This article presents an overview of the controlled group and affiliated service group U.S. federal tax rules as they apply to qualified retirement plans – including defined benefit, cash balance, profit sharing, 401(k), SEP and SIMPLE plans – and so-called cafeteria and dependent care plans. These rules are extremely important, as they must be followed in order to maintain the tax-favored status of a plan!
Observation: This brief article provides an introduction to key concepts, but the application of the rules is extremely complex.
The rules basically state that if two or more corporations, trades or businesses are part of a controlled group of businesses, then the controlled group members are treated as a single employer when applying certain employee benefit plan requirements (enumerated below). Similarly, two or more employers who are members of an affiliated service group are also treated as a single employer for purposes of satisfying the controlled group requirements.
The applicable requirements are the following:
Observation: Plans that do not satisfy the applicable requirements, when taking into account all the members of the controlled group, may be disqualified – resulting in additional taxable income, loss of tax deductions and possible penalties.
A control group relationship exists if the businesses have one of the following relationships:
Observation: Complex rules define each alternative and include ownership attribution rules for stock options, partnerships, estates, trusts and corporations, as well as spouses, children, parents and grandparents.
In addition, the so-called affiliated service group rules are intended to preclude an entity from establishing an employee benefit plan for just one entity if there are two or more organizations that constitute an affiliated service group which, for employee benefit plan purposes, would be aggregated into a single employer. 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. Regardless of whether the above test is met, an organization that is engaged in any one or more of the following fields is generally considered a service organization:
Observations: Special rules apply to define different organizations within an affiliated service group. Separate rules also define so-called management-type affiliated service groups.
There are essentially two options for compliance with the controlled group rules: a single employer-wide plan or multiple plans, and the latter itself has two alternatives.
If the companies that comprise a controlled group do not represent diverse industries, the simplest solution may be to cover all the employees of the controlled group under an employer-wide plan.
Observation: Covering all employees under an employer-wide plan generally should make testing and administration of the plan simpler and more efficient.
If the companies that comprise a controlled group represent diverse industries and/or are geographically dispersed, then it may be necessary to maintain multiple plans with different levels of benefits in light of business requirements.
Observation: In such situations, the plans within the controlled group may be tested as a single plan, but it is unlikely that they will pass the annual nondiscrimination testing on an employer-wide basis.
Qualified Separate Lines of Business
As an alternative for such a larger and more diverse controlled group, the employer should consider electing to be treated as operating Qualified Separate Lines of Business (QSLOB) for purposes of retirement plans and dependent care plans. This election requires filing with the Internal Revenue Service. Once the QSLOBs are established, each QSLOB can conduct nondiscrimination testing without regard to employees of the other QSLOBs. The QSLOB election is valid until there is a substantial change in the demographics within the controlled group (due to hiring or firings) or there is a change in the members of the controlled group itself. At that point the QSLOB must be reviewed, re-tested and re-established so that a revised election may be filed.
Observation: This alternative approach clearly facilitates the testing of a specific plan and corrections if the plan fails one of the testing requirements.
Compliance with rules for qualified plans is difficult even for businesses that are not part of a controlled group. This becomes even more difficult with multiple U.S. affiliates and operations. Adding foreign affiliates and operations into the equation adds substantial additional complexity, which multinational businesses need to recognize and address.
The risks of noncompliance are too costly to ignore!
Peter Alwardt is a Partner in the Compensation & Benefits Practice of EisnerAmper LLP and gratefully acknowledges the assistance of his colleagues Christine Faris and Ralph Fernandez in the preparation of this article. This publication is intended to provide general information but does not constitute accounting, tax or legal advice; nor is it intended to convey a thorough treatment of the subject matter.