Introduction
Qualified retirement plans are employer-sponsored plans that meet IRS requirements, offering tax advantages to both employers and employees. When establishing such plans, common ownership rules are critical because they determine which employees must be included and how benefits and contributions are calculated. Understanding these rules helps avoid compliance issues, ensures fairness, and maximizes the benefits of the plan.
1. Definition of Common Ownership
Common ownership refers to situations where multiple businesses or entities are owned by the same individual(s) or group of individuals. The IRS considers these ownership relationships when applying rules for qualified retirement plans, including eligibility, contribution limits, and nondiscrimination testing.
Types of Common Ownership
- Parent-Subsidiary: One company owns at least 80% of another company’s stock or capital.
- Brother-Sister: Two or more companies are owned by the same five or fewer individuals, with at least 80% overlap in ownership and effective control.
- Combined Control Groups: Combinations of parent-subsidiary and brother-sister relationships where ownership and control rules are aggregated.
2. Impact on Plan Coverage
Common ownership affects which employees must be covered under the plan:
- Employees of all entities within a controlled group may need to be included to satisfy nondiscrimination rules.
- Aggregating employees across commonly owned entities ensures the plan does not favor highly compensated employees.
Example:
- Company A (Parent) owns 85% of Company B (Subsidiary).
- Both companies want to maintain separate 401(k) plans.
- IRS rules require considering employees of both companies when performing nondiscrimination testing.
3. Contribution and Benefit Limits
When entities have common ownership, contribution limits may be applied collectively:
- Defined contribution plans (e.g., 401(k), profit-sharing) have annual limits per participant ($66,000 for 2025, including employer contributions).
- Employees with compensation from multiple controlled entities must have total contributions aggregated to ensure limits are not exceeded.
Example:
- Employee works for Company A and Company B within a brother-sister group.
- Company A contributes $30,000 to the 401(k), Company B contributes $25,000.
- Total contributions: 30,000 + 25,000 = 55,000 , which is under the $66,000 limit.
4. Nondiscrimination Testing
Common ownership influences nondiscrimination testing, ensuring the plan does not disproportionately favor highly compensated employees (HCEs):
- Aggregated employee counts across controlled entities are used for top-heavy testing and actual deferral percentage (ADP) testing.
- Failing to include all relevant employees can result in plan disqualification and loss of tax benefits.
5. Employer Considerations
Employers establishing a qualified plan within a common ownership context should:
- Identify all controlled group entities to ensure coverage and compliance.
- Coordinate contributions for employees working across multiple entities.
- Plan for consolidated nondiscrimination testing to avoid corrective distributions or penalties.
- Consult legal and tax advisors to properly structure the plan under IRS rules.
6. Benefits of Properly Considering Common Ownership
- Ensures the plan remains qualified and tax-advantaged.
- Protects against disqualification penalties.
- Promotes fair treatment of all employees across controlled entities.
- Facilitates accurate reporting and compliance for IRS audits.
Conclusion
Common ownership plays a critical role when establishing a qualified retirement plan. Parent-subsidiary, brother-sister, and combined control relationships impact coverage, contribution limits, and nondiscrimination testing. Employers must carefully identify ownership structures, coordinate plan contributions across entities, and ensure compliance with IRS rules to maintain plan qualification and maximize benefits for all employees. Proper planning and consultation with financial and legal experts reduce the risk of errors and protect the long-term integrity of the retirement plan.
