Knowing and understanding that businesses are classified as controlled groups or affiliated service groups for the purposes of qualified retirement plan eligibility is important for legal and ethical reasons. Once a controlled group is determined to exist, certain rules govern the implementation and maintenance of sponsored retirement plans and other benefits such as health insurance. Determining the group status of your company (or companies) can be complicated yet extremely important in meeting employer mandates and avoiding penalties, fees, and liabilities.

The following article mentions sections of the Internal Revenue Code that pertain to controlled groups and how they can affect businesses in terms of retirement planning, specifically 401(k). Remember, if your company offers retirement benefits, you have a fiduciary responsibility standard that you must meet. Understanding the following information will help you meet regulations, prevent penalties and costly fees, and avoid liabilities. What business owner has time for all of that when they are trying to run a successful business?

Controlled Groups legislation was put in place to protect worker benefits including 401(k).

Controlled Groups legislation was put in place to protect worker benefits including 401(k) retirement plans.

1. Know The History Of Controlled Groups

It helps to understand the context of controlled groups and how they came to be so that you can understand why it is even necessary to consider things such as controlled groups in the first place. The Controlled Groups Provisions were enacted in 1964 as part of the Revenue Act. This act intended to lower certain taxes for small businesses. Larger businesses, taking note of the tax benefits -mainly the avoidance of the corporate tax, began to restructure themselves into multiple corporations in order to avoid being taxed as a single, large corporation.

In addition to avoiding certain taxes (and without going too far into the detailed history of the events that lead to the enactment of The Employee Retirement Income Security Act (ERISA) of 1974) there was a more basic problem of corporations dividing themselves into smaller ones so that certain retirement plan coverage criteria could be avoided altogether. Corporations and related entities found it difficult to navigate IRS rulings and regulations that essentially made the provision of retirement plans complicated and expensive.

The result was that large businesses, for example, would split into two smaller businesses; one would maintain highly compensated employees that received pensions, and the other business would employ lower-level employees that received far less attractive retirement plans. This is known as ‘discrimination’ in regards to retirement plan benefits. As a side note, the IRS requires qualified plans to pass, among other tests, an anti-discrimination test in order to maintain qualified status.

In 1974, Congress enacted ERISA and added to it sections 414(b) and (c), in order to address some of these issues and to better protect employees, especially those deemed non-highly compensated employees. These sections defined what business arrangements qualified as being part of a controlled group and also determined that all employees of ‘commonly controlled’ businesses, entities, or corporations were to be treated as employees of only a single corporation.

Although this is a complex subject with a long history, these regulations were put in place so that employers could not establish multiple entities in order to avoid paying certain costs and benefits that are required by the IRS in order to comply with and meet qualified retirement plan criteria.

2. Know How A Controlled Group Is Defined

Let’s start with a simplified explanation of a controlled group. A controlled group exists when there is shared ownership between two or more companies. Shared ownership, therefore, makes all companies eligible for placing all of the employees of these companies under a single retirement plan. Remember that this is a simplified definition but it is useful to keep in mind when you are digging into the more complicated and detailed definitions established by the IRS.

The detailed IRS definition uses sections 414(b) to define controlled groups consisting of corporations and 414(c) to define controlled groups consisting of trades or businesses such as partnerships or proprietorships, regardless of being incorporated or not.

There are three types of controlled groups:

  • Parent-subsidiary
  • Brother-sister
  • A combination of the above groups

A parent-subsidiary group exists when the parent business owns 80% or more of the subsidiary business(es). Put another way, if 80% or more of the stock of each corporation (except the parent corporation) is owned by one or more of the corporations in the group and the parent corporation owns at least 80% of any one of those subsidiary corporations, then a parent-subsidiary group exists.

In evaluating whether or not a controlled group exists and then distinguishing between a parent-subsidiary or brother-sister controlled group, it is important to look at whether a controlling interest or effective control is present.

Controlling interest is determined by the business type involved and is present if:

  • For a corporation, ≥80% of the total combined stock or voting power is owned
  • For a trust or an estate, ≥80% of actuarial interest is owned
  • For a partnership, ≥80% of profit or capital interest is owned
  • For a proprietorship, the sole proprietorship establishes ownership.

A brother-sister group concerns five or fewer people that are individuals, estates, or trusts and directly or indirectly own a controlling interest and have effective control.

Effective control is when:

  • In a corporation, shareholders hold more than 50% of the total combined stock or 50% of the total combined voting power
  • In the case of a trust or an estate, an aggregate of 50% or more of the actuarial interest is owned
  • In a partnership, an aggregate of 50% or more of the capital or profit interest is owned
  • In a sole proprietorship, the sole proprietor has effective control.

Effective control refers to the ability to actually control the workings of a given company, trust, or estate and therefore effect change within a given entity.

A combined group exists when three or more organizations are part of either a parent-subsidiary group or a brother-sister group and one or more corporations also a common parent and part of a brother-sister group.

Once you determine which type of group exists, you will know which entities are involved, which are subject to controlled group regulations, which evaluations and tests are necessary, and which documents are to be filed with the IRS. Look at these different examples of business structures to better understand how controlled groups are established in different situations. However, once established the employers that make up a controlled group are treated as a single employer and not as multiple employers.

3. Know What Retirement Plan Requirements Are Affected By Controlled Group Rules

One of the most important reasons to know control group status is that any qualified retirement plan must meet the minimum requirements set forth by the IRS for retirement plans of a single employer. Once a controlled group exists, all employers of the group are viewed as a single employer. Therefore, any and all retirement plans must meet the following single-employer plan requirements that are affected by controlled group rules:

  • Pass nondiscrimination, coverage, and average deferral percentage testing
  • Compensation limits and minimum participation rules
  • Vesting determination
  • Maximum contribution and benefit limits
  • Required minimum contributions to pension plans and related taxes
  • Number of key employees and top-heavy status regulations
  • Required employer contributions for SEPs and SIMPLEs

4. Know What Other Mandates Are Affected By Controlled Group Status

Yet another reason to know control group status is that this status determination is used for the purposes of Medicare Secondary Payer, COBRA, and Affordable Care Act rules and regulations that some companies must also meet.

The Affordable Care Act actually provides a great example of why companies may want to split up into smaller ones. Under the Affordable Care Act, companies with 50+ full-time employees are required to offer a degree of minimum health insurance coverage or pay a tax penalty.

Of course, providing health insurance coverage comes with a cost so company owners may think that the tax penalty and costs of health insurance could be avoided by breaking the company up into to smaller ones in order to reduce the number of employees per company. However, assuming that breaking up a single company would not change the ownership, all companies would be considered a single employer, since they remain part of a controlled group with shared ownership as defined above.

In short, none of the companies would be able to avoid the employee health care mandate. The same holds true when a company is considering retirement plans. Although business owners may be tempted to split up a business in order to provide a retirement plan to some employees but not others, thereby saving money, this cannot be done if the business is part of a controlled group.

5. The Consequences Of Not Knowing Your Company’s Controlled Group Status

  • Risk the legality of the retirement plan and having the plan lose qualified status
  • Pay fees, penalties, and interests to the IRS
  • Risk being subject to lawsuits
  • Possibly pay legal fees to an ERISA lawyer
  • Spend extra time, money, and resources performing additional tests and correcting errors
  • Having to retroactively make monetary contributions for new plan members upon expanding a retirement plan that previously and incorrectly excluded some employees

The IRS and Department of Labor (DOL) have programs that aid in correcting non-compliant retirement plans, but this will also cost you additional fees.

The Following Are Additional Important Items To Know

Know How Business Ownership Is Attributed To Family Members

Establishing correct levels of ownership is essential in determining if a controlled group exists. Ownership can be affected by attribution rules, often in ways that you may not expect. Attribution rules add in yet another layer of difficulty in determining group status and may take a company from a presumably independent business and move it into controlled group status simply due to a relationship such as a marriage.

If a spouse also has a company with one employee, suddenly both the husband and wife could be considered a single employer of one employee. Unless any exceptions apply, attribution rules may completely change the rules that a business owner must follow. This is why it is crucial to understand how these rules and exceptions operate.

The following table is taken directly from IRS attribution rules that are applied to controlled groups.


The Ownership Interests Of:Are Attributed To:Notes
SpouseSpouseEXCEPTION: No attribution between spouses if there is no:

• direct ownership,

• participation in company, and

• no more than 50% of business gross income is passive investments.

Minor (under 21 years)Parent
ParentMinor child (under age 21)
ParentAdult child (age 21 or older)ONLY IF: Adult child owns greater than 50% of that business.
Adult ChildParentONLY IF: Parent owns greater than 50% of that business.
GrandparentMinor or Adult childONLY IF: Minor/Adult child owns greater than 50% of that business.
Minor or Adult childGrandparentONLY IF: Grandparent owns greater than 50% of that business.

Do all employers of a controlled group have to provide the same retirement plan to all employees of the group?

No, multiple plans can be offered. Likewise, a single plan can be used for all employees but what is important to know is that once it is established that a controlled group exists, all employees of all the entities of the group must be considered when testing the legality of the sponsored retirement plan(s).

How often should controlled group tests be performed?

Perform tests each year. You should also reevaluate to determine if a controlled group exists or if any new entities have become part of, or exited, a controlled group.

How often should compliance of sponsored retirement plans be evaluated?

Compliance should be tested once a year. Perform coverage, nondiscrimination, and average deferred percentage testing every year. Understand though, that incorrect determination of a controlled group will lead to incorrect calculations of these tests, which may falsely yield passing results. Thus, making controlled group status determination is extremely important.

Summary of Controlled Groups and 401(k) Retirement Plans

  • Under controlled group rules, all employers determined to be part of the group are considered to be a single employer for the purposes of qualified plan requirements
  • All employees of this single employer must be considered for eligibility of participating in a sponsored retirement plan
  • Sponsored retirement plans must meet the requirements and legal standards established by the IRS for qualified retirement plans, such as a 401(k)
  • The plan sponsor has a fiduciary duty to make sure that a qualified plan remains qualified and legal
  • Failure to correctly identify one or more companies (or owners, etc.) as being part of a controlled group can lead to incorrect evaluation of sponsored plans and could be a very costly mistake

The subject of controlled groups is, without a doubt, a complex one. There are entire organizations, companies, and lawyers that specialize in the subject and other ERISA elements. If you are feeling confused or overwhelmed with trying to determine controlled group status, don’t hesitate to contact me for a consultation.


Fiduciary responsibility


Duke Law Journal

Cornell Law School

IRS Consequences of losing qualification status