Controlled-group owner must combine additions to two retirement plans

Plain-English summary

A doctor was the sole owner and employee of two entities that formed a brother-sister controlled group. One entity maintained a retirement plan for the doctor, while the other participated in a second plan sponsored within an affiliated medical service group. The doctor argued that membership in the affiliated service group gave the second plan a separate section 415 contribution limit. The IRS concluded that the section 414(c) controlled-group rules applied independently and required both entities to be treated as one employer for section 415 purposes. The annual additions to both plans therefore had to be combined, causing the doctor to exceed the 2012 limit.

Ruling snapshot

• Question: Must annual additions to two plans be aggregated when the participating entities are under common control, even though one also belongs to an affiliated service group?
• Outcome: advice given, the additions must be aggregated under one section 415(c) limit
• Key authorities: IRC §§ 414(c), 414(m), 414(r), and 415(c); Treas. Reg. §§ 1.414(c)-2 and 1.415(a)-1(f); Prop. Treas. Reg. § 1.414(m)-1(a)

Full text (IRS public release)

                        INTERNAL REVENUE SERVICE
              NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                          December 27, 2016

Number: 201715001
Release Date: 4/14/2017
Third Party Communication: None
Date of Communication: Not Applicable

Index (UIL) No.: 414.03-00, 414.13-00, 415.02-00
CASE-MIS No.: TAM-121139-16

Director, Employee Plans Examinations

     Taxpayer's Name:                             ---------------------------------
     Taxpayer's Address:                          --------------------------------
                                                  ---------------------------------
     Taxpayer's Identification No                 ------------------
     Year(s) Involved:                            ---------------------------
     Date of Conference:                          --------------------------

LEGEND:

Taxpayer: ---------------------------------

Entity 1: ----------------------------------------------------

Entity 2: -----------------------------------------

Entity 3: -------------------------------------------------

Entity 4: ---------------------------------

Entity 5: ---------------------------------------------------------------------------------------------------------

Plan A: ------------------------------------------------------------------------

Plan B: ----------------------------------------------------------------------------------------------------------

TAM-121139-16 2

ISSUE:

Are the annual additions credited to the account of the Taxpayer in Plan A and the
annual additions credited to the account of the Taxpayer in Plan B required to be
aggregated for purposes of § 415(c)(1) of the Internal Revenue Code, due to the
application of the controlled group rules under § 414(c)?

CONCLUSION:

The annual additions credited to the accounts of the Taxpayer in Plan A and Plan B are
required to be aggregated for purposes of § 415(c)(1), due to the application of the
controlled group rules under § 414(c).

FACTS:

The Taxpayer is the sole owner and employee of Entity 1 and Entity 2. Entity 1 and
Entity 2 are in a § 414(c) brother-sister controlled group. Entity 2 is also a partner in
Entity 3, along with ---- other partners. All of the partners are professional corporations,
except for two individual doctors. Each partner holds a ------% interest in Entity 3. The
Taxpayer is also a partner as an individual in a related organization, Entity 4, with the
same ---- other partners, as individuals.

Entity 3 is a ------------- group providing medical imaging services. The Taxpayer also
services patients at a hospital and receives separate self-employment income through
Entity 1. Entity 2, Entity 3, Entity 4, and the other professional corporations that are
partners in Entity 3, constitute an affiliated service group, Entity 5, under
§ 414(m)(2)(A).

Both Entity 3 and Entity 4 have staff employees. In 2012, Entity 3 had approximately 12
employees and Entity 4 had approximately ---- employees. The other professional
corporations that are partners in Entity 3 are identical in structure to Entity 2. Each
such professional corporation is also owned 100% by a doctor who is the sole employee
of his or her professional corporation.

Entity 1 maintains Plan A, in which the Taxpayer is the sole participant. Entity 3
sponsors Plan B, a volume submitter profit-sharing plan with a cash or deferred
arrangement. Entity 2 is one of the participating employers in Plan B. The Taxpayer is
participating in Plan B as the sole employee of Entity 2.

Pursuant to § -----of Plan B, the term “Employer” means Entity 3 and any participating
employer, including Entity 2. Section ---------- of Plan B provides that unless the context
of the plan clearly indicates otherwise, the word “Employer” shall be deemed to include

TAM-121139-16 3

each participating employer as related to its adoption of the plan. Section ---------- of
Plan B provides that contributions made by participating employers may be commingled
into one trust fund, but any contributions shall be held for the exclusive benefit of the
employees of each participating employer, and the trustee must keep separate books
and records regarding each employer. Participating employers also pay their
proportional share of expenses of the trust.

The majority of partners of Entity 3 participate in Plan B through their professional
corporations. The employees of the partners of Entity 3 make pre-tax contributions to
Plan B from the pay received through their professional corporations, and the
professional corporations make matching and profit-sharing contributions on their
employees’ behalf. The staff employees of Entity 3 and Entity 4 also participate in Plan
B. Entity 3 and Entity 4 make employer contributions on behalf of their own employees.

The Taxpayer contributed $---------- to Plan A in 2012. The Taxpayer also made
elective contributions to Plan B of $---------- ($---------- in elective deferrals and $-------- in
catch-up contributions) in 2012. In addition, Entity 2 made $---------- in matching
contributions and $---------- in profit sharing contributions to Plan B on the Taxpayer’s
behalf. Thus, in 2012, the Taxpayer contributed a total of $---------- to Plan A and Plan
B. The § 415(c) limit was $50,000, excluding catch-up contributions. Entity 2 filed a
Form 1120, U.S. Corporation Income Tax Return, reporting deductions for plan
contributions and other deductions.

Entity 2 received a Schedule K-1 (Form 1065) Partner’s Share of Income, Deductions,
and Credits, etc., from Entity 3 for its distributive share of Entity 3’s income for 2012 in
the amount of $------------. Entity 2 reported this amount in income on its Form 1120.
Entity 2 deducted compensation of officers, taxes and licenses, interest, depreciation,
pension and profit-sharing plan contributions, employee benefits costs and other items.
After taking deductions, Entity 2 had a 2012 net income of zero. The Taxpayer received
a gross salary from Entity 2 of $------------.

LAW AND ANALYSIS:

Section 414(c) generally provides that all employees of trades or businesses (whether
or not incorporated) which are under common control shall be treated as employed by a
single employer for purposes of §§ 401, 408(k), 408(p), 410, 411, 415 and 416.

Section 1.414(c)-2 of the Income Tax Regulations provides that two or more trades or
businesses under common control includes a brother-sister controlled group. A brother-
sister controlled group is two or more organizations conducting trades or businesses if
(i) the same five or fewer persons own a controlling interest in each organization (at
least 80%) and (ii) taking into account these interests only to the extent they are
identical, have effective control (more than 50%).

TAM-121139-16 4

Congress enacted § 414(m) in 1980 to aggregate certain entities that did not have
sufficient common ownership to form a controlled group. Section 414(m) provides that
all members of an affiliated service group must be aggregated for purposes of the
employee benefit requirements under §§ 401(a)(3), (4), (7), (16), (17),and (26), and
§§ 408(k), 408(p), 410, 411, 415 and 416. Under § 414(m)(2), an affiliated service
group is a group consisting of a First Service Organization (FSO) whose principal
business is providing services, and at least one other related organization. A related
organization can be either an “A” organization – a service organization that is a
shareholder or partner in the FSO and regularly performs services for it or is regularly
associated with it in performing services for others, or a B organization – any other
organization a significant portion of whose business is performing services for the FSO,
the A organization, or both, if those services are of the type historically performed by
employees, and if at least 10% of its interests is held by highly compensated employees
of the FSO or an A-organization.

Proposed regulations were issued in 1983 under § 414(m)(2). Section 1.414(m)-1(a) of
the proposed regulations provides:

(a) In general. Section 414(m) provides rules that require, in some
circumstances, employees of separate organizations to be treated as if
they were employed by a single employer for purposes of certain
employee benefit requirements. For other rules requiring aggregation of
employees of different organizations, see section 414(b) (relating to
controlled group of corporations) and section 414(c) (relating to trades or
business under common control). If aggregation is required under either
of the preceding provisions and also under section 414(m), the
requirements with respect to all of the applicable provisions must be
satisfied.

Section 415(c) provides in part that contributions and other additions with respect to a
participant exceed the limitations under that section when such annual additions are
greater than the lesser of a stated dollar amount ($50,000 in 2012) or 100% of the
participant’s compensation.

Section 1.415(a)-1(f)(1) provides that all employees of controlled groups under
§§ 414(b) or (c) are treated as employed by a single employer so that a plan maintained
by any member is deemed maintained by all of the members. Section 1.415(a)-1(f)(2)
states that any plan maintained by a member of an affiliated service group is deemed
maintained by all members of that affiliated service group.

Entity 1 and Entity 2 are in a controlled group and are treated as a single employer
under § 414(c). The application of § 414(c) requires that Plan A and Plan B
contributions be combined under one § 415(c) limit. When the contributions are
combined, the Taxpayer has exceeded the limit by $---------- for 2012. The result does

TAM-121139-16 5

not change simply because Entity 2 is also in an affiliated service group under § 414(m)
as part of Entity 5. Although another provision of the Code, § 414(r), allows
disaggregation for certain purposes when an employer is operating separate lines of
business for bona fide business reasons, § 414(r) is inapplicable in this case. No other
statutory provisions would allow trades or businesses under common control under
§ 414(c) to be disaggregated.

The conclusion that both sets of rules must be met separately and in their entirety is
consistent with §1.414(m)-(1)(a) of the proposed regulations. As noted above, that
proposed regulation provides that if aggregation is required under either § 414(b) or
§ 414(c) and also under § 414(m), the requirements with respect to all of the applicable
provisions must be satisfied. Thus, the proposed regulations are consistent with, and
support the conclusion that, Entity 2, as a member of both groups, must take into
account its relationship with each group to separately satisfy all of the requirements of
§ 414(c), as well as all of the requirements of § 414(m).

In addition, legislative history supports the position that the application of the § 414(c)
provisions cannot be avoided by application of the provisions under § 414(m).
Legislative history related to amendments made by the Technical and Miscellaneous
Revenue Act of 1988 (P.L. 100-647) to § 414(m) suggests that the controlled group
rules should be considered first, stating that an affiliated service group may not be
treated as consisting of separate lines of business or operating units under § 414(r),
and that “…because generally section 414(b) and (c) applies before section 414(m), a
group that is treated as aggregated under section 414(b) and (c) is not treated as an
affiliated service group even if such group could also have been aggregated under
section 414(m).” 1

If both sets of rules must be separately met, and, further, the controlled group rules
apply before the affiliated service group rules, the applicable tax qualification
requirements must first be separately met by the controlled group (which consists of
Entity 1 and Entity 2). The result is that the contributions to Plan B, in which Entity 2 is
a participating employer, would be combined with the contributions to Plan A for
§ 415(c) purposes.

The Taxpayer argues that Entity 1 and Entity 2 are not in a controlled group for
purposes of determining the § 415(c) limits for Plan A and Plan B. According to the
Taxpayer, because Entity 2 is a part of Entity 5 (an affiliated service group under
§ 414(m)), Entity 2 is not the employer maintaining Plan B on behalf of the Taxpayer for
purposes of § 415(c), but rather, based on § 414(m)(1), Entity 5 is treated as the single
employer maintaining Plan B. The Taxpayer then argues that if Entity 5 is treated as
the single employer maintaining Plan B, Entity 1 does not have a sufficient relationship
with Entity 5 to be treated as a single employer in a controlled group with Entity 5 under

1 th
H.R. Rep. No. 795, 100 Cong., 2d Sess. (1988)

TAM-121139-16 6

§ 414(c) for § 415 purposes (and accordingly the Taxpayer may have a separate § 415
limit apply for purposes of participating in any plans sponsored by Entity 1 from the
§ 415 limit that would apply for purposes of participation in any plans sponsored by
Entity 5).

However, the Code and legislative history indicate that the aggregation of §§ 414(c) and
414(m) must be separately met in their entirety, which is also consistent with §1.414(m)-
(1)(a) of the proposed regulations. While, pursuant to § 414(m)(1), all the employers in
Entity 5 (including Entity 2) are treated as a single employer for § 415(c), in addition,
pursuant to § 414(c), Entity 1 and Entity 2 are treated as a single employer for purposes
of § 415(c). It is with respect to the controlled group under § 414(c) between Entity 1
and Entity 2 that the Taxpayer exceeded the limitations under § 415(c).2

The Taxpayer also argues that he could have had two separate § 415(c) limits if he
owned the partnership interests of Entity 3 as an individual, rather than through Entity 2.
The Taxpayer argues that the IRS is elevating form over substance to come to a
different result just because Entity 2 is the partner in Entity 3, rather than the Taxpayer.
However, Entity 2 is an entity in its own right. Entity 2 is described as a “participating
employer” along with the other professional corporations and is also defined as an
“employer” under the terms of Plan B. Entity 2 performs functions that an employer
would perform, such as making matching contributions to the § 401(k) plan and profit-
sharing contributions, taking deductions under § 404 for employer contributions, and
filing its own Form 1120. The Taxpayer chose to have Entity 2 participate as a partner
in Entity 3, not the Taxpayer, and to treat Entity 2 as the employer of the Taxpayer.

We conclude that the controlled group rules under § 414(c) require that Entity 1 and
Entity 2 be treated as a single employer for purposes of § 414(c), and that the
conclusion that Entity 1 and Entity 2 are a single employer with respect to the Taxpayer
is not affected by any application of § 414(m). As a result, the annual additions credited
to the accounts of the Taxpayer in Plan A and Plan B are required to be aggregated for
purposes of § 415(c)(1).

CAVEAT:

A copy of this technical advice memorandum is to be given to the taxpayer.
Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

2
Because this conclusion is not affected by any application of § 414(m), this technical advice
memorandum does not address any other possible implications resulting from Entity 2’s overlapping
membership in both the § 414(m) affiliated service group and the § 414(c) controlled group.