Controlled Groups, Affiliated Groups and Management Companies: The Heavy Price of Ignorance
Original post ubabenefits.com
It is not unusual for an entrepreneurial family, a group of physicians, or a fast-growing corporation to spin off pieces of a certain segment of a business or to open a completely new business with profits earned from an existing one. When a business is thriving, tax planning is often undertaken, and efficiencies in operations are examined, to evaluate a proposed new corporate structure. The last thing that anyone thinks about in these circumstances is whether a controlled or affiliated service group is being created (or currently exists) and what impact such a group will have on the existing or new employee benefit plans. Yet, the potential financial impact of overlooking related corporate entity issues in these situations may be severe.
Properly Counting Employees under the Affordable Care Act (ACA)
Treasury Regulations promulgated under the employer shared responsibility rules under the ACA provide that controlled groups and affiliated service groups of employers, including management groups, must be aggregated for purposes of deciding how many full-time equivalent employees (FTEs) exist. The number of FTEs dictates whether an employer, or a group of related employers, are an “applicable large employer” (ALE) under the ACA.
Failure to recognize that an employer is an ALE under the ACA has two, potentially expensive, consequences. First, if the employer is not offering minimum essential coverage to full-time employees, the employer may be subject to a penalty equal to $180 per month (in 2016) for each full-time employee (minus the first 30 employees) under Section 4980H(a) of the Internal Revenue Code (the Code).
Failure to properly count FTEs may also cause an employer to miss reporting offers of coverage to those employees by disseminating and submitting Form 1095-C and 1094-C. The penalty for this omission (assuming the omission is not willful) is $250 per form per year. The $250 penalty is assessed for each missing Form 1095-C for each full-time employee, each year.
The number of FTEs also dictates whether an employer or group of employers is a “small employer” that is permitted to participate in the Small Business Health Options Programs (SHOP) and may offer health insurance coverage under SHOP. The determination that an employer is “small” also dictates whether that employer is qualified for a tax credit for offering group health insurance coverage to its employees.
Failing to properly count FTEs may result in a referral by the Department of Health and Human Services to the Centers for Medicaid and Medicare Services or the Internal Revenue Service that the employer is wrongfully participating in SHOP or receiving a tax credit. Tax penalties may result as a consequence of such referrals.
Tax Qualification of Retirement Plans
The failure to recognize the existence of controlled groups, affiliated service groups, and management groups has the potential to wreak havoc with an employer’s tax qualified retirement plan. This is because the Code’s statutory provisions governing a plan’s tax-qualified status (e.g., Code sections 401(a), 410, 411, 415, 416) treat related entities as single employer for purposes of the important inquiries into minimum participation, discrimination, vesting, maximum contribution and top-heavy status.
This means, to highlight only one example, that one employer’s 401(k) plan must be aggregated with all other related employers’ 401(k) plans for purposes of testing the tax qualified status of the plans under Code section 410’s coverage rules. The aggregation rules work similarly for all the other Code provisions that govern whether a retirement plan constitutes a Code section 401(k) plan.
What makes this most concerning is that the operational failure of one or more of the related employer’s plans to satisfy the mandates of the Code in any given year will likely cause all the related entity plans to also be disqualified. Further, there is no statute of limitations that applies to the tax consequences that arise when one or more of the retirement plans fail to satisfy the Code’s requirements for tax-qualified status.
Consequently, if the 401(k) plans of related employers, taken in the aggregate, fail to pass coverage tests, and certain employees should have been offered an opportunity to participate in the right to make elective deferrals, but were not offered such opportunity, the plans must be corrected. This may mean going back many years and giving each of the omitted employees 50 percent of their missed elective deferral amounts, plus 100 percent of the missed employer matching contributions, plus earnings calculated from the date the employees were first eligible to participate in the plans. The cost of such a correction has the potential to put an employer literally out of business.
The potential monetary exposure associated with missing the existence of related entity issues warrants that such issues be a material consideration when any business is considering changing its corporate structure or engaging in an acquisition or divestiture of a portion of its business interests. Not only tax, but civil liability exposure associated with potential breaches of fiduciary duties may arise when related entity issues are not recognized and properly addressed in the environment of employee benefit plans. Employers engaging in corporate transactions should consult with knowledgeable tax professionals regarding related entity issues early in the due diligence process to avoid these potential areas of monetary loss.