Controlled groups: Why do they matter?

Is your company owned by another company, does your company own other companies, or do the owners of your company own other companies? If so, Guideline requires disclosure of related companies and owners for purposes of annual compliance testing for your 401(k) plan, which is required by the IRS.
The general rule is that if your company is related to another company by ownership, you may have a “controlled group” which must allow eligible employees from each related company to have an opportunity to participate in a 401(k) benefit.
In this article, we explain the types of “controlled group” relationships and how those relationships may affect your 401(k) plan. 

Controlled Groups: What They Are and Why it Matters

There are three principal types of controlled groups: parent/child groups, brother/sister groups, and combined groups.

Parent/Child Groups

A parent company owns 80% or more of another company. Child companies are those in which another company holds an ownership interest of 80% or more.

An owner of the parent company is considered to be an owner of the child company in the same percentage as the owner’s holdings in the parent entity. A company can be both a parent and a child company, and it’s possible to string together multiple parent and child companies. For example, if Company A owns 85% of Company B, and Company B owns 85% of Company C, then A is the parent of B and C, B is the parent of C and the child of A, and C is the child of A and B. All three companies are considered to be related entities.



Brother/Sister Groups

A Brother/Sister group exists when the same five or fewer individuals own more than an 80% interest in two or more companies (and 50% or more of the ownership interest is held in an identical manner). See the example below, in which Alan, Bob, Carrie, and Debra are unrelated persons:
Example 1: Company A and Company B are brother/sister entities. Alan, Bob, Carrie, and Debra together own 80% or more of both companies, and more than 50% of the ownership of the two companies is identical because Alan holds 25% in both companies; Bob holds 20% in both companies; Carrie holds at least 20% in both companies; and Debra holds at least 20% in both companies.
Example 2: Company C is not a related entity to Company A or Company B. While more than 50% of the holdings are identical to Companies A & B, Alan, Bob, Carrie and Debra don’t collectively own more than 80% of Company C.
Example 3: Company D is not a related entity. Though Alan, Bob, Carrie, and Debra collectively own 95% of company D and thus meet the control requirement, they don’t meet the identical ownership requirement. Alan owns at least 5% of companies A, B, and D. Bob owns at least 5% of companies A, B, and D. Carrie owns at least 20% of company A and D and at least 25% of B and D. Debra owns at least 25% of company A and D and at least 20% of B and D. Collectively, the identical ownership between A and D and B and D is only 45%, less than the 50% threshold.
A simplified diagram:


Combined Groups

A combined group exists when three or more companies are connected through a combination of Parent/Child and Brother/Sister groupings. Each organization must be either part of a brother/sister or parent/child group, and one organization is both a parent and a brother/sister group. You might think of this as an uncle/nephew relationship. In the diagram below, Companies A, B, and C are a combined group.


A Note On Partnerships

Partnerships are treated almost identically to corporations with an interest in the profits or capital of that partnership being treated as an ownership interest. For example a parent of a partnership has an 80% interest in the profits or capital of that partnership.


Why These Relationships Matter 

The IRS wants to prevent situations in which a plan sponsor avoids compliance testing and allocates employee benefits in an unequal manner by grouping otherwise eligible employees under separate entities. To address this, the IRS requires that certain related companies be subject to compliance testing as a single employer. Therefore, tests of minimum participation and coverage, contributions, and balances must be performed at a group level.
In certain circumstances, larger employers with distinct divisions operating in different industries and having more than 50 employees will be qualified separate lines of business, which can be evaluated independently, despite having overlapping ownership. For example, a conglomerate like General Electric might operate multiple distinct divisions that maintain separate retirement plans.


What Happens if My Company Is Part of a Controlled Group? 

If your company is grouped with another business (as parent/child, sister/brother, or a combined group), compliance testing will be conducted at the group level as though the companies were a single entity. Guideline, or any other organization that is performing testing for companies in the controlled group, will need employee data, including each employee's salary, age, and contribution amounts, as well as year-end contribution balance, for each company in the control group.
Whether your plan passes compliance testing will depend in part on the coverage and participation of employees in related companies. This creates challenges if one company in the group offers a more generous 401(k) plan than another, has higher participation rates, or even just has a different ratio of highly compensated and non-highly compensated employees. If any tests don’t pass, plan corrections will need to be made.


Best Practices For Setting Up 401(k) Benefits For A Controlled Group

When setting up a plan for companies in a controlled group, there are choices you can make at the outset that will make compliance testing easier and more successful.
First, each company in the controlled group should offer a 401(k) plan with comparable terms to the others—if some companies have 401(k) plans while others do not, coverage testing problems are likely, as some employees will be covered by a 401(k) while others will not be. To ensure comparable coverage across the controlled group each related company should adopt the same or identical plan(s).
Second, related companies are factored into your plan’s annual compliance testing. Therefore, Guideline requires disclosure of related companies. Your company must be able to obtain the required information and transmit it to Guideline at year end, for compliance testing purposes.
Third, we strongly encourage you to consider a Safe Harbor plan for your company and related companies. Using a Safe Harbor plan eliminates some of the most problematic compliance tests, thus increasing the likelihood of plan compliance.
Now that you know about controlled groups, you can determine if your company is part of a controlled group and report related companies to Guideline so we can help ensure your plan complies with IRS requirements. If you believe that related companies may not have been included in prior year of compliance testing, please notify Guideline immediately.
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