Controlled Group Rules: When Two Businesses Count as One for Your 401(k)

Many business owners have more than one company. A dentist owns the practice and a separate lab. A contractor owns a construction company and a property management firm. Two partners own a restaurant together and each owns another business on the side.

For retirement plan purposes, the tax code may treat those businesses as one employer. If they form a controlled group, all of their employees generally have to be considered when the plan is tested, even if only one company sponsors the plan. Missing a controlled group is one of the more expensive mistakes a small plan can make, because it can cause testing failures going back years.

Why it matters

When businesses are part of a controlled group, they are treated as a single employer for many retirement plan rules, including:

• Coverage testing. The plan must benefit enough non-highly compensated employees across all businesses in the group, not just the company that sponsors it.
• Nondiscrimination testing. Contributions are tested using employee data from the whole group.
• Contribution limits. The annual limit on contributions to a participant applies across plans of all group members.
• Top-heavy rules. Plans of related businesses may need to be considered together.
• SIMPLE IRA eligibility. A SIMPLE IRA generally cannot be maintained if any member of the group sponsors another retirement plan.
• Startup tax credits. Prior plans and employee counts of related businesses can affect eligibility.

Consider a business owner whose 401(k) covers his consulting firm, which has three employees. He also owns a separate company with 15 employees who are not covered by any plan. If the two companies form a controlled group, the plan may fail coverage testing because most of the group's employees are excluded.

Parent-subsidiary groups

A parent-subsidiary controlled group exists when one business owns at least 80% of another. Chains of ownership count too. If Company A owns 80% of Company B, and Company B owns 80% of Company C, all three are in the same group.

Brother-sister groups

A brother-sister controlled group exists when five or fewer individuals, estates, or trusts own both:

1. At least 80% of each business, counting only owners who hold an interest in every business being tested, and
2. More than 50% of each business when you count only each owner's identical ownership, meaning the smallest percentage that owner holds in any of the businesses.

Here is a simple example. Alex owns 60% of Company X and 40% of Company Y. Jordan owns the other 40% of X and 60% of Y. Together they own 100% of each, which meets the 80% test. Alex's identical ownership is 40% (the smaller of 60% and 40%), and Jordan's is also 40%, for a total of 80%. That exceeds 50%, so X and Y are a controlled group.

Affiliated service groups

Professional practices face an additional set of rules. Affiliated service groups can form when service organizations, such as medical, dental, legal, accounting, and consulting practices, are related through ownership and regularly perform services for one another or for the same clients. These rules can link businesses that would not meet the controlled group ownership tests, and they can be complex enough to warrant professional review.

Family attribution

Ownership is not limited to what you hold in your own name. Attribution rules can treat you as owning shares held by family members and entities:

• Spouses. A spouse is generally treated as owning the other spouse's business interest. There are limited exceptions when the spouse has no direct ownership, does not work for or help manage the business, and the business does not earn most of its income from passive sources, among other conditions.
• Minor children. Ownership is generally attributed between parents and children under age 21.
• Adult children, parents, and grandparents. Attribution can also apply when an individual owns more than 50% of a business.
• Entities and options. Interests held through partnerships, corporations, estates, trusts, and stock options can be attributed to their owners.

SECURE 2.0 made two helpful changes for plan years beginning after December 31, 2023. Community property laws are disregarded for spousal attribution in many cases, and attribution through a minor child no longer, by itself, creates a controlled group between businesses owned separately by each parent.

Mergers and acquisitions

When a business buys or sells another company, controlled group status can change overnight. A transition rule generally gives plans relief from coverage testing through the end of the plan year after the year of the transaction, as long as the plan passed coverage before the change and is not significantly changed during the transition period. That window is the time to decide how to cover the new employees.

What to do

• Tell your plan administrator about every business that you, your spouse, your children, and your business partners own, including partial interests.
• Review ownership annually, usually through the census or compliance questionnaire your administrator sends.
• Ask before you act. Check with your plan administrator and tax advisor before forming a new company, buying a business, adding a partner, or transferring ownership to family.
• Consider plan design. Related businesses can share one plan or maintain separate plans, but the plans must satisfy testing on a combined basis.
• Fix problems promptly. If a controlled group was missed, the IRS correction program offers ways to correct, and earlier corrections are generally less costly.

Own more than one business? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm helps business owners review plan design and coordinate with their plan administrators and tax advisors. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

My spouse owns a separate business. Are our companies a controlled group?

Possibly. Spousal attribution often applies, but there are limited exceptions. Whether your businesses are related depends on ownership percentages and each spouse's role, so review the facts with your plan administrator or tax advisor.

Do all companies in a controlled group need to offer the same plan?

No. Related companies can sponsor different plans or share one plan. However, the plans are tested together, so employees of every company in the group must be considered.

We just bought a company. Do its employees have to join our plan immediately?

Not necessarily. A transition rule generally provides coverage testing relief through the end of the plan year after the acquisition, giving you time to decide how to cover the new employees.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.