Beginning January 1, 2014, the Patient Protection and Affordable Care Act (PPACA) will require employers with at least 50 full-time equivalent employees to offer health insurance. Many hospitality employers are having difficulty determining whether they fit into this bucket (click here for a more extensive description of the PPACA). Employers conceptually understand that a full-time employee under the PPACA works at least 30 hours per week, a part-time employee works less than 30 hours per week and full-time equivalent employees are calculated by aggregating part-time employee hours in a month and dividing by 120. Another important concept is that contract personnel may be counted as employees if they exert too much control over their work. Future regulations specific to PPACA may also clarify these issues.
What many employers are struggling over, however, is the concept of controlled group status — the concept that certain commonly owned or controlled enterprises, regardless of whether they are separately incorporated or not incorporated at all, are counted as one for determining whether an employer meets the fifty full-time equivalent employee threshold. Many employers, especially hotel and restaurant franchisees, operate several small hotels or restaurants under separately incorporated companies, which may or may not be owned by the same individuals. While controlled group concepts have long applied to certain pension plan issues, the idea that separate businesses can be treated as one is foreign to many.
The following are commonly asked questions regarding controlled group status that should help you begin to understand if controlled group status impacts you.
Q1. What is a controlled group?
A. A controlled group is a group of commonly owned and controlled (either incorporated or not) trades or businesses, that under Treasury regulations are treated as one entity for certain purposes, namely relating to pensions and other employee benefits (e.g., withdrawal liability, non-discrimination testing limits on retirement benefits, etc.). A controlled group will begin to include trades or businesses with at least fifty full-time equivalent employees and will be required to offer health insurance or else face penalties effective January 1, 2014.
Q2. When are trades or businesses sufficiently commonly controlled and owned to constitute a controlled group?
A. There are three basic types of controlled groups: (1) parent-subsidiary groups; (2) brother-sister groups; and (3) combined groups. An organization may be a member of more than one controlled group and/or type of controlled group.
[Note: Affiliated service group rules provide another alternative for the aggregation of organizations for purposes of finding all employees as employed by a single employer for benefit purposes. Under the current affiliated service group rules, however, it is difficult for us to see how hospitality-related enterprises owned by the same individuals might end up subject to these rules, but every combination of businesses is different and an employer wishing to determine controlled group status should have counsel confirm that this alternative is indeed inapplicable to its situation.]
Q3. When is a parent and its subsidiary companies considered to be a controlled group?
A. A parent-subsidiary controlled group exists if one organization (a holding company, for example) owns a controlling interest in another organization which is at least 80% of the total combined voting power of all classes of stock entitled to vote, or at least 80% of the total value of shares of all classes of stock of the corporation or of the profits or capital interest or actuarial interest as applicable to the organization(s). The determination of “controlling interest” is subject to constructive ownership rules and exclusions.
Example (assumes one class of stock): On January 1, 2014, ABC Hospitality Inc. employs ten full-time equivalent employees in Illinois. It has an 80% ownership interest in the Bates Motel, Inc., which employs 30 full-time equivalent employees in Delaware. ABC Hospitality also owns 95% of the Empire Hotel, which employs 10 full-time employee equivalents in New York. ABC Hospitality, the Bates Motel and the Empire Hotel will be considered to be a controlled group and, as they jointly employ 50 or more full-time equivalent employees, will be required to offer their full-time employees health insurance.
Q4. When is a brother-sister group considered to be a controlled group?
A. A brother-sister controlled group exists with two or more organizations conducting trades or business if (1) the same five or fewer persons who are individuals, estates or trusts directly or indirectly own a controlling interest in each organization; and (2) taking into account the ownership of each such person (but only to the extent such ownership is identical with respect to each organization), such persons are in “effective control” of each organization. The test for determining “controlling interest” is the same 80% test for determining whether a parent-subsidiary controlled group exists (see Q3 above). The “effective control” requirement is met if the individuals:
(1) In the case of a corporation: own stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote, or more than 50% of the total value of shares of all classes of stock of the corporation;
(2) In the case of a trust or estate: individuals own an aggregate actuarial interest of more than 50% of the trust or estate;
(3) In the case of a partnership: individuals own an aggregate of more than 50% of the profits or capital interest of the partnership; or
(4) In the case of a sole proprietorship: one of the individuals owns the sole proprietorship.
The ownership determination is subject to constructive ownership rules and exclusions.
Example (assumes one class of stock): On January 1, 2014, ABC Hospitality Inc. employs 10 full-time equivalent employees in Illinois. John and Mary each own 50% of the stock. John and Mary each own 40% of the shares of the Bates Motel, Inc., which employs 30 full-time equivalent employees in Delaware. John owns a 50% interest and Mary owns a 45% interest in the Empire Hotel partnership that owns the Empire Hotel, which employs 10 full-time equivalent employees in New York. ABC Hospitality, the Bates Motel, and the Empire Hotel will be considered to be a controlled group based on brother-sister rules because John and Mary together own at least 80% of each of the companies and, taking into account each concurrent ownership in that entity, together they are in “effective control” of the entities. Since the group jointly employs fifty or more full-time equivalent employees, it will be required to offer their full-time employees health insurance.
Q5. When is a combined group considered to be a controlled group?
A. A “combined group” controlled group connotes any group of three or more organizations if:
(1) Each organization is a member of a parent-subsidiary or brother-sister controlled group; and
(2) At least one such organization is the common parent organization of a parent-subsidiary group and is also a member of a brother-sister group.
Example (assumes one class of stock): On January 1, 2014, ABC Restaurants, Inc. employs 10 full-time equivalent employees in Illinois. John and Mary each own 50% of the stock. John and Mark each own 40% of the shares of Mr. Cluckers, Inc., which employs 30 full-time equivalent employees in Delaware. ABC Hospitality also owns 95% of the Empire Eats, which employs 10 full-time equivalent employees in New York. ABC Restaurants, Mr. Cluckers and Empire Eats will be considered to be a controlled group (based on a combination of parent-subsidiary and brother-sister rules) and, as they jointly employ fifty or more full-time equivalent employees, will be required to offer their full-time employees health insurance.
Q6. Are there special rules when families or trusts are involved in the ownership structure?
A. Yes. There are special attribution rules applicable when certain related parties are involved. Such rules apply with parents and children, spouses, trust holdings, and, in certain cases, when interests are owned by corporations or partnerships in which an individual has an interest.
Q7. What is the basic rule regarding husbands and wives?
A. An individual is treated as owning the interests owned by his/her spouse (directly or indirectly unless the spouses are legally separated under a decree of divorce or separate maintenance).
Exception: A spouse’s interest is not attributed if all of the following four circumstances are met, that is, in the conjunctive:
(1) The attributee spouse does not, during the taxable year, own any direct interest in the attributor spouse’s business; and
(2) The attributee spouse is not a member of the Board of Directors, a fiduciary, an employee of the attributor spouse’s business and does not participate in the management of the business during the taxable year; and
(3) Not more than 50% of the attributor spouse’s business was derived from royalties, rents, dividends, interest and annuities during the year; and finally
(4) During the taxable year, the spouse’s interest is not subject to conditions which substantially limit or restrict the spouse’s right to dispose of his/her interest and which run in favor of the individual or the individual’s children who have not attained the age of 21 years.
Example 1: Fred owns 100% of a sole proprietorship, the Apple Restaurant (30 full-time equivalent employees), and his wife Wilma owns 100% of a sole proprietorship, the Bedrock Restaurant (30 full-time equivalent employees). Fred and Wilma each own 50% of a third corporation, the Cherry Valley Restaurant (30 full-time equivalent employees). Under the attribution rules, Fred’s interest in the Cherry Valley Restaurant is attributed to Wilma and vice versa. Thus, there are two controlled groups: (1) Fred’s Apple Restaurant and the jointly owned Cherry Valley Restaurant, which in total employ 50 full-time equivalent employees or more and thus must offer insurance; and (2) Wilma’s Bedrock Restaurant and the jointly owned Cherry Valley Restaurant, which in total employ 50 full-time equivalent employees or more and thus must offer insurance.
Example 2: Hank owns 100% of the Always Open Hotel and his wife Winona owns 100% of the Bread and Breakfast Hotel. Hank has no ownership in Winona’s hotel, is not a member of the Board, is not a fiduciary or employee and does not participate in management. Winona’s business is an operating company and not a passive investment company. Finally, Winona is not subject to conditions which limit her right to dispose of her interest in her hotel in a manner which runs in favor of Hank or Hank’s children under the age of 21. There is no attribution of ownership from Winona to Hank and therefore no controlled group.
Q8. What are the basic rules regarding parents and children?
A. An individual is treated as owning the interests owned by his/her children who have not attained the age of 21, and the child under 21 is treated as owning the interest owned directly or indirectly by or for his/her parents.
If the child is 21 or older, however, an individual is only treated as owning the interests owned by his/her children if the individual is in effective control of the entity (i.e., owns more than 50% of the total combined voting power or value of the interests in the entity, directly and through attribution, as explained above). In this case, the individual is also treated as owning the interests owned by his/her parents, grandparents, and grandchildren — provided that the individual is in effective control of the entity. In other words, the attribution rules for parents and children (and grandparents and grandchildren) can run both ways when the persons are 21 and older.
Example 1: Ron owns 40% of Hotel California and 80% of the No-Tell Motel. Ron’s minor daughter owns 50% of Hotel California. Ron is treated as owning his daughter’s interest and is therefore treated as owning 90% of Hotel California. Under the brother-sister controlled group rules, Hotel California and the No-Tell Motel are part of a controlled group.
Example 2: Hannah owns 40% of the Ambassador Hotel and 80% of the Motor Inn. Hannah’s adult daughter owns 51% of the Ambassador Hotel, and 81% of the Empire Hotel. Hannah is not treated as owning her daughter’s interest in the Ambassador Hotel. However, Hannah’s adult daughter is in effective control of the Ambassador Hotel and, therefore is treated as owning 91% of the Ambassador Hotel. Given that the daughter Hannah also owns 81% of the Empire Hotel, under brother-sister controlled group rules, the Ambassador Hotel and the Empire Hotel are part of a controlled group.
Q9. What are the basic rules regarding trusts?
A. An interest in an estate or trust is only treated as owned by a beneficiary if the beneficiary has an actuarial interest of 5% or more of such entity and the interest owned by the entity. The individual’s interest is proportionate to his/her actuarial interest.
Exceptions: Attribution from an estate or trust is more complicated than attribution between spouses or parents and children. However, there are three main exceptions:
(1) A beneficiary with less than a 5% actuarial interest is not treated as owning anything owned by the estate or trust;
(2) If the trust is a grantor trust, such as are certain trusts used for estate planning purposes, then the grantor is treated as owning the interests owned by the trust, not the beneficiaries; and
(3) If under an estate or trust, an interest in a business is specifically for the benefit of certain beneficiaries, the other beneficiaries, regardless of whether they own an actuarial interest of 5% or more of the estate or trust, are not treated as owning an interest in that business.
Example: John and Mary are equal beneficiaries of Trust Costello (which is not a grantor trust). Trust Costello owns a 30% interest in Hotel Abbott. John owns the remaining 70% of Hotel Abbott and also owns 81% of the Jester Hotel. John and Mary are each treated as owning a 15% interest in Hotel Abbott as a result of Trust Costello. Since John is treated as owning a total of 85% of Hotel Abbott when his trust interest is combined with his direct ownership interest, Hotel Abbott and Jester Hotel are part of a bother-sister controlled group.
Q10. Are there rules which would cause attribution to me of interests owned by a corporation or partnership in which I have an interest?
A. Yes. The general rule is that an interest owned directly or indirectly by a corporation is treated as being owned by any shareholder who owns (directly and in some circumstances by attribution) 5% or more in value of the stock of the corporation. The shareholder would be treated as owning a proportionate share of the interest owned by the corporation.
Example: Adam owns an 81% interest in Royal Hotel, Inc. and a 50% interest in Mom’s Fine Cooking, Inc. Royal Hotel, Inc. owns the other 50% interest in Mom’s Fine Cooking, Inc. Since Adam owns more than a 5% interest in Royal Hotel, Inc., Royal Hotel’s interest in Mom’s Fine Cooking is attributed to Adam in the same proportion as his ownership interest in the Royal Hotel (81% x 50% = 40.5%). After attribution, Adam owns an 81% interest in Royal Hotel, Inc. and a 90.5% interest (50% directly and 40.5% by attribution) of Mom’s Fine Cooking, Inc. Therefore, Royal Hotel, Inc. and Mom’s Fine Cooking, Inc. form a brother-sister controlled group.
Similar attribution rules apply to interests owned by partnerships.
Q11. Is this all I need to know about controlled group status to figure out if my companies are subject to this?
A. Unfortunately, no. While this is a good start to obtaining a basic understanding, these Q&A’s are simplified answers that assume various exceptions do not apply. Moreover, in many circumstances ownership interests are far more complicated and involve mixes of family and non-family, trusts, parent-subsidiary corporations and brother-sister enterprises.
Q12. How then do I find out if, because of controlled group rules, my hotel or restaurant will be required to provide health insurance?
A. The easiest way is to get a legal opinion from one of our Seyfarth benefits or tax attorneys who are familiar with these rules. It may be that with some advance planning and taking into account business successorship plans and estate tax issues, changes can be made to avoid controlled group issues, or at least limit their impact. The time to do this is now, before January, 2014 rolls around.
