Understanding Controlled and Affiliated Service Groups for Solo 401ks
Solo 401ks are a powerful retirement savings tool designed for self-employed individuals and business owners without full-time employees. However, the IRS imposes strict rules when determining whether a business owner qualifies for a Solo 401k. These rules often involve understanding controlled groups and affiliated service groups. Below is a comprehensive guide to these concepts.
Controlled Groups: An Overview
A controlled group exists when multiple businesses are connected through common ownership. The IRS uses these rules to ensure that retirement plans are applied consistently across related businesses. If your businesses are part of a controlled group, they are treated as a single employer for retirement plan purposes.
Types of Controlled Groups
Parent-Subsidiary Controlled Group
This occurs when one business owns at least 80% of another business. For example:Business A owns 85% of Business B.
These businesses are considered a controlled group.
Brother-Sister Controlled Group
This applies when:Five or fewer individuals, estates, or trusts own at least 80% of two or more businesses, and
They hold more than 50% of the total ownership when considering identical ownership across the businesses.
Combined Controlled Group
A combined group involves elements of both parent-subsidiary and brother-sister groups. For example:Business A owns 85% of Business B.
Business B and Business C share 80% common ownership among the same individuals.
Organizational attribution
Stock ownership could also be attributed to individuals through an organization.
Corporations: If a corporation owns stocks, directly or indirectly, ownership is attributed to any individual who owns at least 5% of the corporation.
Partnerships: If a partnership owns stock, directly or indirectly, ownership is attributed to each partner who has a 5% or greater interest in the capital or profits, in proportion to each partner’s interest in the partnership.
Partner: If a partner owns stock, directly or indirectly, ownership is attributed to the partnership.
Estates and trusts: If an estate or trust owns stock, directly or indirectly, ownership is attributed to each beneficiary, in proportion to each beneficiary’s interest in the estate or trust.
Implications for Solo 401k Eligibility
If your businesses form a controlled group:
Employees across all businesses must be considered when determining Solo 401k eligibility.
Having full-time employees in any of the controlled businesses disqualifies you from maintaining a Solo 401k.
Affiliated Service Groups
An affiliated service group involves businesses that are closely related due to shared services or ownership. These rules prevent business owners from splitting employees across multiple companies to circumvent retirement plan regulations.
Key Characteristics of Affiliated Service Groups
A-Organization
A business (the "A-Org") provides significant services to another business and owns part of it. For example:A law firm and its wholly-owned consulting subsidiary may be considered an affiliated service group.
B-Organization
A group of businesses regularly works together to provide services. Ownership is not required, but the businesses are highly integrated. For example:A medical practice and its associated laboratory.
Management Groups
If one entity manages another, they may form an affiliated service group.
Implications for Solo 401k Eligibility
If businesses are part of an affiliated service group, they are treated as a single entity for retirement purposes. Any full-time employees within the group disqualify the business owner from using a Solo 401k.
Family Attribution
Family attribution rules exist to prevent the use of your family members in order to get around the controlled group rules. For example:
if you own 45% of Company A and your spouse owns 45% of Company B, you would each be considered to be 90% owners of the company – 45% through direct ownership and 45% through attribution.
The rules vary by relationship:
Spouse: If a spouse owns stock, directly or indirectly, it is attributed to their spouse (unless they qualify for exceptions – explained further down below).
Parents: If a parent owns stock, directly or indirectly, it is attributed to their children under 21 years of age. If the child is over the age of 21, stock is attributed only if the over 21 child owns more than 50% of the company, either through direct ownership or attribution.
Child: If a child owns stock, directly or indirectly, it is attributed to their parents if the child is under 21 years of age. If over the age of 21, stock is attributed only if the parent owns at least 50% of the company, either through direct ownership or attribution.
Grandchild: If a grandchild owns stock, directly or indirectly, it is attributed to their grandparents, regardless of age, only if the grandparents owns at least 50% of the company, either through direct ownership or attribution.
Grandparent: If a grandparent owns stock, directly or indirectly, it is attributed to their grandchildren, regardless of age, only if the grandchild owns at least 50% of the company, either through direct ownership or attribution.
Legally adopted children: Legally adopted children are considered as an individual’s child by blood for attribution purposes.
Siblings: Ownership is not attributed.
The 50% rule explained
Some relationships require that the ownership be greater than 50% in order for the stock to be attributed. The total ownership after attribution must be greater than 50%.
Exceptions for spouses
A spouse is attributed their spouse’s ownership. However, exceptions can be made if all of these conditions are satisfied.
Spouse has no direct ownership in their spouse’s company.
Spouse is not a director or employee, and does not participate in the management of their spouse’s company at any time during the taxable year.
No more than 50% of business income is from passive investments (such as rent, royalties, dividends, interest, and annuities).
Spouse’s stock is not subject to ownership restrictions running in favor of the first spouse or their under age 21 children.
Solo 401k Controlled Group Scenarios
Understanding whether your businesses are part of a controlled or affiliated service group is critical for Solo 401k compliance. Here are some examples:
Scenario 1: You own 90% of a consulting business and 85% of a tech startup. These businesses form a controlled group, so you must consider employees from both when determining Solo 401k eligibility.
Scenario 2: You own 70% of a law firm and 25% of an accounting practice that regularly provides services to your clients. These may constitute an affiliated service group, requiring compliance with broader retirement plan rules.
Next Steps for Business Owners
If you're uncertain about your business structure, consult a tax advisor or retirement plan specialist. Proper classification ensures compliance with IRS rules and protects the integrity of your retirement plan.
Key Takeaways:
Controlled and affiliated service groups aggregate businesses for Solo 401k eligibility.
Full-time employees in any connected business disqualify the plan.
Review your business structure to ensure you qualify for a Solo 401k.
Learn more about controlled groups here.