Stock Ownership Attribution |
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January 6, 2005 |
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Attribution is a fancy way of saying that an individual owns something that they technically do not own. In tax law, this translates into saying that for certain purposes an individual is considered to own something that is owned by his or her spouse, child, grandchild or parent. Essentially, attribution is the basis for safeguards to prevent abuse of otherwise proper strategies to avoid or minimize taxes. In the retirement plan arena, the concept of attribution arises chiefly when determining whether there is the required amount of common ownership necessary to create a controlled or affiliated services group and to determine whether an individual has the status of a highly compensated or key employee. As with most things in tax law, determining whether ownership attribution exists can be a complicated process, with many snares for the unwary. As stated above, an individual is almost always considered as owning the same interest in stock as his or her spouse when determining whether a controlled group exists. The principal exceptions to that rule concern individuals who divorce or legally separate or where the spouse is not involved in the other spouse’s business. State domestic relations law dictates issues of divorce and separation, and this can be a particularly thorny issue in states that follow community property principles. ‘Non-involvement’ is chiefly a fact and circumstances determination, which looks for confirmation that the spouse to be excluded does not have any independent, direct ownership interest or participation in the management of the business entity. Things get really interesting, however, when dealing with ownership attribution between parent and child in determining whether a controlled group exists. The two key rules to remember here are: (1) an individual is deemed to own stock owned by his or her minor child who is under the age 21, and (2) an individual is be deemed to own stock of a child (regardless of that child’s age), parent, or grandparent if the individual owns a controlling interest (defined as a more than 50% interest) in the corporation’s voting shares or equity interest shares. Example : Adam owns 49% of Eden Garden, Inc. His son Abel (age 30) owns 35% and his son Seth (age 18) owns 16%. Adam also owns 100% of Eden Apple Pie Company. In this instance, Adam is deemed to own 65% of Eden Garden (his share plus Seth’s because Seth is a minor), but is not considered to have an ownership interest in Abel’s 35% share. Because Adam’s common ownership percentage in Eden Garden and Eden Apple Pie does not amount to at least 80%, the two companies do not constitute a controlled group. (Had Adam’s direct ownership of Eden Garden exceeded 50% a controlled group would exist as he would have also been considered the owner of Abel’s share and therefore would be deemed to own 100% of both companies; see IRC §1563(e)(6)(B).) |
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Caution: The attribution rules are very different when determining highly compensated and key employee status! Although the age of a child with an ownership position is critical in determining whether a controlled group exists, the child’s age (or the parent’s age, for that matter) is irrelevant when determining whether an individual is a highly compensated or key employee by attribution to a more than 5% owner. Using the above example, Adam’s other son Cain (age 31) is an employee of Eden Garden, but he owns no stock. Because his father owns more than 5% of the stock of Eden Garden, Cain has the status of a highly compensated employee for non-discrimination testing purposes and is also deemed a key employee for top-heavy testing. The same result would occur if Cain was the owner and Adam was the employee without an ownership interest. |
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As noted above, the attribution chain can be broken where spouses divorce or legally separate. However, “breaking up is hard to do” especially where there are minor children. Example : Later that year, Adam divorced his wife Eve because of that affair with their snake of a next-door neighbor. As part of the settlement, Eve received 100% of the stock of the Eden Apple Pie Company and quit her job as Vice President of Eden Garden. Adam subsequently adopts a 401(k) plan for the employees of Eden Garden. Will Adam have to include the employees of Eden Apple Pie when determining if his retirement plan passes coverage and nondiscrimination testing? Yes. Although Adam and Eve are divorced, both companies are required to be included in the testing because of their minor child, Seth. Under the attribution rules of IRC §318, Seth is deemed to be an owner by attribution of the ownership interests of both his parents, which results in the companies being combined for testing purposes. Thus, unless Adam’s company can pass coverage separately—he’ll either have to cover Eve’s employees or wait until Seth attains age 21 to establish a separate 401(k) plan for Eden Garden. The moral of this story is to approach ownership attribution questions carefully. If you are careless, the IRS won’t allow you a second bite at the apple. |
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