You own two businesses.
One has a 401(k). The other doesn’t.
They have separate payrolls. Separate bank accounts. Maybe completely different employees, customers and industries.
For 401(k) purposes, that doesn’t necessarily make them separate employers.
Under the controlled group rules, businesses with certain common ownership can be treated as a single employer for important retirement plan requirements.
That can affect:
- Which employees must be considered for coverage testing
- Nondiscrimination testing
- Highly compensated employee determinations
- Certain contribution and benefit limits
- Top-heavy testing
- Eligibility and service rules
And this is where business owners get caught:
You can’t determine controlled-group status just by looking at the company name, payroll or EIN sponsoring the 401(k).
You have to look at ownership.
The three controlled group relationships business owners should know
There are three types of controlled groups:
- Parent-subsidiary
- Brother-sister
- Combined groups
For most small and midsize business owners, the first two are the ones most likely to come up.
| Type | What it generally means | What to look for |
|---|---|---|
| Parent-subsidiary | One business owns a controlling interest in another | One company owning 80% or more of another |
| Brother-sister | The same small group of owners controls multiple businesses | Five or fewer common owners satisfying both the 80% and more-than-50% tests |
| Combined group | A group contains both parent-subsidiary and brother-sister relationships | More complex multi-entity ownership structures |
Parent-subsidiary controlled groups
The basic concept is straightforward: one business owns a controlling interest in another.
For corporations, a parent-subsidiary controlled group generally exists when the parent owns at least 80% of another corporation under the applicable voting-power or stock-value rules. Similar principles can apply to partnerships, LLCs and other trades or businesses under common control.
Example
Company A owns 90% of Company B.
For retirement plan purposes, A and B generally aren’t treated as two completely independent employers.
Parent-subsidiary relationships tend to be easier to recognize because the ownership relationship usually shows up clearly on an organizational chart.
Brother-sister groups are where things get more interesting.
Brother-sister controlled groups
A brother-sister controlled group can exist when the same five or fewer common owners own interests in two or more businesses.
Two ownership tests generally must be satisfied:
| Test | Requirement |
|---|---|
| 1. Controlling interest | The five or fewer common owners generally own at least 80% of each business |
| 2. Effective control | Those same owners own more than 50% of each business when measured using identical ownership |
Passing the 80% test by itself does not necessarily create a brother-sister controlled group.
How identical ownership actually works
The second test is where people tend to get tripped up.
Identical ownership is not:
- The average ownership between the companies
- The owners’ combined ownership percentages
- The highest percentage each owner holds
Instead, you take each owner’s lowest ownership percentage across the businesses being compared and add those percentages together. Consider this example:
| Owner | Company X | Company Y | Identical ownership |
|---|---|---|---|
| Ann | 60% | 20% | 20% |
| Ben | 30% | 50% | 30% |
| Cara | 10% | 30% | 10% |
| Total | 100% | 100% | 60% |
The three owners collectively own 100% of both companies, so the first test is satisfied.
For identical ownership, we use the lower percentage for each owner:
- Ann: 20%
- Ben: 30%
- Cara: 10%
Total identical ownership: 60%.
Because that exceeds 50%, the businesses satisfy the effective-control test as well.
Here’s the important part:
Company X and Company Y do not have to share:
- A company name
- Employees
- Customers
- Office space
- Payroll
- An industry
The ownership relationship can be enough. That’s why controlled groups are difficult to identify by looking at the businesses themselves.
Attribution: when you can be treated as owning something you don’t own
Controlled-group rules contain attribution rules that can treat someone as owning an interest actually held by someone else.
Common forms of attribution include:
| Attribution type | Why it matters |
|---|---|
| Spousal attribution | Ownership held by one spouse may be attributed to the other |
| Parent-child attribution | Ownership may be attributed between parents and children in certain circumstances |
| Entity attribution | Ownership held through partnerships, corporations, trusts or estates may flow through to individuals |
| Option attribution | An option to acquire ownership can sometimes be treated as current ownership |
This is particularly important in family-owned businesses.
Spousal attribution
In many circumstances, ownership held by one spouse can be attributed to the other.
There is an exception where specific requirements are satisfied, including restrictions involving the other spouse’s direct ownership and participation in the business. The practical takeaway is simple: two spouses running separate businesses should not automatically assume those businesses are unrelated for retirement plan purposes.
Parent and child attribution
Ownership can also be attributed between parents and children under specified circumstances.
These rules differ depending on factors such as:
- The child’s age
- The parent’s ownership level
- The ownership held by other family members
- Whether other attribution rules apply
SECURE 2.0 also changed certain family-attribution rules for plan years beginning after December 31, 2023. If your controlled-group analysis predates those changes, it may be worth revisiting.
What a controlled group means for your 401(k)
Finding a controlled group does not automatically mean every company must have exactly the same 401(k). But it does mean you can no longer analyze each company in isolation. For several important retirement plan rules, employees of controlled-group members are treated as though they work for a single employer.
Here are some of the biggest areas affected:
| Plan requirement | Why controlled-group status matters |
|---|---|
| Coverage testing | Employees at related companies may need to be included in §410(b) testing |
| Nondiscrimination testing | Testing may need to account for employees across the related employer group |
| HCE determinations | Ownership and compensation across related entities can affect HCE status |
| §415 limits | Certain contribution and benefit limits may require aggregation |
| Top-heavy testing | Related entities can affect key employee and top-heavy determinations |
| Eligibility and service | Service with another controlled-group member may count for plan purposes |
The key point: a company doesn’t necessarily have to sponsor the 401(k) to affect the 401(k).
The coverage rule business owners often misunderstand
You’ve probably heard that a 401(k) has to cover “70% of employees.” That’s not quite right. Section 410(b) provides multiple ways for a plan to satisfy minimum coverage requirements.
Under the commonly used ratio percentage test, the plan compares:
- The percentage of non-highly compensated employees who benefit under the plan
to
- The percentage of highly compensated employees who benefit under the plan
That ratio generally must be at least 70%.
Why controlled-group status matters
Imagine Company A sponsors a 401(k).
Company A has:
- 10 highly compensated employees
- 40 non-highly compensated employees
Company B has another:
- 25 non-highly compensated employees
If A and B are members of the same controlled group, Company B’s employees may need to be considered in the coverage analysis. Suddenly, a plan that looked fine when Company A was analyzed by itself may produce a very different testing result. Related-company employees can change the denominator.
What happens if you discover the controlled group late?
This is where the problem can become expensive.
A common pattern we see looks like this:
- You start Company A.
- Company A establishes a 401(k).
- A few years later, you start or acquire Company B.
- Company B doesn’t participate in the plan.
- Nobody revisits the controlled-group determination.
- Company B grows from a handful of employees to a meaningful workforce.
- The ownership relationship is eventually discovered.
- Prior coverage and nondiscrimination testing has to be revisited.
Depending on the facts, that can create a retirement-plan qualification failure requiring correction.
The IRS’s Employee Plans Compliance Resolution System, or EPCRS, provides correction mechanisms including:
- Self-Correction Program (SCP)
- Voluntary Correction Program (VCP)
Which method is available depends on the nature of the failure and the specific circumstances.
Catching the ownership issue before it creates a testing failure is obviously the better outcome.
Don’t forget affiliated service groups
Passing the controlled-group ownership tests does not necessarily end the analysis. Section 414(m) contains a separate set of rules for affiliated service groups.
These rules can require certain organizations to be treated as a single employer based on a combination of ownership and service relationships even when the traditional controlled-group tests aren’t satisfied.
These situations deserve particular attention when businesses involve:
- Medical or dental practices
- Law firms
- Accounting firms
- Architecture or engineering firms
- Consulting companies
- Management companies
- Staffing or professional service entities
A medical practice with a related management company, for example, should not assume the businesses are independent for retirement plan purposes simply because they don’t satisfy the traditional brother-sister test.
Controlled groups and affiliated service groups are related concepts, but they are not the same analysis.
A quick controlled group self-check
If you’re a business owner, start with these questions:
- Do you or another owner of your company own an interest in another business?
- Does your spouse, parent or child own an interest in another business?
- Does your company own part or all of another company?
- Is ownership held through a partnership, corporation, trust or similar entity?
- Have you acquired, sold, reorganized or started another business?
- Has your ownership structure changed since your last controlled-group review?
- Do you operate multiple professional-service or management entities?
A yes does not mean you have a controlled group. It means the ownership structure deserves a closer look.
Frequently Asked Questions
Does a controlled group file one Form 5500?
Not necessarily. Controlled-group status and Form 5500 filing are separate questions.
Generally:
- A single plan covering multiple related employers may have one Form 5500 filing.
- Separate retirement plans generally have their own filing obligations.
Can controlled-group companies have different 401(k) plan designs?
Controlled-group companies do not necessarily need to offer identical benefits to every employee.
But differences in plan design can affect:
- Coverage testing
- Nondiscrimination testing
- Eligibility
- Employer contributions
- Profit-sharing allocations
Different designs should therefore be evaluated across the entire controlled group.
What happens when we acquire another company?
An acquisition can immediately change the related-employer analysis. There is a limited transition rule for certain acquisitions and dispositions, but it should not be treated as a permanent solution. The ownership and retirement plan structure should be reviewed when the transaction occurs.
Does a small ownership stake in another company matter?
Sometimes. A small ownership interest may not independently create a controlled group. But the answer can change when you consider:
- Other common owners
- Family attribution
- Entity ownership
- Options to acquire ownership
That’s why all business ownership interests should be reviewed before making the determination.
Do controlled group rules apply to LLCs and partnerships?
Yes. The common-control rules are not limited to traditional corporations. They can apply to:
- LLCs
- Partnerships
- Sole proprietorships
- Corporations
- Other trades or businesses
Changing the entity type doesn’t necessarily change the related-employer analysis.
Your ownership structure is part of your 401(k) plan
Most business owners think about their 401(k) in terms of the company sponsoring it. That’s not always enough. If you own multiple businesses—or other owners or family members do—the first question isn’t just: “Who sponsors the plan?”
It’s: “Who is the employer under the controlled-group rules?”
That distinction can determine:
- Which employees need to be considered
- Whether your plan passes testing
- How certain plan rules are applied
- Whether another business affects your 401(k), even if it doesn’t participate in the plan
If your ownership structure has changed or no one has ever mapped it for retirement-plan purposes, let’s run the determination before it turns into a correction project.
This article is for general educational purposes and is not intended as legal or tax advice.