Among other things, the Patient Protection and Affordable Care Act (the “Act”), commonly referred to as Obamacare, requires “large employers” to provide qualified health coverage for all of their full-time employees, or pay an annual penalty. A large employer is generally an employer with 50 or more full-time employees.
In order to prevent employers from dividing businesses into several smaller businesses to avoid the “50 full-time employees” rule, the Act also contains rules that require businesses with common ownership to be treated as a single employer.
These rules refer to two Code sections – Code §1563 which deals with groups of corporations that qualify to file consolidated tax returns, and Code §414 which deals with commonly controlled businesses under ERISA. These rules are quite complicated though also somewhat mechanical. For groups of family-owned businesses with 50 or more employees in total, the ownership structure must be evaluated against the tests detailed in the statute and regulations to determine if the businesses are aggregated. Below is a brief summary of the rules and a discussion of potential planning opportunities.
Under the statutory tests, a controlled group can be either (1) a parent-subsidiary controlled group, (2) a brother-sister controlled group, or (3) a combination of parent-subsidiary and brother-sister controlled groups. There are also rules for attribution of ownership between related individuals, trusts and non-corporate entities.
A “parent-subsidiary controlled group” exists when a common parent corporation owns 80% or more of the stock of subsidiary corporations. This does not apply to most family businesses because they typically are not owned in parent-subsidiary ownership structures.
A brother-sister controlled group is a group of two or more corporations, in which five or fewer common owners (a common owner must be an individual, a trust or an estate) own directly or indirectly a “controlling interest” of each group and have “effective control.” “Controlling interest” is defined in Regs §1.414(c)-2(b)(2) and generally means 80% or more of the stock of each corporation (but only if such common owners own stock in each corporation). “Effective control” is defined in Regs §1.414(c)-2(c)(2) and generally means more than 50% of the stock of each corporation, but only to the extent that such stock ownership is identical with respect to such corporation.
Under Code §414(m), there also can be aggregation for entities that are considered to be part of an “affiliated service group,” which applies to companies whose principal business is the performance of services.
For most closely held businesses, the key analysis will be whether the entities constitute brother-sister corporations. Also, in most cases, the first prong of the brother-sister test – the “controlling interest test” – will be satisfied because five or fewer shareholders together frequently own 80% or more of the ownership interest in each company. (On the other hand, it is worth noting that if two family members whose interests are not attributed to each other, such as father and son-in-law, each own a separate business, the businesses may fail this prong of the test.)
The second prong of the brother-sister test – the “effective control” test – looks at the common ownership in both entities and deems them to be effectively controlled by an owner group that owns more than 50%. One must first calculate the ownership interest that each owner has in both entities, and then determine if they exceed 50%.
For example, if A, B, C and D are each 25% owners of two companies, they each own 25% of both companies and together they effectively control 100%, so the companies would be brother-sister companies.
But, for example, assume that the ownership of the two companies is as follows:
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In this example, A, B, C and D together own 100% of the stock of both companies, but they do not have “effective control” because the sum of each stockholder’s common ownership in both companies does not exceed 50% (A = 20%, B = 10%, C = 5% and D = 5%, and the sum is 40%). See Larry Lawson and Jeff Nelson, Controlled and Affiliated Service Groups, IRS Tax-Exempt and Government Entities, pp. 7-7 – 7-8 (available here).
The effective control test raises some interesting possibilities, as stock ownership can be arranged to flunk the test and therefore avoid aggregation as a large employer. The following charts show ownership percentages for corporations with two and three shareholders that will not pass the effective control test.
Example for two owners (no attribution):
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In this case, A has 24% common ownership in both companies, and B has 24% common ownership in both companies. The total is 48%, which is below 50%, and the companies should not be a brother-sister controlled group.
Example for three owners (no attribution):
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In this case, A, B and C together will not have more than 48% common ownership in any two companies. The total is 48%, which is below 50%, and none of the companies should be considered a brother-sister controlled group.
While the controlled group rules will effectively cause many family-owned businesses to be aggregated for purposes of Obamacare’s large employer test, for some businesses there may be planning opportunities to avoid these rules.
In addition, for more information on the Act, see Michael Morea and Lauren Manduke’s recent article, “Preparing for the Employer Mandate,” New Jersey Law Journal, April 29, 2013.
Tags: Applicable large employer, single employer, controlled group, parent-subsidiary controlled group, brother-sister controlled group, Code §1563, Code §414, Obamacare, Patient Protection Act.