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The Potential Benefits of Treating Your Companies as a “Controlled Group” Come with Legal Risks

In general, for a company that offers its employees health insurance benefits, the more employees there, the lower the premium costs are per employee. So if a business owner owns more than one business, it might be tempting to try to bundle all the people they employ under one plan, which would cost less than having two plans in place. However, this can be a classic “penny wise, pound foolish” scenario.

For any financial benefit the business owner might gain, there are significant corresponding legal risks.

What is a Controlled Group?

A “controlled group” of companies is, as the term suggests, a group of companies under common control. The Internal Revenue Code and the Employee Retirement Income Security Act (ERISA) each include their own definitions of a controlled group.

In general, businesses are treated as members of the same controlled group if there is at least 80 percent direct or indirect common ownership between or among different entities. For example, if a parent company owns at least 80 percent of a subsidiary, they would be considered part of a controlled group.

Determining whether two or more entities are part of a controlled group and involves the analysis of a number of factors. For instance, determining ownership is based on the type of business. For a corporation, ownership is based on the percentage of the corporation’s stock owned, and for a partnership, ownership is based on the capital interest or profits interest in the partnership. And a number of attribution rules and constructive ownership rules apply in determining whether entities are part of a controlled group.

In short, it’s complicated. And if you own (in full or in part) multiple businesses, it’s important to work with your legal counsel to understand whether the businesses are part of a controlled group. And if businesses are part of a controlled group, it’s critical that you know the consequences. Indeed, there are real risks—many of them unanticipated by business owners.

What are the Risks of Being Part of a Controlled Group?

Controlled group status applies in various circumstances, such as with respect to tax-qualified retirement plans, welfare plans, and non-qualified deferred compensation plans. ERISA and the Income Tax Code impose significant requirements and liabilities that apply not only to the sponsor of an employee benefit plan but also to other entities that are part of the same controlled group. All entities that are part of the controlled group are treated as a single employer and, therefore, can be held jointly and severally liable, for example, for the pension liabilities of a single entity within the group.

The broader lesson here for business owners is that they need to think carefully (and consult legal counsel) about the formalities of corporate formation and governance. One of the primary benefits of using a corporate structure to conduct business is that it allows a business owner to shield their personal assets from their business liabilities. However, if the business owner doesn’t respect corporate formalities—such as commingling personal and business assets—their personal assets may be exposed.

The same principle applies when it comes to two separate business entities. Each should operate as a separate entity. Failing to do so can lead one entity to be held liable for the debts of another.

In sum, there are reasons to operate multiple entities as a controlled group. But business owners need to think carefully about whether the benefits of doing so outweigh the risks.

If you have questions about these issues, please contact Zana Tomich at Dalton & Tomich.

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