Controlled Groups FAQ

It seems that businesses of all sizes are more frequently being structured using multiple companies and/or that business owners are acquiring interests in other companies. With the implementation of the Affordable Care Act, some companies actively restructured to stay below the 50-employee coverage threshold. Regardless of the reason, there are complex IRS rules that must be considered when it comes to both the retirement and health benefits being offered to employees.

During the mid-1980s, Congress created a series of complex rules that require all companies in a related group to be combined when determining whether employee benefit plans are providing adequate benefits to enough of the employee population. While this may sound onerous, with some careful planning, these rules can also be used to provide retirement benefits to multiple companies more cost effectively.

The introductory paragraphs mention related companies. What exactly does that mean?

Although there are many ways in which companies can be related to each other, in this context, we are referring to overlapping ownership between companies and situations in which two or more businesses have formal working or management relationships. There are two broad categories of related companies — controlled groups and affiliated service groups. (See Internal Revenue Code sections 414(b) and (c) for more information.)

The remainder of this FAQ will focus on controlled groups.

We have prepared a separate FAQ on affiliated service groups, available here. 

What do you mean by ownership?

Ownership in this context is more of a generic term that refers to not only shares in a corporation but also to membership in an LLC, partnership interest in a partnership or LLP, and composition of the Board of Directors in a not-for-profit organization.

Perhaps more important, there are instances in which the ownership held by one person or entity is attributed to another person or entity. One of the most common forms of attribution is among family members. While we will spare you the gory details here, we have prepared a separate FAQ on the ownership attribution rules. 

My tax advisor told me the other companies I own are disregarded entities. Doesn’t that mean I can disregard them for my benefit plans also?

Actually, no. Even though certain companies may be disregarded for other tax or financial reporting purposes, there is no such exclusion in the context of the controlled group and affiliated service group rules. In other words, just because an entity may be disregarded for some purposes does not mean it can be disregarded for all purposes.

What is a controlled group?

Controlled groups are driven completely by overlapping ownership, and there are two types — the parent/subsidiary-controlled group and the brother/sister-controlled group.

• Parent/subsidiary: Exists when one entity owns 80% or more of another entity, e.g. Company A owns at least 80% of Company B.
• Brother/sister: Exists when the ownership structure meets two thresholds. 
  • Common Ownership: The same five or fewer individuals must own 80% or more of each company under consideration; and
  • Identical Ownership: The same five or fewer individuals from the previous step have identical ownership of more than 50%.

Common and identical ownership sound kinda like the same thing. Can you explain in more detail?

Common ownership is a little easier to explain, so we’ll start there. Basically, you start by identifying those people who have ownership in both companies. The sum of their ownership percentages is common ownership.

Identical ownership is a little trickier and is probably best explained using a short example. If Jane owns 10% of one company and 5% of another company, her identical ownership is the lowest common denominator among the two - 5%.

Suit Says Fiduciaries of $700 Million 401(k) Fell Short

BY NEVIN E. ADAMS, JD

401k Match

Employers are not required by law to offer matching contributions in a 401k plan. However, many employers choose to do so as a way to encourage employee participation and help employees save for retirement.

If an employer does offer a matching contribution, the terms of the match can vary. Some employers match a percentage of the employee's contributions, while others may match a specific dollar amount. Additionally, there may be restrictions on when the matching contributions are fully vested, meaning when the employee has full ownership of the funds.

It's important to carefully review the terms of your employer's 401k plan to understand if and how they offer a match, and if there are any conditions or restrictions on the matching contributions. If your employer does offer a match, it's generally recommended to contribute at least enough to receive the full match, as it is essentially free money that can help grow your retirement savings faster.

Loan Provisions

A 401k plan is a retirement savings plan sponsored by an employer that allows employees to save a portion of their income before taxes are taken out. While contributions to a 401k plan are meant for retirement, the IRS allows certain provisions for borrowing or withdrawing funds under certain circumstances.

The loan provisions of a 401k plan allow an employee to borrow a portion of their vested account balance, up to a maximum of $50,000 or 50% of their vested account balance, whichever is less. The loan must be repaid with interest, typically within five years, although longer repayment periods may be allowed for loans used to purchase a primary residence. The interest rate for the loan is usually tied to the prime rate and may be slightly higher than the current prime rate.

It's important to note that not all 401k plans allow for loans, and even those that do may have specific rules and limitations, so it's important to check with your plan administrator for details.

In addition to loans, a 401k plan may also allow for hardship withdrawals, which are withdrawals made from the plan due to an immediate and heavy financial need, such as medical expenses, funeral costs, or the purchase of a primary residence. Hardship withdrawals may be subject to income taxes and a 10% penalty if the employee is under age 59½.

It's important to remember that while loans and hardship withdrawals may provide a source of short-term financial relief, they can have a significant impact on an employee's retirement savings, as they reduce the amount of money that can continue to grow tax-deferred in the account. Therefore, it's generally recommended that these options be used only as a last resort after all other options have been exhausted.

Can I Make Roth Contributions in a 401k Plan?

Yes, some 401k plans offer a Roth option that allows you to make after-tax contributions. These contributions are then invested and grow tax-free, and you won't have to pay taxes on the money when you withdraw it during retirement.

However, not all 401k plans offer a Roth option, so you should check with your plan administrator to see if it's available. Also, there are limits to how much you can contribute to a Roth 401k each year, just like with traditional 401k contributions. In 2023, the annual contribution limit for both traditional and Roth 401k contributions is $22,500, with an additional catch-up contribution of $7,500 for those age 50 and older.

Simple IRA vs. 401k

A Simple IRA (Savings Incentive Match Plan for Employees) is typically used by small businesses with fewer than 100 employees. It allows employees to contribute a portion of their pre-tax income to the plan, up to a certain limit, and employers are required to make either a matching contribution or a non-elective contribution. Contributions to a Simple IRA are tax-deductible, and the money grows tax-deferred until it's withdrawn in retirement. Simple IRA plans have lower contribution limits than 401k plans, which can make them a good choice for small businesses that want to offer retirement benefits without incurring high administrative costs.

A 401k is a retirement savings plan offered by larger employers. It allows employees to contribute a portion of their pre-tax income to the plan, up to a certain limit, and employers may also make contributions to the plan. The money in a 401k grows tax-deferred until it's withdrawn in retirement, and contributions to a 401k are tax-deductible. 401k plans typically have higher contribution limits than Simple IRA plans, and some employers may also offer matching contributions, profit-sharing contributions, or other incentives to encourage employees to save for retirement.

In summary, while both a Simple IRA and a 401k are retirement savings plans, the Simple IRA is typically used by small businesses with lower contribution limits and required employer contributions, while the 401k is more commonly offered by larger employers with higher contribution limits and optional employer contributions.

Cash Balance Pension Plan

A cash balance pension plan is a type of defined benefit retirement plan that combines features of both traditional pensions and defined contribution plans. In a cash balance plan, the employer contributes a set percentage of each employee’s compensation into an individual account, similar to a defined contribution plan.

However, the employee’s account balance is based on a predetermined formula that calculates the hypothetical balance of a traditional pension plan, with a guaranteed rate of return. This formula typically takes into account the employee’s age, years of service, and salary history.

The employee is guaranteed to receive at least the vested portion of their account balance, which accrues over time, and can receive a lump sum payout or an annuity payment upon retirement. Unlike traditional pensions, which typically provide an ongoing stream of income throughout retirement, cash balance plans typically provide a single distribution at retirement.

Cash balance plans are regulated by the Employee Retirement Income Security Act (ERISA) and are typically offered by employers as a way to provide retirement benefits to their employees while managing the risk and cost associated with traditional pension plans.

Solo 401K

A Solo 401k is a retirement savings plan designed for self-employed individuals or business owners who do not have any full-time employees, other than themselves and their spouse. Also known as a one-participant 401k, it operates similarly to a traditional 401k plan, but with some distinct differences.

With a Solo 401k, you can make contributions as both the employer and the employee, allowing you to save more money for retirement compared to other self-employed retirement accounts like a SEP IRA or a SIMPLE IRA. As the employee, you can contribute up to $19,500 in 2021 and 2022, and if you are over 50 years old, you can make an additional catch-up contribution of $6,500. As the employer, you can contribute up to 25% of your net self-employment income up to a maximum of $58,000 in 2021 and 2022.

Solo 401k plans offer several benefits, including tax-deferred growth, flexible contribution options, and the ability to borrow against your retirement savings.

New Comparability Profit Sharing Plan

New comparability profit sharing is a type of profit sharing plan that allows employers to allocate a larger percentage of the company's profits to certain employees, typically higher-paid or key employees, compared to a traditional profit sharing plan.

In a new comparability profit sharing plan, the employer groups employees into different categories based on their compensation levels, job titles, or other factors. Each group is then assigned a different percentage of the company's profits to be allocated as contributions to their retirement accounts.

For example, the employer may assign 10% of profits to a group of executives earning $200,000 or more per year, while assigning only 5% to a group of administrative staff earning less than $50,000 per year.

This type of plan can be attractive to employers who want to reward and retain their top-performing employees, while still offering some level of retirement benefits to all employees. However, it can also be complex to set up and administer, and may require the services of a financial professional or retirement plan expert.

Profit Sharing Plan

A profit sharing plan is a type of retirement plan in which an employer contributes a portion of its profits to a pool of funds that is distributed among eligible employees. This type of plan is designed to incentivize employees to work towards the success of the company, as they stand to benefit from the company's profits.

In a typical profit sharing plan, the employer determines how much of the company's profits will be contributed to the plan, and then allocates that amount among eligible employees based on a predetermined formula. The formula may take into account factors such as an employee's salary or length of service with the company.

The funds contributed to the plan are typically invested, and employees may be able to choose from a selection of investment options. The funds grow tax-deferred until the employee withdraws them, typically at retirement.

Profit sharing plans can be a valuable tool for employers to attract and retain talented employees, as well as to motivate them to work towards the success of the company. For employees, profit sharing plans can provide a valuable source of retirement income, as well as a sense of ownership and investment in the success of the company.