Summary

Action: Internal Revenue Service has proposed regulations to determine whether or not tax exempt corporations are part of a "controlled group" for purposes of qualified retirement and other employee benefit plans.

Impact: Will require analysis of corporate structure and review of retirement plan testing by tax exempt organizations with affiliates.

Effective Date: Plan years beginning on and after January 1, 2006, unless postponed by the Internal Revenue Service.

After 30 years, the Internal Revenue Service ("IRS") has proposed regulations to incorporate concepts it has informally applied in the past to determine whether organizations are part of a "controlled group." The "controlled group" rules are important because retirement plan discrimination testing applies on a "controlled group" basis, rather than employer-by-employer. In addition, pension liabilities are joint and several as to each member in a controlled group. Some other employee benefit nondiscrimination rules are also tested on a controlled group basis, such as self-insured medical plans, but it is less likely that such testing will be a problem, no matter how the testing is conducted.

Under current IRS regulations in the case of stock corporations, a controlled group exists where one corporation owns 80% or more of either the voting stock or stock value of another corporation. In 1996, the IRS issued temporary guidance that allowed, but did not require, tax exempt corporations to treat control of another tax exempt corporation's board of directors the same as stock ownership Thus, if one entity controlled the appointment and removal of 80% or more of the directors of a tax exempt corporation, the two entities could be treated as part of a controlled group. However, the 1996 IRS guidance also allowed employers to use a good faith interpretation of the controlled group statute and regulations, and a literal reading of the existing statute and regulation permits a conclusion that non-stock corporations are simply not a part of a controlled group, because there is no 80% or greater "owner."

The IRS has now proposed a formal rule for tax exempt corporations effective for plan years beginning on and after January 1, 2006. The rule incorporates the prior guidance that control is established by determining who or what controls the directors of a tax exempt corporation, but eliminates any interpretation that a non-stock corporation cannot be a part of a control group. Under the proposed new rule, if one tax exempt corporation has the power to appoint and remove 80% or more of the directors of another tax exempt corporation, the two are part of a common controlled group.

The new rule also permits tax exempt organizations to treat themselves as a controlled group in certain instances where they would not be considered as such, but they do in fact coordinate day to day corporate business activities. This is a favorable change, although we suspect that it will seldom be used.

The new rule should not affect tax exempt organizations that have historically taken the conservative approach and have performed nondiscrimination testing using the control test that is found in the new rule. However, some tax exempt organizations may not have been following the 80% director control test and may now have to restructure their pension arrangements effective January 1, 2006 (assuming the IRS does not withdraw or postpone the new regulations) or consider other changes to their governance. Some tax exempt organizations may also have to consider the impact of potential pension liabilities of other entities that will now be a part of a controlled group that arguably did not exist before.

This new test for tax exempt corporations is limited to the Internal Revenue Code and ERISA, and will not be dispositive of other common employer status situations in areas such as wage-hour, the National Labor Relations Act's provisions or affirmative action obligations.

It is highly recommended that tax exempt corporations take the following measures in 2005:

  • Review their organizational structures to ensure that all "controlled group" entities are identified.
  • Determine whether discrimination testing for retirement plans (and other benefit programs subject to discrimination testing), passes on a control group basis, or take appropriate action to revise the benefits.
  • Recognize that pension liabilities, both those for current funding and unfunded liabilities upon termination, apply to all members of the control group and plan accordingly.
  • Consider restructuring corporate control if the consequences of control group testing are negative.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.