Understanding Common Control Rules and Their Impact on Employee Benefit Plans

Why are they important?

Common control rules ensure fairness in employee benefit plans. The owner is prevented from exploiting the plan by making it only cover certain employees while excluding others. All entities that are under common control are seen as one employer and this ensures equal distribution of benefits to all employees.

Basics of Control Group

Control group rules are applicable to businesses which have a common ownership or control.

3 main kinds of rules:

Controlled Group of Corporations (Section 414(b)): Employees of all corporations constituting a controlled group are considered to be employees of one employer. This is important for participation and coverage tests under various sections of the tax code.

Commonly Controlled Partnerships and Proprietorships (Section 414(c)): Similar to the rules of corporations, these rules apply to partnerships and proprietorships where there is common control.

Affiliated Service Groups (Section 414(m)): Furthermore, affiliated service groups treat their employees as if they were employed by the same entity, thereby limiting their participation in qualified plans.

Examples of Control Groups:

1. Example 1. A’s Corporation owns 80 percent of the stock of B’s Corporation. A and B are members of a parent subsidiary-controlled group of corporations. In applying the participation and coverage rules of Code section 410, A and B must be considered as a single employer.

2. Example 2. Medical Services, Inc., provides administrative and laboratory services for Dr. Jim and Dr. Robert, each of whom is an incorporated sole practitioner. Dr. Jim and Dr. Robert each own 50 percent of Ocean Services, Inc. If either Dr. Jim or Dr. Robert adopts a qualified plan, employees of Ocean Services, Inc., will have to be taken into account in determining whether plan coverage is nondiscriminatory.

3. Example 3. Macdot Incorporated, an actuarial firm, contracts with Rio, Inc., an employee-leasing firm, to lease employees. If the leased employees perform services on a substantially full-time basis for at least one year, the leased employees will have to be taken into account in determining nondiscrimination in any qualified plan of Macdot, unless Rio maintains a minimum (10 percent nonintegrated) money-purchase pension plan for the leased employees. See below for more information on leased employees.

Consequences of Control Groups

For various tax purposes all employees within the controlled group corporations will be treated as having been working under one employer. These include:

Coverage Tests: All three coverage tests under Section 410 are applied to the entire group. One of these tests must be met in order for a plan for a single member of the group to satisfy it.

Aggregation Advantage: The aggregation rules may sometimes benefit the employer. For example, although one company in a controlled group may have less than five highly paid employees participating, a plan might easily pass the average benefit test as set out for that controlled group.

Businesses can follow these rules and ensure fair distribution of employee benefits while complying with tax regulations.