In Technical Advice Memorandum 20175001 (the TAM), the IRS addressed the application of certain qualification requirements to tax-qualified plans maintained by an entity whose owner is both a member of a Section 414(c) controlled group and a member of a Section 414(m) affiliated service group. The TAM provides insight into the application of the complicated controlled group and affiliated service group rules when a single business entity is a member of both a Section 414(c) brother-sister controlled group and a Section 414(m) affiliated service group.

The application of the controlled group and affiliated service group rules is critically important to ensure that qualified defined contribution and defined benefit plans comply with tax-qualification requirements, such as the nondiscrimination rules under Sections 401(a)(4) and 410(b) and the annual contribution limitations under Section 415. These controlled group and affiliated service group rules can be complicated, and the IRS has issued scant guidance in recent years to assist employers in ensuring that their business structures comply.

The regulations under Section 414(b) and (c) were finalized in 1988; proposed regulations under Section 414(m) addressing affiliated service groups were issued in 1983, but never finalized. Since this guidance was issued, business structures and relationships have evolved significantly, leaving many unanswered questions and much ambiguity in the application of the rules. Some of the most vexing questions relate to the application of the controlled group rules to limited liability corporations (LLCs) that are corporations for state law purposes, but are partnership for tax purposes, and the application of the affiliated service group rules to management services entities that provide services to professional and nonprofessional businesses.

The issue addressed by the TAM is limited to the application of the tax-qualification rules in the case of an overlapping controlled group and affiliated service group. Although it does not address the most complicated controlled group and affiliated service group open questions, the TAM provides helpful insight into the application of these rules to relatively common business structures.

Background

Entities that operate as trades or businesses and are under common control within the meaning of Section 414(b) or (c), or are aggregated as an affiliated service group within the meaning of Section 414(m), are considered a single employer for purposes of the coverage and nondiscrimination rules under Section 401(a)(4), Section 410(b) and the other tax-qualification requirements under Section 401(a), including the annual contribution limitation under Section 415.

Section 414(b) and (c) define a controlled group as a parent-subsidiary relationship or a brother-sister relationship. A parent-subsidiary group is one or more chains of entities conducting trades or businesses that are controlled by a common parent that owns at least 80% of the vote and value of the entities' shares or partnership interest. A brother-sister controlled group consists of two or more organizations conducting trades or businesses if the same five or fewer persons own at least 80% of each entity (referred to as a controlling interest) and, taking into account the identical interests, the group owns at least 50% (referred to as effective control).

Section 414(m) addresses arrangements in which entities may have interconnected business activities, but no entity or person has a controlling interest. Under Section 414(m)(2), an affiliated service group consists of a "first service organization" whose principal business is providing services to at least one other related organization. Under the proposed regulations, the first service organization must be a professional services corporation, such as a licensed medical practice, legal practice or public accounting practice. Also, under Section 414(m)(2), for the entities to be considered affiliated, there must be some overlapping ownership interest. Section 414(m)(5) provides, however, that a management service organization may be affiliated with another organization, even if there is no overlapping ownership, if the principal purchase of the service organization is to perform services on a regular and continuing basis for one organization (or related organizations).

The specific issue addressed by the TAM is whether annual additions (i.e., contributions) made on behalf of a taxpayer to two separate plans must be aggregated for purposes of complying with the Section 415 tax-qualification requirements. Section 415(c) provides that contributions and other additions with respect to a participant must not exceed the lesser of a stated dollar amount ($54,000 in 2017) or 100% of the participant's compensation. Contributions and other additions to separate plans must be aggregated for purposes of Section 415 if the plans are maintained by entities that are considered a single employer under the controlled group or affiliated service group rules.

TAM 201715001

The taxpayer in the TAM was the owner of separate professional corporations through which the taxpayer provided medical services practices, and the businesses of the professional corporations were managed by a service organization. Under the facts presented in the TAM, the taxpayer was the sole owner of separate professional corporations, referred to as Entity 1 and Entity 2, which were brother-sister corporations. The taxpayer was also employed by each of these entities. Entity 2 was also a partner, together with a number of other professional corporations, in a service organization (referred to as Entity 3). Entity 3 and several other entities formed an affiliated service group, which the TAM refers to as Entity 5.

Entity 1 maintained retirement Plan A and made contributions to the plan for the benefit of the taxpayer in connection with the taxpayer's employment services for Entity 1. Entity 3 also maintained retirement Plan B in which Entity 2 was a participating employer. As a participating employer in the Entity 3 Plan B, Entity 2 made contributions for the benefit of the taxpayer in connection with the taxpayer's employment services for Entity 2. If the contributions to Plans A and B were required to be aggregated, the contributions would exceed the Section 415 annual addition limitation.

The question presented in the TAM is whether a plan maintained by an entity in connection with its relationship with an affiliated service group must be aggregated with a plan maintained by another member of the controlled group. The taxpayer argued that Entity 1 and Entity 2 were not in a controlled group for purposes of the Section 415 annual addition limitation rules. The basis of taxpayer's argument was that Entity 5 (the affiliated service group), not Entity 2, was the employer that maintained Plan B and that Entity 1 did not have a sufficient relationship with Entity 5 so as to be treated as a single employer for purposes of Section 415. The IRS rejected this argument.

The IRS ruled in the TAM that Entity 1 and Entity 2 were in a controlled group and were treated as a single employer for purposes of Section 415 and other tax-qualification requirements. The IRS further stated that this result did not change because Entity 2 was also in an affiliated service group that maintained a retirement plan for the benefit of the participating employers, including Entity 2. In support of this ruling, the IRS concluded that the controlled group and the affiliated service group rules must be met separately and in their entirety.

The taxpayer also argued that he could have arranged the employment relationship so that he would have received contributions up to the Section 415 annual addition limit for both plans if he had no ownership interest in Entity 2. Although the IRS did not concede this point directly, it rejected the taxpayer's "form over substance" argument and concluded that, under the facts presented, Entity 2 was a separate entity that operated as an employer, was a participating employer in the affiliated service group Plan B, and had made contributions to Plan B on taxpayer's behalf. Therefore, Entity 1 and Entity 2 were treated as a single employer under Section 414(c) and Entity 2's participation in the affiliated service group and the Section 414(m) rules did not change this conclusion.

Implications

Taxpayers who are employed by separate businesses that are not part of a controlled group or affiliated service group may receive contributions to separate plans maintained by the businesses up to the maximum annual addition under each plan. To ensure that a taxpayer is entitled to separate Section 415 limitations, however, taxpayers must ensure that their business structure does not create a controlled group or an affiliated service group relationship.

This TAM addresses only the Section 415 annual addition limitation tax qualification requirement. Taxpayers should also be aware that entities that are members of a controlled group or affiliated service group may be treated as a single employer for purposes of the other tax qualification requirements, including the nondiscrimination rules.

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