McKay Hochman

CONTROLLED GROUP

If a husband and wife are sole proprietors with distinctly different occupations — let's say one is a dentist and the other a mystery writer — are they considered to be a controlled group under the family attribution rules? E-mail Alert 2004-8 Rev. 04/15/04

As with most case studies involving qualified retirement plans, the answer is “it depends.” If a husband and wife each worked for the same company, they would be deemed to own the stock of the other. For example, if the husband owned 9% of the company and the wife owned nothing. Through the family attribution rules found in Tax Code Section 318(a) (FAQ on family attribution), the wife would be deemed to also own 9%. Thus, the husband and wife would both be considered highly compensated employees and key employees as they would satisfy the more than 5% ownership rule of each definition because the husband's ownership of 9% is also attributed to the wife. There is an exception in the family attribution rules where the husband and wife are each sole proprietors in unrelated businesses. In such a case, the husband and wife will not attribute ownership to each other and, thus, each will only be considered to have ownership in their own entity provided the following conditions are met:
	•	Each spouse has no ownership interest in the other's business entity
	•	Neither spouse participates in the management of the other's business entity, nor is the spouse an employee of the other spouse
	•	Not more than 50% of either business entity's gross income was derived from passive income such as royalties, rents, dividends, interest and annuities
	•	There is no restriction on the right of the spouse to dispose of the stock.
However, in situations where the individuals have a child under age 21, a controlled group will be deemed to exist because the parents will each be attributed ownership through the child, even if all of the foregoing conditions are met. This will continue to be the case in those situations where the marriage is subsequently dissolved by divorce for as long as there is a minor child. Community Property States Caveat: The above spousal exception to the controlled group rules does not appear to apply in those states with community property laws. However, if the community property is relinquished or if the community property law permits the business ownership to be treated as separate property, the exception may apply. In community property states, it is suggested that an ERISA attorney familiar with that state's law be engaged. Bill Grossman and Steve Oberndorf For the reference supporting the above answer we refer to Code Section 1563(e)(5) Code Section 1563(e)(5) Spouse An individual shall be considered as owning stock in a corporation owned, directly or indirectly, by or for his spouse (other than a spouse who is legally separated from the individual under a decree of divorce whether interlocutory or final, or a decree of separate maintenance), except in the case of a corporation with respect to which each of the following conditions is satisfied for its taxable year--
	(A)	The individual does not, at any time during such taxable year, own directly any stock in such corporation;
	(B)	The individual is not a director or employee and does not participate in the management of such corporation at any time during such taxable year;
	(C)	Not more than 50 percent of such corporation's gross income for such taxable year was derived from royalties, rents, dividends, interest, and annuities; and
	(D)	Such stock in such corporation is not, at any time during such taxable year, subject to conditions which substantially restrict or limit the spouse's right to dispose of such stock and which run in favor of the individual or his children who have not attained the age of 21 years.

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