sole
shareholder, and
• Trimble regularly performs services for the FSO.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-67
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Example-Org.
Attribution for
an FSO
Dr. Dawson is the sole shareholder of the Dawson Medical Corporation. She
has a 25% interest in Fairfield Diagnostic Imaging, Inc. and regularly refers
her patients for services. Dr. Dawson’s 25% interest in Fairfield Diagnostic
Imaging, Inc. is attributed to Dawson Medical Corporation.
An affiliated service group exists as follows:
• Fairfield is the FSO
• Performance of services is the principal business of the organization
Dawson Medical is the A-Org. The organization is a shareholder in the FSO
(determined by applying the attribution rules), and the organization is
regularly associated with the FSO in performing services for third parties.
Note - Dawson Medical is not a B-Org because it does not perform services
for an FSO.
Dawson
Example-Could
be an FSO
Dawson Medical could be a FSO, but Fairfield is not an A-Org.
To be an A-Org, Fairfield must be a shareholder in Dawson Medical.
Dawson Medical could be a FSO, but it is not clear as to whether Fairfield is
a B-Org.
The facts do not allow a determination as to whether a significant portion of
Fairfield’s business is the performance of services for Dawson Medical. If
there was significant performance of services of a type historically performed
by employees in the medical field of the FSO, however, Fairfield would be a
B-Org because at least 10% of the interest in Fairfield is held by highly-
compensated employees of Dawson Medical. Dr. Dawson, through
attribution, is a highly-compensated employee of Dawson Medical.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-68
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Other Rules
under
Section 318
After an individual is attributed the ownership of a family member, the
interest does not get attributed from the individual to another family member.
However:
1. The ownership interests of an individual may be attributed to more
than one family member.
2. After an individual is attributed the ownership of a corporation,
partnership or trust (whether that interest is derived from a family
member or an organization), the interest may then be taken into
account under other attribution rules.
Options to acquire stock are, generally, treated as stock ownership under
section 318. Refer to Rev. Rul. 68-601 and 89-64 for further information.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-69
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Section 318-
Example
An unrelated person owns the remaining interest in XYZ.
Analysis-Dad
Dad is considered to own a total of 90% of the profits interest in XYZ
Partnership as follows:
• He directly owns 40% of XYZ Partnership
• He is considered as owning the 30% interest owned by minor Son A.
He is also considered as owning the 20% interest of XYZ that is owned by his
adult son. (Remember that, for affiliated service group purposes, the child’s
age and percentage ownership of parent and child are not relevant.
Continued on next page
SON
A
(Age 20)
SON B
(Age 30)
X
YZ
PARTNERS
DAD
40
30
20
Chapter 7- Controlled and affiliated service groups
Page 7-70
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Analysis-Son A
Son A is considered to own a total of 70% of the profits interest in XYZ:
− He directly owns 30%, and
−
− He is considered to own the 40% profits interest owned directly by Dad.
Son A is not, however, considered to own the 20% owned directly by Son B
(and attributed to Dad).
Analysis-Son B
Son B is considered to own a total of 60% of the profits interest in XYZ:
− He directly owns 20%, and
− He is also considered to own the 40% interest of XYZ that is owned by
his father.
Examples-
Other Rules for
Spousal
Attribution
The following examples illustrate other spousal attribution rules:
Example 1-
Attribution
between
spouses
Marian and Mitchell are the parents of Norton and Oliver. Mitchell has a
45% interest in the Pitkin Corporation and his son, Norton, has a 55%
interest.
Marian is treated as owning Mitchell’s 45% interest in Pitkin.
FAMILY ATTRIBUTION IS NOT ATTRIBUTED AGAIN TO
ANOTHER FAMILY MEMBER:
The 45% interest attributed to Marian is not further attributed to Oliver.
This rule would not prevent Mitchell’s interest from being attributed to Oliver
(see below)
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-71
Controlled and Affiliated Service Groups
Attribution Rules for Affiliated Service Groups, Continued
Example 2-
family
attribution
rules may be
applied to more
than one family
member
In addition to attributing Mitchell’s 45% interest in Pitkin to his wife, Marian,
using the rule for attribution between spouses, Mitchell’s 45% interest is
attributed again to both Norton and Oliver under the family attribution rule
for parents and children.
NO ATTRIBUTION BETWEEN SIBLINGS:
The 55% interest owned by Norton is not treated as owned by Oliver.
Example 3-
attribution
rules applied
after
organizational
attribution
Assume the same facts as in previous example. In addition, the Pitkin
Corporation has a 50% interest in Rich and Riley, Inc. and Norton is married
to Shannon.
ATTRIBUTION RULES APPLIED AFTER ORGANIZATIONAL
ATTRIBUTION:
• Norton is considered to own a 50% (100% x 50%) interest in Rich and
Riley, Inc.
• Norton is treated as owning 100% of Pitkin (55% directly and 45%
attributed from his father).
• Shannon is attributed the 50% interest in Rich and Riley, Inc.
Chapter 7- Controlled and affiliated service groups
Page 7-72
Controlled and Affiliated Service Groups
Management Organizations
Introduction
Section 414(b), (c), and (m) were enacted to avoid violating the “exclusive
benefit” requirement applicable to qualified plans. Even after rules were
created to define controlled groups and affiliated service groups, the
definition of “control” was subject to circumvention.
In Silvano Achiro and Carol Achiro, and Peter Rossi and Gemma Rossi v.
Commissioner of Internal Revenue, 77 T.C. 62 (1981), the Tax Court
determined that a company performing management services should be
aggregated with the company it was performing management services for as
part of a control group relationship under section 414(b). This case was
initiated before the addition of section 414(m). The Achiro and Rossi case
represents the type of maneuver that taxpayers tried to use in order to avoid
coverage of certain employees.
In 1982, TEFRA added section 414(m)(5). This section added organizations
that perform management services as another type of affiliated service group.
Organizations
Performing
Management
Functions
A management-type affiliated service group exists when:
• An organization performs management functions, and
• The management organization's principal business is performing
management functions on a regular and continuing basis for a
recipient organization.
There does not need to be any common ownership between the management
organization and the organization for which it provides service.
Any person related to the organization performing the management function
is also to be included in the group that is to be treated as a single employer.
See section 414(m)(5).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-73
Controlled and Affiliated Service Groups
Management Organizations, Continued
Recipient
Organization
A recipient organization is:
− An organization for which management services are performed,
− Any organizations aggregated under section 414(b), 414(c), 414(m), and
414(o), and
− All related organizations (for this purpose, related organization has the
same meaning as related person within the meaning of section 144(a)(3)).
The recipient need not be a service organization.
Example-
Section 414(m)
Anson and Branch Corporations constitute a controlled group of corporations
under section 414(b).
Crockett and Duval Corporations constitute an affiliated service group under
section 414(m)(2).
Assume Crockett or Duval (or both) perform management functions and other
services for Anson or Branch (or both) and the performance of these
management functions or services satisfy the requirements of a principal
business on a regular and continuing basis.
Crockett and Duval are treated as a single management organization and
Anson and Branch are treated as a single recipient organization for purposes
of section 414(m)(5).
Anson, Branch, Crockett and Duval would constitute an affiliated service
group under section 414(m)(5).
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-74
Controlled and Affiliated Service Groups
Management Organizations, Continued
Principal
Business on
Regular and
Continuing
Basis
There are several tests used in the determination of principal business on a
regular and continuing basis:
− Two-Tax-Year Rolling Percentage
− Percentage of Gross Receipts
− Facts and Circumstances
Two-Tax Year
Rolling
Percentage
For an organization to be a management organization with respect to a
recipient for a tax year of the management organization, the performance of
management functions and other services for the recipient organization must
constitute more than 50 percent of the management organization's business
activities during the two tax year period that includes such tax year and the prior
tax year.
If the management organization was not in existence prior to the current tax
year, the "more than 50 percent test" shall apply only to the current tax year.
Once the "more than 50 percent test" is met, the management organization
will continue to be a management organization with respect to a particular
recipient organization for each subsequent tax year during which the
performance of management functions and other services for such recipient
organization constitutes more than 40 percent of the management
organization's business activities during the two tax year period that includes
such subsequent tax year and the immediately preceding tax year, unless one
of the following exceptions are met:
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-75
Controlled and Affiliated Service Groups
Management Organizations, Continued
Two-Tax Year
Rolling
Percentage
(continued)
• The performance of management functions and other services for the
recipient organization constitutes less than five percent of the
management organization's subsequent tax year. In that case, the
organization that had been a management organization with respect to
the recipient organization is no longer a management organization. Of
course, it could be a management organization with respect to some
other recipient organization.
• There is an intervening tax year for which the management
organization and the recipient organization do not satisfy the “more
than 40 percent test”.
• The management organization satisfies the “more than 50 percent
test” with respect to a different recipient organization for such
subsequent year and the immediately preceding tax year. In that case,
the second organization becomes the recipient organization and the
first organization no longer has that status.
The principal business test will be made on the basis of the gross receipts
derived from management functions, as compared with the gross receipts
derived from all business activities.
Examples-the
principal
business test
The following examples illustrate the principal business test:
Example 1
The Ramsey Management Company performed services for unrelated entities:
Ellsworth, Inc., Forrest, Inc. and Garfield, Inc. The gross receipts for 1999
and 2000 were $148,000 and $258,000, respectively. The following are
Ramsey Management Company's gross receipts with respect to each company
for which Ramsey performed management services.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-76
Controlled and Affiliated Service Groups
Management Organizations, Continued
Year 1999 2000
Gross
Receipts
Percent
of Total
Gross
Receipts
Percent of
Total
Two-Year
Average
Ellswort
h
$ 68,000 46% $160,000 62% 56.2%
Forrest 50,000 34 58,000 22 26.6
Garfield 30,000 20 40,000 16 17.2
Total $148,000 100% $258,000 100% 100 %
Analysis
In 2000, Ramsey Management Company and Ellsworth, Inc. satisfy the
"principal business on a regular and continuing basis" test because
management activities performed by Ramsey Management Company for
Ellsworth, Inc., on average, is more than 50 percent of the management
organization's business activities during this two-year tax period.
Use of Gross
Receipts to
Determine
Principal
Business
Except for the use of facts and circumstances to determine principal business,
the determination of principal business on a regular and continuing basis is
made on the basis of the percentage of gross receipts derived from
management functions and other services performed for a recipient
organization, as compared to the gross receipts derived from all business
activities. In determining the two tax year percentage, gross receipts for the
combined two tax year period are compared. Thus, it is not permissible to
average the percentages determined separately for each tax year.
Gross receipts derived from all business activities do not include gross
receipts from the sale of any asset.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-77
Controlled and Affiliated Service Groups
Management Organizations, Continued
Use of Facts
and Circum-
stances to
Determine
Principal
Business
The Commissioner has the discretion to determine that the use of gross
receipts is not an appropriate method for determining principal business.
In that event, the determination of principal business shall be made on the
basis of all relevant facts and circumstances, such as the amount of time
actually spent by individuals in performing management functions and other
services for a recipient organization.
The determination that the use of gross receipts is not an appropriate method
for determining principal business may not be made by the taxpayer.
Aggregated
Organizations
with Different
Tax Years
If the gross receipts test is being used and the aggregated organizations have
different tax years:
− Any 12 month period used at any time by any such organization may be
used for purposes of the determination of principal business
− Provided that the 12-month period selected is used consistently
Management
Functions
The term "management functions" includes two concepts:
− "Management activities", and
− "Historically performed by employees."
Both must be satisfied to be considered a management function.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-78
Controlled and Affiliated Service Groups
Management Organizations, Continued
Definition of
Management
Functions
Management functions are:
− Only those management activities and services historically performed by
employees.
− Management activities and services that include determining,
implementing, or supervising (or providing advice or assistance) in
accomplishing any of the foregoing:
1. Daily business operations (such as production, sales, marketing,
purchasing, and advertising),
2. Personnel (such as staffing, training, supervising, hiring and
firing.),
3. Employee compensation and benefits (such as salaries and wages,
paid vacations and holidays, life and health insurance, and
pensions),
4. Short-range and long-range business planning (such as product
development, budgeting, financing, expansion of operations, and
capital investment),
5. Organizational structure and ownership (such as corporate
formation, stock issues, dividends, mergers, and acquisitions), and
6. Any other management activity or service.
Management activities and services also include professional services that
relate to such services. In addition, professional services of the same type as
the professional services performed by the recipient organization for third
parties are deemed to be management activities and services, and are deemed
to be management functions regardless of whether such professional services
are historically performed by employees.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-79
Controlled and Affiliated Service Groups
Management Organizations, Continued
Historically
Performed by
Employees
Management activities and services are historically performed by employees
in a particular business field, (such as the health field):
− If it was not unusual for management activities and services of such type
to be performed by employees of organizations in that particular business
field, in the United States, on September 3, 1982. To the extent that
particular business field did not exist on September 3, 1982, whether
management activity or service will be considered historically performed
by employees in that a particular business field will be determined by
analogy to similar business fields in existence on September 3, 1982.
− In some situations, even if it is unusual for a particular management
activity or service to be performed by employees of organizations in a
particular business field, the activity or service may be considered
“historically performed”.
If a particular management activity or service was ever performed by any
employee of a particular organization in a business field, such activity or
service is considered to be a management activity or service historically
performed by employees for purposes of applying section 414(m)(5) to that
particular organization for the period beginning on the date such activity or
service was first performed and ending on the date five years after such
activity or service is no longer performed.
For purposes of this section, the term "employee" also includes a self-
employed individual as defined in section 401(c)(1).
Services performed for a person other than as an employee of such person
means services performed directly or indirectly for such person.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-80
Controlled and Affiliated Service Groups
Management Organizations, Continued
Example-
Management
Services
Performed
Justin Anderson is the sole owner and employee of the Mankato
Management Company. Dr. Jeb Blackburn is the sole owner and
sole employee of Jeb Blackburn, M.D., P.C. Justin Anderson was
formerly an employee of Dr. Jeb Blackburn, but has since
established Mankato Management Company, which handles the
daily business operations, of Jeb Blackburn, M.D., P.C. These are
the types of management services historically performed by
employees in the health field. All of Mankato Management services
are performed solely for Jeb Blackburn, M.D., P.C.
Mankato Management Company and Jeb Blackburn, M.D., P.C. constitute an
affiliated service group under section 414(m)(5).
Insubstantial
Management
Functions
A management organization shall not exist with respect to a particular recipient
organization for a tax year of the management organization during which the
performance of management functions for such recipient organization, in
relation to all services performed for such recipient organization, is not
substantial.
The performance of management functions for a recipient organization is not
substantial for a tax year only if during such tax year less than 50 percent of the
compensation provided by the management organization, with respect to
services performed for the recipient organization (including services performed
as employee of the management organization and in any other capacity), is
provided to individuals who perform a significant amount of management
functions for the recipient organization.
An individual performs a significant amount of management functions for the
recipient organization if, during the tax year, at least 15 percent of the
individual's service (including service performed as an employee and in any
other capacity) for the recipient organization (based on time) is performing
management functions for the recipient organization.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-81
Controlled and Affiliated Service Groups
Management Organizations, Continued
Example-No
Management
Organization
Exists
Stetson and Stevens is a management organization that provides services to a
number of recipient organizations, including the Fannin Corporation. The
only employee of Stetson and Stevens is Clayton Plumas. Clayton Plumas
works 40 hours a week (2080 hours a year) and spends 2 hours a week (104
hours a year) performing services for the Fannin Corporation.
Stetson and Stevens is not a management organization with respect to the
Fannin Corporation because Clayton Plumas does not perform a significant
amount of management services for the Fannin Corporation. Less than 15
percent of his time (104 / 2080 = 5 percent) is spent performing services for
the Fannin Corporation.
Chapter 7- Controlled and affiliated service groups
Page 7-82
Controlled and Affiliated Service Groups
Attribution Rules for Management Organizations
Section 267
Section 267 contains the rules of attribution to determine “control” for
management organizations section 414(m)(5)).
General Rules –
Family
Attribution
The family attribution rules are applied to management organizations as
follows:
An individual is attributed interests owned by his spouse, siblings, ancestors
and lineal descendants.
• Remember that siblings were not included in section 1563 and 318.
• Section 267(c)(3) is not applied to partnerships and trusts.
Example-
General Rules
Illustrated
Marian owns 80% and Milton owns 20% in the Double M Corporation.
Double M Corporation owns a 40% interest in Nasson Company, Inc.
• Marian and Milton are considered to own a proportionate share of the
Nasson stock owned by Double M Corporation.
• Marian is attributed 32% (80% and 40%) of Nasson, and
• Milton is attributed .08% (20% and 40%) of Nasson.
General Rules
Org Attribution
The ownership interests of a corporation, partnership, or trust are attributed,
proportionately, to all of its shareholders, partners, or beneficiaries.
• Remember that, for purposes of section 1563 (controlled group
attribution) and 318 (affiliated service group attribution, other than
management organizations), the shareholders, partners, or beneficiaries
must have a minimum ownership percentage before the organization’s
interest is attributed to them.
Chapter 7- Controlled and affiliated service groups
Page 7-83
Controlled and Affiliated Service Groups
Exercises – Management Organizations
Exercise 1
Barry Baylor is the sole owner and employee of the Baylor Medical Services,
Co., Inc. Dr. Reed Rockford is the sole owner and sole employee of Reed
Rockford, M.D., P.C. Barry Baylor was formerly an employee of Dr. Reed
Rockford, but has since established Baylor Medical Services, Co., Inc., which
handles the daily business operations of Reed Rockford, M.D., P.C. These are
the types of management services historically performed by employees in the
health field. All of Baylor Medical Services, Co., Inc. services are performed
solely for Reed Rockford, M.D., P.C.
In order to constitute an affiliated service group under IRC § 414(m)(5),
which of the following must exist?
a. Common ownership must exist between Baylor Medical Services,
Co., Inc. and Reed Rockford, M.D., P.C.
b. Baylor Medical Services, Co., Inc., the management organization,
must perform management functions to more than one recipient
organization in order to satisfy the “principal business” test.
c. The principal business of Baylor Medical Services, Co., Inc., the
management organization, must be the performance of management
functions on a regular and continuing basis for Reed Rockford, M.D.,
P.C., the recipient organization.
d. Since Barry Baylor was formerly an employee of Reed Rockford,
M.D., P.C. and is performing essentially the same functions, as when
he was employed, Baylor Medical Services, Co., Inc. is not considered
a management organization.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-84
Controlled and Affiliated Service Groups
Exercises – Management Organizations, Continued
Exercise 2
Spencer and Todd were formerly employed by Sterling Industries, Inc. After
leaving Sterling, they began Spencer and Todd Consulting Partners, L.L.C.
Spencer and Todd started their business with four clients, one of which was
Sterling Industries, Inc., their former employer. Spencer and Todd, or their
business, do not, and have never had a common ownership interest with
Sterling. None of the clients are related. Spencer and Todd Consulting
Partners, L.L.C. derives about one quarter of its business from each of its
clients.
Which of the following is true?
a. Spencer and Todd Consulting Partners, L.L.C. and Sterling Industries,
Inc. constitute an affiliated service group under IRC § 414(m)(5).
b. In order for an affiliated service group to exist, there would have to be
common ownership between Spencer and Todd Consulting Partners,
L.L.C. and Sterling Industries, Inc.
c. In order for an affiliated service group to exist, the highly
compensated employees of Sterling Industries, Inc. would have to
have an ownership interest in Spencer and Todd Consulting Partners,
L.L.C.
d. An affiliated service group exists with Spencer and Todd Consulting
Partners, L.L.C. as the FSO and Sterling Industries, Inc. as the A-Org.
e. Since Spencer and Todd Consulting Partners, L.L.C. does not derive
its principal business from any one client, it is not part of an affiliated
service group with Sterling Industries, Inc. or any of the other 3
clients.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-85
Controlled and Affiliated Service Groups
Exercises – Management Organizations, Continued
Exercise 3
Meredith is 50% owner of the Meredith and Martin Law Firm. The law firm
specializes in real estate and their principal client, from whom they derive
approximately 90% of their business, is the Lincoln and Langley Real Estate
Corporation.
In addition, Meredith has a 100% ownership interest in the M Title Insurance
Company, Inc.
Which of the following is not true?
a. A management-type affiliated service group cannot exist once any of
the owners have a controlling interest in another company.
b. A management-type affiliated service group exists between the
Meredith and Martin Law Firm and Lincoln and Langley Real Estate
Corporation.
c. An affiliated service group exists with M Title Insurance Company,
Inc. as the FSO and Meredith and Martin Law Firm as the A-Org.
d. Since Martin, Meredith’s partner in the law firm, is attributed with her
ownership in the M Title Insurance Company, Inc. under section 267,
he is also treated as owning a 100% interest.
e. A management-type affiliated service group consists of a management
organization that derives its principal business from the performance
of management functions, on a regular and continuing basis, for a
recipient organization.
Chapter 7- Controlled and affiliated service groups
Page 7-86
Controlled and Affiliated Service Groups
Determination letter Program: Affiliated Service Groups
Form 5300 for
Affiliated
Service Group
If an employer requests a ruling concerning the effect of section 414(m) on
the plan being submitted or because of a change in the affiliated service group
membership or if the employed is not certain if they are a member of an
affiliated service group, the employer must submit a Form 5300, with
question number 3(a), answered with a “3”.
Additional
Information
In addition to the Form 5300, the application must include the following
information: (Rev. Proc 85-43 and Rev. Proc 2004-6).
Affiliated
Service Group
Statement
1. A description of the nature of the business of the employer, specifically
whether it is a service organization or an organization whose principal
business is the performance of management functions for another
organization, including the reasons therefore;
2. The identification of other members (or possible members) of the
affiliated service group;
3. A description of the business of each member (or possible member) of the
affiliated service group, describing the type of organization (corporation,
partnership, etc.) and indicating whether the member is a service
organization or an organization whose principal business is the
performance of management functions for the other group member(s);
4. The ownership interests between the employer and the members (or
possible members) of the affiliated service group (including ownership
interests as described in section 414(m)(2)(B)(ii) or section
414(m)(6)(B));
5. A description of services performed for the employer by the members (or
possible members) of the affiliated service group, or vice versa (including
the percentage of each member’s (or possible member’s) gross receipts
and service receipts provided by such services, if available, and data as to
whether such services are a significant portion of the member’s business)
and whether, as of December 13, 1980, it was not unusual for the services
to be performed by employees of organizations in that service field in the
United States;
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-87
Controlled and Affiliated Service Groups
Determination letter Program: Affiliated Service Groups,
Continued
Affiliated
Service Group
Statement
(continued)
6. (6) A description of how the employer and the members (or possible
members) of the affiliated service group associate in performing services
for other parties;
7. In the case of a management organization under section 414(m)(5):
• A description of the management functions, if any, performed by the
employer for the member(s) (or possible member(s)) of the affiliated
service group, or received by the employer from any other members
(or possible members) of the group (including data explaining whether
the management functions are performed on a regular and continuous
basis), and
• whether or not it is unusual for such management functions to be
performed by employees of organizations in the employer’s business
field in the United States;
8. A brief description of any other plan(s) maintained by the members (or
possible members) of the affiliated service group, if such other plan(s) is
designated as a unit for qualification purposes with the plan for which a
determination letter has been requested;
9. A description of how the plan(s) satisfies the coverage requirements of
§ 410(b) if the members (or possible members) of the affiliated service
group are considered part of an affiliated service group with the employer;
10. A copy of any ruling issued by the headquarters office on whether the
employer is an affiliated service group; a copy of any prior determination
letter that considered the effect of § 414(m) on the qualified status of the
employer’s plan; and, if known, a copy of any such ruling or
determination letter issued to any other member (or possible member) of
the same affiliated service group, accompanied by a statement as to
whether the facts upon which the ruling or determination letter was based
have changed.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-88
Controlled and Affiliated Service Groups
Determination letter Program: Affiliated Service Groups,
Continued
Application
Review
Form 8388, Affiliated Service Group (Worksheet Number 10) is a worksheet
that should be used in reviewing a request concerning the effect of IRC
section 414(m) on the plan submitted or because of a change in the affiliated
service group (ASG) membership or if the plan sponsor is not certain if they
are a member of an ASG. Note: The worksheet is not designed to address
every possible issue, which may arise in reviewing a form 5300 requests for
ASG status.
Analysis of
Determination
Application for
414(m)
Qualified Plans
If the worksheet indicates deficiencies and amendments should be requested,
Form 8400, EP Deficiencies Checksheet provides sample language for
requesting plan amendments.
After reviewing the affiliated service group information and testing it against
IRC section 414(m), if it is determined that the application meets the
requirements of an affiliated service group, then the Determination Letter is
caveated with a “21” caveat (Affiliated Service Group request).
If the requirements are not met, the Determination Letter receives a “23”
caveat (Does not meet Affiliated Service Group).
Additional
Processing
Determination
Letter Request
Another impact of being an affiliated service group, is when a plan sponsor
submits an application for determination (Forms 5300, 5307, 5310 and 6406),
question 6(a) on the applications, asked if the employer is a member of a
controlled group or affiliated service group.
If the plan employer is a member of a controlled group of corporations, trades
or businesses under common control, or an affiliated service group, all
employees of the group will be treated as employed by a single employer for
purposes of certain qualification requirements.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-89
Controlled and Affiliated Service Groups
Determination letter Program: Affiliated Service Groups,
Continued
Additional
Processing
Determination
Letter Request
(continued)
If question 6 is answered “Yes”, the EP Specialist should secure and review
the following information (if not present with the application):
• All members of the group;
• Their relationship to the plan employer;
• The type(s) of plan(s) each member has, and
• Plans common to all members.
Once the above information is secured, it should be tested, using affiliated
service group rules under section 414(m).
Chapter 7- Controlled and affiliated service groups
Page 7-90
Controlled and Affiliated Service Groups
The Impact of Section 414(m) on Qualified Plans
The Effect of
Section 414(m)
and Section
414(b) and (c)
on Qualified
Plans
The impact of section 414(m) on qualified plans is the same as the impact of
section 414(b) and (c).
All of the employees in the affiliated service group or controlled group must
be considered, as if they were employees of one employer.
Note: See the impact of section 414(b) and (c) on qualified plans, in the
control group section for guidance.
Professional Employee Organizations (PEOs)
Introduction
A PEO is a complex employer/employee relationship, which the PEO
provides workers to its clients. There is no one universally agreed definition
of a PEO. Revenue Procedure 2002-21 only describes a typical PEO as an
entity that makes an agreement with another employer (called a client
organization or a “CO”) whereby Worksite Employees (individuals who
perform work at, and under the direction of, a (CO) are placed on the payroll
of the PEO, claimed as PEO employees, and claimed to be eligible to
participate in PEO sponsored employee benefit plans.
Note: PEOs are also known as “Employee Leasing Organizations”
History
PEOs evolved from early forms of temporary staffing agencies. These
businesses provide employees to employers on a temporary basis.
Over the years the size of this workforce increased and being a contingent
workforce, they were subject to lower wages and the first to be layed off
during slow periods.
The size of this workforce caused problems for employers in the employee
benefits area, because of the non-discrimination rules developed under the
Internal Revenue Code. Also there were problems with violations of the
exclusive benefit rules under section 401(a)(2).
In May 2002, the IRS issued Rev. Proc. 2002-21, which addresses the steps
that may be taken to ensure the qualified status of defined contribution plans
maintained by PEOs for the benefit of Worksite employees.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-91
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
PEO
Retirement
Plans
Rev. Proc. 2002-21, section 6.01 defines a PEO retirement plan as defined
contribution plan (including a plan that includes a cash or deferred
arrangement described in section 401(k) intended to satisfy the requirements
of section 401(a) or 403(a).
Rev. Proc.
2002-21 Relief
Section 4.01 of Rev. Proc 2002-21, states that no disqualification of a PEO
retirement plan will occur. If a PEO has a PEO retirement plan in existence
on May 13, 2002, that benefits Worksite Employees, section 5 (rev. Proc.
2002-21) provides the PEO the option of either:
− Converting the PEO plan to a multiple employer plan or;
− Terminating the plan.
Determination
Letter
Applications
In order to obtain the relief provided in section 4, the plan sponsor must:
− File a Form 5300 to convert the PEO plan to a multiple employer plan or;
− File a Form 5310 to terminate the plan.
Rev. Proc. 2002-21 provides instruction on how to analyze PEO applications
and what information needs to be secured to submit under Rev. Proc. 2002-
21. See Rev. Proc. 2002-21.
Rev. Proc 2003-
86
This revenue procedure amplifies Rev. Proc. 2002-21, relating to relief
provided to certain defined contribution plans maintained by PEOs that
benefits Worksite Employees who perform services for a client organization.
These plans are referred to below as PEO Retirement Plans. The questions
and answers contained in this revenue procedure provide guidance on certain
transitional issues that were raised by practitioners after the publication of
Rev. Proc. 2002-21.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-92
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Rev Proc 2003-
86
Q & A,
The following questions and answers provide guidance on common inquiries
that the Service has received relating to certain transitional issues for a PEO
Retirement Plan and a Multiple Employer Retirement Plan.
Q-1, successor
plans
Q-1: Successor Plans. Can a Spin-off Retirement Plan make distributions
upon termination of the plan in accordance with section 5.04(2) of Rev. Proc.
2002-21 to Worksite Employees who perform services for a CO, if (following
termination of the PEO Retirement Plan or conversion of the PEO Retirement
Plan to a Multiple Employer Retirement Plan) the CO maintains a defined
contribution plan for its employees (whether or not the plan covers Worksite
Employees) or if the PEO maintains another plan that covers the PEO's own
employees?
A-1: (a) Section 1.401(k)-1(d)(3) of the Income Tax Regulations provides
that a distribution may not be made upon termination of a § 401(k) plan if the
employer establishes or maintains a successor plan. A successor plan is
defined as any other defined contribution plan maintained by the same
employer if the plan exists at any time during the period beginning on the date
of plan termination and ending 12 months after distribution of all assets from
the terminated plan. The plan is not a successor plan if at all times during the
24-month period beginning 12 months before the termination, fewer than two
percent of the employees who were eligible under the terminated plan as of
the date of plan termination are eligible under the plan.
(b) Neither a defined contribution plan maintained by the CO for its
employees (whether or not the plan covers Worksite Employees) nor a plan
maintained by the PEO covering the PEO's own employees will be treated as
a successor plan to the Spinoff Retirement Plan for purposes of § 1.401(k)-
1(d)(3). Accordingly, the Spinoff Retirement Plan is permitted to make a
distribution to Worksite Employees regardless of whether the CO or the PEO
maintains a plan described in the preceding sentence.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-93
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-2-top heavy
rules
Q-2: Top-heavy rules. After a PEO Retirement Plan converts to a Multiple
Employer Retirement Plan, how do the top-heavy rules apply with respect to
participants' benefits that accrued in the PEO Retirement Plan by the
Compliance Date?
A-2: (a) Q&A G-2 of § 1.416-1 provides that a multiple employer plan is
subject to the requirements of § 416, but only with respect to each individual
employer. Q&A T-2 of § 1.416-1 provides that, for top-heavy purposes, a
multiple employer plan to which an employer makes contributions on behalf
of its employees is treated as a plan of that employer to the extent that
benefits under the plan are provided to its employees because of service with
the employer.
(b) Section 7.01(3) of Rev. Proc. 2002-21 provides that, for purposes of
determining whether a Multiple Employer Retirement Plan is top-heavy (as
defined in § 416(g)(1)(A)(ii)) in its first plan year, the determination date with
respect to the first plan year will be the last day of such plan year.
(c) In general, a CO that is a sponsor of a Multiple Employer Retirement Plan
may treat the benefits of Worksite Employees who perform services for the
CO that accrued in the PEO Retirement Plan on or before the Compliance
Date as attributable to contributions made by the CO when determining
whether the plan is top heavy for plan years beginning after the Compliance
Date. If a CO chooses this option, in subsequent years the CO must continue
to treat the benefits of Worksite Employees who provide services to the CO
that accrued in the PEO Retirement Plan on or before the Compliance Date as
attributable to contributions made by the CO when determining whether the
plan is top-heavy.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-94
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-2-top heavy
rules
(continued)
(d) However, it is also permissible for a CO that is a sponsor of the Multiple
Employer Retirement Plan to treat the benefits of Worksite Employees who
perform services for the CO that accrued in the PEO Retirement Plan prior to
the plan conversion as attributable to contributions made by the PEO and not
the CO. Thus, when testing the Multiple Employer Retirement Plan for top-
heaviness, a CO may treat the benefits of Worksite Employees who perform
services for the CO that accrued in the PEO Retirement Plan on or before the
Compliance Date prior to the plan conversion as being zero. Nevertheless, the
Multiple Employer Retirement Plan must include in these Worksite
Employees' benefits the amounts that accrued in the PEO Retirement Plan
prior to the plan conversion and compute the gains and losses attributable to
these benefits in subsequent plan years.
(e) For purposes of this Q&A-2, the following applies:
(1) The consistency rule of section 4.06 of this revenue procedure is
deemed satisfied if each CO is consistent in treating the accrued
benefits of all Worksite Employees who perform services for that
CO in accordance with either (c) or (d) of this question and
answer.
(2) In determining whether a plan is top-heavy, the aggregation rules
under § 414(b), (c), and (m) apply with respect to a CO. See Q&A
T-1 of § 1.416-1.
(3) Regardless of whether the plan uses the option set forth in (c) or
(d) of this Q&A-2, the determination date with respect to the first
plan year of the Multiple Employer Retirement Plan will be the
last day of such plan year.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-95
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-3-ADP and
ACP testing
Q-3: ADP and ACP Testing. How do the actual deferral percentage (ADP)
and actual contribution percentage (ACP) tests under § 401(k)(3) and (m)(2)
apply to a Multiple Employer Retirement Plan in its first plan year?
A-3:
(a). General rule. A Multiple Employer Retirement Plan must be treated as a
new plan for purposes of ADP and ACP testing rules rather than as a
successor plan to the PEO Retirement Plan. Thus, for the first plan year
beginning after the Compliance Date, a Multiple Employer Retirement
Plan can elect to use the prior year testing method for the ADP and/or
ACP test without regard to the ADP and ACP testing methods used by the
PEO Retirement Plan.
(b). ADP testing. A Multiple Employer Retirement Plan that uses the prior
year testing method for the ADP test is permitted to provide that the ADP
for the nonhighly compensated employees for the first plan year
beginning after the Compliance Date is 3% or is determined based on the
actual deferral percentages of the nonhighly compensated employees for
that year.
(c). ACP testing. A Multiple Employer Retirement Plan that uses the prior
year testing method for the ACP test is permitted to provide that the ACP
for the nonhighly compensated employees for the first plan year
beginning after the Compliance Date is 3% or is determined based on the
actual contribution percentages of the nonhighly compensated employees
for that year.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-96
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-4, minimum
distribution
requirements
Q-4: Minimum Distribution Requirements. For purposes of applying the
required minimum distribution rules under § 401(a)(9) with respect to
Worksite Employees who have attained age 70 1/2 but have not yet retired,
who will be treated as a 5-percent owner of a CO in the first plan year of the
Multiple Employer Retirement Plan, what is the first calendar year for which
a minimum distribution is required, and how is the required distribution
calculated for that calendar year?
A-4:
(a). General Rule. Section 401(a)(9)(A) provides that a trust will not be a
qualified trust unless the plan provides that the entire interest of each
employee will be distributed to the employee not later than the required
beginning date or, in accordance with the regulations, will be distributed
beginning not later than the required beginning date over the life of the
employee or the lives of the employee and a designated beneficiary. The
required beginning date is defined in § 401(a)(9)(C) as April 1 of the
calendar year following the later of the calendar year in which the
employee attains age 70 1/2 or the calendar year in which the employee
retires. However, § 401(a)(9)(C)(ii) provides that, in the case of an
employee who is a 5-percent owner (as defined in § 416(i)(1)(B)(i)), the
required beginning date is April 1 of the calendar year following the
calendar year in which the employee attains age 70 1/2.
(b). Options for Determining 5--Percent Ownership Status. Beginning in
2004, a Multiple Employer Retirement Plan may use either of the
following two options in determining whether Worksite Employees who
have attained age 70 1/2(but have not yet retired) before the first day of
the first plan year of the Multiple Employer Retirement Plan are 5--
percent owners of a CO for whom they perform services. Under the first
option, a Multiple Employer Retirement Plan may opt to test whether
Worksite Employees are 5--percent owners of a CO on the first day of the
first plan year of the Multiple Employer Retirement Plan. If a Worksite
Employee is a 5--percent owner on that day, the Worksite Employee will
be treated as a 5--percent owner of the CO in the plan year ending in the
calendar year in which the employee attained age 70 1/2. Under the
second option, a Multiple Employer Retirement Plan may opt to test
whether Worksite Employees
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-97
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-3-ADP and
ACP testing A-
4(c)-minimum
distribution
requirements
(c). Minimum Distribution Requirements for Worksite Employees who are 5-
Percent Owners. Under either option, a Multiple Employer Retirement
Plan will not be required to make minimum distributions under §
401(a)(9) for calendar years before 2004 to Worksite Employees who
have attained age 70 1/2 before the first day of the first plan year of the
Multiple Employer Retirement Plan and who have not retired (and the
employees will not be subject to the excise tax under § 4974 for failure to
receive required minimum distributions for those years) even if they are
5-percent owners of a CO for whom they perform services. However, a
minimum distribution is required for 2004 and subsequent years for each
Worksite Employee who is a 5-percent owner of a CO (determined under
paragraph (b) of this Q&A-4) and who attained age 70 1/2 before January
1, 2004, as well as each Worksite Employee who is a 5-percent owner of
a CO and who attains age 70 1/2 in 2004. The required beginning date for
the 2004 required minimum distribution for those Worksite Employees
(those who attained age 70 1/2 in 2004 and in any earlier year) is April 1,
2005. Thus, the required minimum distribution for 2004 for those
employees is not required to be made until April 1, 2005, but subsequent
required minimum distributions must be made by the end of the calendar
year for which they are made, including the required minimum
distribution for 2005. For calculating the minimum required distributions
for Worksite Employees for each calendar year, see Q&A-4 of §
1.401(a)(9)-5 and the Uniform Lifetime Table in Q&A-2 of § 1.401(a)(9)-
9.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-98
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Q-3-ADP and
ACP testingQ-
5-
determiniation
of HCE status
Q-5: Determination of Highly Compensated Employee (HCE Status). If
an individual was a Worksite Employee in the year preceding the first plan
year of the Multiple Employer Retirement Plan, is compensation received by
that individual during that year taken into account in determining if the
individual is a highly compensated employee, as defined in § 414(q)(1), in the
first plan year of the Multiple Employer Retirement Plan?
A-5:
(a). (a) General Rule. HCE status is generally determined on the basis of the
plan year of the plan for which a determination is being made (the
determination year) and the preceding 12-month period (the look-back
year). Section 414(q)(1) defines a highly compensated employee as any
employee who was a 5-percent owner at any time during the
determination year or the look-back year and any employee who, for the
look-back year, had compensation from the employer in excess of $
80,000 (adjusted for inflation) and, if the employer elects, was in the top-
paid group of employees for the look-back year.
(b). Worksite Employees Treated as CO Employees. For purposes of Rev.
Proc. 2002--21, the HCE status of an individual who was a Worksite
Employee in the year preceding the first plan year of the Multiple
Employer Retirement Plan (the MERP look--back year) and who
performed services for a CO in that year is determined by treating the
Worksite Employee as an employee of the CO for the MERP look--back
year. Any compensation received by the Worksite Employee from the
PEO or the CO in the MERP look--back year for services performed for
the CO must be treated as received from the CO. Accordingly, all
compensation received by a Worksite Employee from the PEO or the CO
for services performed for the CO in the MERP look--back year must be
considered in determining whether the Worksite Employee is an HCE of
the CO for the first plan year of the Multiple Employer Retirement Plan.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-99
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Rev Proc 2002-
21 Relief-
Example
The following examples illustrate relief under Rev Proc 2001-21
A PEO maintains a PEO Retirement Plan established in 1994, and the PEO
uses the calendar year for its plan year. The PEO Retirement Plan treats all
Worksite Employees performing services for COs as employees of the PEO.
There are 75 COs with Worksite Employees benefiting under the PEO
Retirement Plan.
(ii) After reviewing the options set forth in section 5, the PEO decides to
convert the PEO Retirement Plan to a Multiple Employer Retirement Plan. In
accordance with the requirements of section 5.03, on January 31, 2003, the
PEO adopts amendments to the PEO Retirement Plan converting the plan to a
Multiple Employer Retirement Plan, effective January 1, 2004. On February
14, 2003, the PEO mails notification to each CO that it has decided to convert
the PEO Retirement Plan to a Multiple Employer Retirement Plan and
explains the options available to the CO as described in section 5.03(4). In its
letter to the COs, the PEO explains that each CO has until August 15, 2003, to
notify the PEO, in writing, of its choice. The letter explains that if the CO
does not notify the PEO of its selected option on or before August 15, 2003,
the PEO will treat the CO as having selected the spin-off and termination
option. The letter further explains that if a CO elects to adopt the Multiple
Employer Retirement Plan, the Plan must be adopted on or before December
1, 2003.
(iii) By August 15, 2003, fifty of the COs with Worksite Employees
benefiting under the PEO Retirement Plan notify the PEO of their decision to
adopt and maintain the Multiple Employer Retirement Plan for the Worksite
Employees. By December 1, 2003, forty-nine of the fifty COs adopted the
Multiple Employer Retirement Plan, effective January 1, 2004. In accordance
with section 5.03(4)(a) of this revenue procedure, on December 10, 2003, the
PEO spins off the assets and liabilities attributable to the one CO that did not
timely adopt the Multiple Employer Retirement Plan to a Spin-off Retirement
Plan.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-100
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Rev Proc 2002-
21 Relief-
Example
(continued)
Example cont.
(iv) Ten COs timely elect a transfer, in which the assets and liabilities
attributable to each CO's Worksite Employees are transferred to a qualified
retirement plan established and maintained by each CO, and that satisfy the
requirements described in section 5.04(1). The ten COs timely provide all
information required to effect the transfer, including documentation of the
plans' qualified status. The transfers to each of the CO plans are completed by
December 31, 2003.
(v) Ten COs affirmatively elect the spin-off and termination option. The PEO
spins off plan assets and liabilities attributable to the Worksite Employees
performing services for those COs to the Spin-off Retirement Plan on
December 10, 2003.
(vi) The remaining five COs failed to notify the PEO of their choice by
August 15, 2003. Therefore, in accordance with requirements in section
5.03(5), each of those COs is treated as having selected the spin-off and
termination option as its choice. The PEO spins off the assets and liabilities of
these COs to the Spin-off Retirement Plan on December 10, 2003.
(vii) On December 11, 2003, the PEO terminates the Spin-off Retirement
Plan. On February 5, 2004, the PEO submits an application for a
determination letter on the termination of the Spin-off Retirement Plan. The
PEO receives a favorable determination letter on the termination of the plan.
As soon as administratively feasible following the termination, distributions
are made to the Worksite Employees performing services for the sixteen COs
(the one CO that failed to timely adopt the Multiple Employer Retirement
Plan, the ten COs that selected the spin-off and termination option, and the
five COs that failed to timely notify the PEO of their choice) with assets in
the Spin-off Retirement Plan.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-101
Controlled and Affiliated Service Groups
Professional Employee Organizations (PEOs), Continued
Rev Proc 2002-
21 Relief-
Example
(continued)
Example cont.
(viii) On February 5, 2004, the PEO submits an application for a
determination letter on the qualified status of the Multiple Employer
Retirement Plan, and subsequently receives such a determination letter from
the Service. Because the PEO took all of the steps required in section 5 of the
revenue procedure, the PEO Retirement Plan is entitled to the relief set forth
in section 4 of the revenue procedure.
PEOs not electing to take advantage of relief under this revenue procedure. If
a PEO does not, as of the Compliance Date, either terminate the PEO
Retirement Plan it maintains for Worksite Employees performing services for
COs (as provided for in section 5.02) or convert the PEO Retirement Plan to a
Multiple Employer Retirement Plan (as provided for in section 5.03), the
relief in this revenue procedure is not available for any violations of the
qualification requirements, including violations of the exclusive benefit rule,
by PEO Retirement Plan.
No Reliance on Determination Letters for PEO Retirement Plans. After the
Compliance Date, a PEO may not rely on a determination letter for a PEO
Retirement Plan that benefits Worksite Employees performing services for
COs, regardless of when the determination letter was issued.
Chapter 7- Controlled and affiliated service groups
Page 7-102
Controlled and Affiliated Service Groups
Leased Employees
Introduction
Congress enacted section 414(n) in 1982 as part of TEFRA to prevent
employers from providing pension benefits only to the highly compensated
employees, by leasing other workers. The TEFRA became effective January
1, 1984.
In 1984, the Service published Notice 84-11, 1984-2 C.B. 469. The Notice
provided question and answers relating to the employee leasing provisions of
section 414(n). Until applicable regulations are published the guidance
provided by these questions and answers may be relied upon to comply with
the provisions of section 414(n).
Definition,
Section 414(n)
A leased employees for purposes of section 414(n), is any person who
performs services for a recipient if:
1. Such services are provided pursuant to an agreement between the
recipient and any other person (“the leasing organization”),
2. Such person has performed such services on a substantially full-time
basis for a period of at least one year, and
3. Such services are performed under the primary direction or control of
the recipient.
Leased
Employee,
Determination
Letter Request
If an employer requests a ruling concerning the effect of section 414(n) on the
plan being submitted, the employer must submit a Form 5300, with question
number 3(a), answered with a “4”.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-103
Controlled and Affiliated Service Groups
Leased Employees, Continued
Required
Information for
a
Determination
Letter, Section
414(n)
Unless the plan provides that all leased employees within the meaning of
section 414(n)(2) are treated as common law employees for all purposes
under the plan, a determination letter issued with respect to the plan’s
qualification under section 401(a), 403(a), or 4975(e)(7) will be a
determination as to the effect of section 414(n) upon the plan’s qualified
status only if the application includes:
1) A description of the nature of the business of the recipient organization;
2) A copy of the relevant leasing agreement(s);
3) A description of the function of all leased employees within the trade or
business of the recipient organization (including data as to whether all
leased employees are performing services on a substantially full-time
basis);
4) A description of facts and circumstances relevant to a determination of
whether such leased employees’ services are performed under primary
direction or control by the recipient organization (including whether the
leased employees are required to comply with instructions of the
recipient about when, where, and how to perform the services, whether
the services must be performed by particular persons, whether the
leased employees are subject to the supervision of the recipient, and
whether the leased employees must perform services in the order or
sequence set by the recipient); and
5) If the recipient organization is relying on any qualified plan(s)
maintained by the employee leasing organization for purposes of
qualification of the recipient organization’s plan, a description of such
plan(s) (including a description of the contributions or benefits provided
for all leased employees which are attributable to services performed for
the recipient organization, plan eligibility, and vesting).
Determination
Letter
If the plan meets the requirements of section 414(n), the determination letter
should include caveat “22”(Meets section 414(n) status), if not, the letter
should include caveat “24” (Does not meet section 414(n).
Chapter 7- Controlled and affiliated service groups
Page 7-104
Controlled and Affiliated Service Groups
Independent Contractors
Independent
Contractor
The courts have considered many facts in deciding whether a worker is an
independent contractor or an employee. The relevant facts fall into three
categories:
− Behavioral control
− Financial control, and
− Relationship of the parties
Rev. Rul. 87-21 lays out the “20” factor test for determining independent
contractor status. Also, IRS publication 1779 is an excellent source for
information about independent contractors.
Chapter 7- Controlled and affiliated service groups
Page 7-105
Controlled and Affiliated Service Groups
Exercises – Affiliated Service Groups
Exercise 1
Margaret Jackson, an attorney, is incorporated as Margaret Jackson, P.C., and
this professional corporation is a partner in Snead Law Firm. Margaret and
her corporation are regularly associated with Snead Law Firm in performing
services for third parties.
Which of the following best describes this relationship?
a. MJ, P.C. and Snead Law constitute an affiliated service group. Snead
Law is the First Service Organization because it is a service
organization and its principal business is the performance of services.
MJ, P.C. is the A-Organization because it is a partner in the FSO and
is regularly associated with the FSO in performing services for third
parties.
b. MJ, P.C. and Snead Law constitute an affiliated service group. MJ,
P.C. is the FSO because it is a service organization and its principal
business is the performance of services. Snead Law is the A-
Organization because one of the partners is the FSO and it is regularly
associated with the FSO in performing services for third parties.
c. There is no affiliated service group relationship. A controlled group
exists between MJ, PC and the Snead Law Firm because the “regular
association” between the organizations constitutes control within the
meaning of section 414(c).
d. There is no affiliated service group because the qualifications for a
parent-subsidiary group or brother-sister group are not met.
e. There is no affiliated service group because neither organization
qualifies as a B-Organization.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-106
Controlled and Affiliated Service Groups
Exercises – Affiliated Service Groups, Continued
Exercise 2
Cole Properties, Inc. sells land that it has purchased and developed. Jack is a
25% shareholder of Cole and a 50% shareholder of Jack and Son
Construction Company, Inc.
Cole Properties regularly engages the services of Jack and Son. Does a
affiliated service group exist?
a. Yes, Cole Properties, Inc and Jack and Son Construction Co., Inc. are
members of a affiliated service group because Jack is a 25%
shareholder of Cole Properties..
b. No, although it appears that Cole Properties could be a First Service
Organization, the affiliated service group rules do not apply because
Cole is not a service organization.
Continued on next page
Chapter 7- Controlled and affiliated service groups
Page 7-107
Controlled and Affiliated Service Groups
Exercises – Affiliated Service Groups, Continued
Exercise 3
Boise Properties, Inc. sells land that it has purchased and developed.
Eddy is a 25% shareholder of Boise and a 50% shareholder of Eddy and Son
Construction Company, Inc. Boise Properties regularly engages the services
of Eddy and Son. Which of the following best describes this situation?
a. Eddy and Son Construction Company is the FSO and Boise
Properties, Inc. is the A-Org.
b. Eddy and Son Construction Company is the FSO and Boise
Properties, Inc. is the B-Org.
c. Although it appears that Boise Properties, Inc. could be a FSO, the
affiliated service group rules do not apply because Boise Properties,
Inc. is not a service organization.
d. Boise Properties, Inc. is the FSO and Eddy and Son Construction
Company, Inc. is the B-Org.
Boise Properties, Inc. is the FSO and Eddy and Son Construction Company,
Inc. is the A-Org.
Exercise 4
Dr. Douglas is the sole shareholder of the Douglas Medical Corporation. She
has a 25% interest in Hinsdale Diagnostic Imaging, Inc. and regularly refers
her patients for services. Does an affiliated service group exist? Why or why
not?
a. Yes. Hinsdale is the FSO; Douglas Medical is the A-Org
b. No. Douglas cannot be an A-Org because the ownership test is not
satisfied.
c. Yes. Douglas Medical is the FSO; Hinsdale is the A-Org.
d. No. A corporation cannot be a FSO.
No. This is a controlled group of corporations.
Chapter 7- Controlled and affiliated service groups
Page 7-108
Controlled and Affiliated Service Groups
Affiliated Service Group Summary
Summary
The purpose of section 414(m) is to eliminate the practice of excluding
non-highly-compensated employees from plan coverage through the creation
of artificial business entities.
A plan that is maintained by an employer, within a group of employers that is
part of an affiliated service group, must meet the requirements of section
401(a) as if a single employer employed all employees of all employers in the
group.
This lesson explains how to identify situations where the plan sponsor is a
member of an affiliated service group and how to recognize the impact on
qualified plans and the Determination Letter Process.
Also different forms of related employee groups were discussed, including
PEOs, Leased employees and Independent Contractors.
