CHAPTER
2
Controlled Groups
Chapter 1 introduced the concept of employer types and briefly explained that the Affordable Care Act (ACA) considers related (and even unrelated) legal entities to be classified as a single-employer type business. This chapter expands the discussion of private20 employer types and shows how various single legal entities can be collected and treated as a single-employer business.
If you conduct business through multiple legal entities, this section is particularly relevant to you and is also relevant to business owners who are considering splitting one owned legal entity into several legal entities. The ACA’s provisions collect related legal entities in several ways and treat them as a single-employer business. There are two main forms of groups—controlled groups and affiliated service groups.21 In this chapter, the discussion addresses controlled groups22 and a slight variation, common control groups.23 Chapter 3 will address affiliated service groups.
The only difference between controlled groups and common control groups are the legal entities involved.24 Controlled groups arise from incorporated legal entities (corporations). Common control groups arise from all other unincorporated legal entities (everything other than a corporation). The rules are the same for both groups. Remember then, when I refer to a controlled group, I also mean a common control group. Although most of the examples in this chapter are corporations, the legal entities involved could also be other types of legal entities (partnerships, limited liability companies, etc.).
Legislators sometimes take shortcuts when drafting new laws. One common shortcut is to borrow definitions from older laws. Courts interpret the definition in the new law the way they have interpreted the definition in the old law.One reason for the shortcut is to create stability in the law. Another reason is to take advantage of the work already performed to explain the old law.
The ACA is a new law that borrows definitions, processes, and rules from an old law, the Employee Retirement Income Security Act (ERISA). The ACA specifically borrows ERISA’s single-employer definitions.25 In keeping with ERISA’s definition, a single-employer type business includes controlled groups, common control groups, and affiliated service groups. All employees of all companies within a controlled group are treated as being part of a single-employer business.26 There are three types of controlled groups: a parent-subsidiary controlled group, a brother-sister controlled group, and a combined group.27
Parent-Subsidiary Controlled Groups
If you only do business through a single legal entity, and you are the only owner of that one legal entity, and that legal entity does not own any other legal entities, then this discussion of parent-subsidiary controlled groups does not apply to your business. Skip ahead to the section entitled Brother-Sister Controlled Group.
A parent-subsidiary controlled group may exist if your present or future ownership structure meets any of the following conditions: your legal entity owns another legal entity; another legal entity owns part of your legal entity; or you are thinking about breaking up your legal entity into several smaller entities and intend to remain as the owner of all of the smaller entities. The ACA considers a parent-subsidiary controlled group to be a single-employer type.28Employers must consider all employees in all the companies within a parent-subsidiary controlled group when determining applicable large employer (ALE) status.29
There are generally four steps used to determine if a legal entity is part of a parent-subsidiary controlled group:
• Identify ownership interests of the legal entity and of businesses that the legal entity owns.
• Attribute certain ownership interests.
• Exclude certain ownership interests.
• Test for 80% ownership.
Generally, a parent-subsidiary group exists if one legal entity owns more than 80% of another legal entity within the group.
Whereas the ACA has only existed since March 2010, the regulations governing parent-subsidiary controlled groups are much older. Because business owners started trying to hide their ownership interests through various organizational tricks in the 1960s, regulations were designed to test for collusion (attributing interests of one owner to another family member or close business associate) and to exclude dummy ownership interests that disguise the ownership interests of the real owners.30
Identify Involved Ownership Interests
This step requires a survey that defines the owners (business partners) of the legal entity through which you transact business, the owners of other legal entities that own part of your legal entity, and other legal entities that your legal entity owns. People and legal entities may own those other legal entities as well. You have to identify who owns the legal entities with which you might share ownership interests in a subsidiary.
The two most common business organizations involved in parent-subsidiary controlled groups are corporations and partnerships.31 Ownership interests are different across different business organizations. Ensure that the correct ownership interest is used for each legal entity. Corporate ownership interests include (a) the combined voting power of all classes of outstanding stock and (b) the total value of all shares of all classes of outstanding stock. Generally, an individual’s total voting power is tied to the total value of the shares owned in the company. For example, Byron owns 56% of BBO Inc.’s stock. Byron probably has 56% of the voting power at BBO unless another arrangement has been made.
Situations exist where voting power and ownership interests are two different things for the same owner. You must use the higher percentage interest in such a situation for the analysis that follows. For example, Byron owns 56% of BBO Inc.’s stock. Byron has 75% of the voting power in BBO. You must use 75%, not 56% when evaluating ownership interests.
Partnership ownership interests include profit interests and capital interests. Generally, an individual’s profit interests are the same as their capital interests. For example, Daria owns 65% of Fried Apple Inc.’s profit interests and owns 65% of the capital interests in Fried Apple. However, situations exist in which profit interests and capital interests are two different things for the same owner. You must use the higher percentage interest in such a situation for the ownership tests that follow. For example, Daria owns 65% of Fried Apple Inc.’s profit interests and 22% of its capital interests. You must use 65%, not 22% when testing for ownership.
[Figure 2] Schematic showing ownership interests within three interrelated legal entities: the parent Acme Corporation and two subsidiaries, Beta and Charlie corporations.
To illustrate this step and all subsequent steps in identifying parent-subsidiary controlled groups, we will work through an example. Bill owns a company called Acme Corporation. Acme owns two other companies: Beta Corporation and Charlie Corporation. No legal entities own any part of Acme. Figure 2 shows the relationship between the involved legal entities, and the ownership interests in each separate legal entity have been documented in preparation for the second step in which the attribution of ownership interests is established.
Attribute Ownership Interests
The rules for attribution of ownership interests are very complex and will only be highlighted here. Regulators will track indirect ownership interests (ownership interests that someone owns through an intermediary) to identify who really owns a particular legal entity.32 In our example in Figure 2, we have only direct ownership interests in the related legal entities. Regulators will look past two intermediary groups to attribute ownership interests back to an owner in a parent-subsidiary controlled group. The two main intermediary groups are (a) options and (b) partnership, estate, and trusts.
Stock Options. Private and public employers sometimes give employees (or others) the opportunity to buy a specific interest in the company through stock purchase. The employer specifies the time and price at which the employee may buy the stock. People refer to this employer offer as a stock option purchase.
For example, assume ABC Company shares are trading at $20. An employee buys a stock option contract that allows the purchase of ABC shares at $20 any time before the contract expires in three months. After one month, ABC company shares are trading at $30, but the employee still has the right to buy those shares at $20. The employee will make a $10 profit on each share purchased with that option (buy at $20 and immediately sell for the current market price of $30). If someone owns stock options to acquire stock, that person is considered (according to ACA rules) as if they own the stock.33 Stock options are considered the same as owning the actual stock under this attribution rule.
Partnership, Trust, and Estate Attribution. If you are using a partnership, estate, or trust as a mask for your own ownership interests, the attribution rules will track those ownership interests back to you.34 The only exception arises if you...
