Looking to open a Solo 401k plan? Get started today with just a few clicks – The Carry Solo 401k Plan is a featured-packed self-directed account that lets you invest in both traditional and alternative assets, take out a loan, or do a Mega Backdoor Roth conversion with a few clicks.
Maximize Your Retirement Savings With a Solo 401k
As a business of one, you can contribute more and potentially save more on taxes.* Carry’s Solo 401k is built for entrepreneurs, freelancers, and high earners who want flexible investing and bigger retirement contributions, all in one streamlined plan.
LEARN MORE*Solo 401(k) eligibility and contribution limits depend on IRS rules. Carry does not provide tax advice, consult a tax advisor. Carry Advisors LLC, an SEC-registered investment adviser, provides investment advisory services for discretionary and non-discretionary accounts (e.g., Solo 401(k), IRA, taxable brokerage accounts). Bank and trust accounts are not advised by Carry Advisors. Brokerage accounts are introduced by Global Carry LLC and carried by DriveWealth LLC, both members FINRA/SIPC. Advisory fees may apply and additional disclosures are described in our Form ADV and CRS.
Understanding controlled group rules are important for business owners with multiple business interests. Controlled group rules exist to prevent business owners from offering themselves a retirement plan, like a Solo 401k, through a side business, without offering any retirement benefits to their employees.
Controlled group rules, especially affiliated service rules, are complex, but can be simplified down to the following:
- If a company has 80% or greater ownership of another company, the two companies would then be considered as a controlled group. This is called a parent-subsidiary controlled group.
- If 5 or fewer individuals have ownership in the same companies, the companies would be considered a brother-sister controlled group if their combined ownership in all companies is 80% or greater, and the identical ownership is over 50%. Identical ownership is measured by adding together the lowest ownership percentage of all owners.
Even if you don’t fall under a parent-subsidiary or brother-sister relationship, there are additional rules that can still place your companies in a controlled group:
- Stock ownership can be attributed to family members and through organizations. For example, if your spouse owns 100% of a company, you’re automatically considered as a 100% owner because their stock gets attributed to you. This is referred to as family attribution.
- Affiliated service rules can also qualify companies as a controlled group if they perform services for one another, even if there is no common ownership.
When multiple companies are considered as a controlled group, they’re viewed as one employer by the IRS in terms of retirement plans. When a retirement plan is started at one company of a controlled group, it must offer retirement benefits for all employees across the companies. Eligibility for retirement plans also takes into consideration all companies, rather than just one individual company. For example, a Solo 401k requires that you have no full-time employees. If you own two companies, one with employees and one without, and they’re considered as a controlled group, you cannot open a Solo 401k for the company without employees because the other company does have employees and would make you ineligible for the plan.
Here’s a simple example:
John owns a restaurant. He has 10 full-time employees but doesn’t offer any sort of retirement plan so that he could save on costs and avoid additional administration work and annual tax filings. One day, he gets a brilliant idea. Instead of opening a retirement plan at the restaurant, and have to offer benefits to all his employees, he decides to open a side LLC with no employees, and use it to open a Solo 401k for himself. He’ll use the money from the restaurant to pay his LLC, then use that money to max out his Solo 401k. His restaurant employees don’t receive any of the retirement plan benefits John will get from his Solo 401k. In fact, they don’t even know about it.
The Internal Revenue Code established the Controlled Groups Provisions as part of the Revenue Act of 1964 in order to ensure that any qualified retirement plan maintained by an employer doesn’t discriminate in favor of highly compensated employees (HCEs). A highly compensated employee is any individual with at least 5% ownership at any time during the tax year, regardless of their compensation.
In the example above, John owns 100% of both companies, so they would be considered as a brother-sister controlled group. John wouldn’t be eligible for a Solo 401k because his restaurant employs full-time employees. If he wanted to open a retirement plan for his LLC, he would need to provide retirement benefits for all of his employees in his restaurant as well. Controlled group rules apply for all business entities (including sole proprietorships and partnerships), not just corporations.
Types of controlled groups
Determining controlled group status can be straightforward for some cases, but get more complex when business ownership involves stocks, trusts, or estates.
There are six different types of controlled groups:
- Parent-subsidiary
- Brother-sister
- Combination of parent-subsidiary and brother-sister
- Family attribution
- Organizational attribution
- Affiliated service
Parent-subsidiary controlled group
The parent-subsidiary controlled group is the simplest scenario, and is the easiest to understand. If a parent company owns at least 80% of another company’s stock, measured by vote or value, this relationship would be considered a parent-subsidiary controlled group.
For example, if Company A has 80% or more ownership of Company B, then they’d qualify as a controlled group. Company A would be the parent and Company B would be the subsidiary. If a retirement plan is offered to employees in Company A, it must also be offered to employees in Company B.
The companies could be in completely different industries, have different business structures, and have separate tax filings, but in the eyes of the IRS, in terms of retirement plans, the two companies are grouped as one employer.
This also applies for retirement plan eligibility. For example, a Solo 401k can be opened by any business owner with no full-time employees (excluding their spouse). If Company A has several full-time employees, but Company B has none, John is not eligible to open a Solo 401k with Company B because Company A has employees.
What if my company acquires another company?
There’s a special transition rule for mergers and acquisitions. If your company buys all of the stock of another company, you may be given one or two years before the parent-subsidiary controlled group rules take effect.
Brother-sister controlled group
In a brother-sister controlled group, the relationship is between common individual owners of a business.
A brother-sister controlled group relationship exists if at least two companies have both of the following attributes:
- Controlling interest: The same 5 or fewer individuals own (directly or indirectly by attribution) 80% or more of each company.
- Identical ownership: The common owners have identical ownership of more than 50%. Identical is the keyword here. It’s determined by adding together the lowest ownership percentage for each owner in the companies being tested.
Owners can be individuals, trusts, or estates. Both of the following attributes must apply in order for it be considered a brother-sister controlled group. Having just one of these attributes, but not the other, would not be considered a controlled group.
A simple example: You and your spouse both own a business
The most common case of a brother-sister controlled group is if you and your spouse both have your own businesses. Because you’re married, family attribution rules automatically consider you and your spouse as owners of both businesses. Your ownership is attributed to your spouse, and vice versa.
In this case, both businesses are considered as one brother-sister controlled group. You directly own your business and indirectly own your spouse’s business by attribution. If you have no employees and want to open a Solo 401k, you’re not eligible if your spouse’s business does have full-time employees. For retirement plan purposes, both businesses are considered as one employer.
There are exceptions for spouses, which we’ll discuss further down below.
Another example: You and other individuals have ownership in multiple businesses.
Jim, John, and James all have ownership of companies A, B, and C.
| Owner | Company A | Company B | Company C | Identical Ownership |
|---|---|---|---|---|
| Jim | 35% | 35% | 45% | 35% |
| John | 35% | 25% | 30% | 25% |
| James | 15% | 20% | 20% | 15% |
| Total | 85% | 80% | 95% | 75% |
In total, the three of them own at least 80% of all three companies. This meets the first brother-sister attribute of controlling interest. They also meet the identical ownership test because their identical ownership adds up to 75%, which is over the 50% requirement.
Identical ownership clarified further
An easy way to think about identical ownership is the percentage of ownership that an owner has in each company. The lowest ownership percentage across all three companies would be used, since that’s the percentage that an owner holds in each company.
Combined group
A combined group is the combination of a parent-subsidiary and a brother-sister controlled group, and consists of three or more organizations that meet the following attributions:
- Each organization is part of a parent-subsidiary or brother-sister controlled group.
- At least one corporation is the common parent of a parent-subsidiary, and is also a member of the brother-sister group.
Family attribution
Family attribution rules exist to prevent the use of your family members in order to get around the controlled group rules. You could be attributed ownership of a company that’s owned by your spouse, parents, grandparents, children, or grandchildren.
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.
Direct ownership could be attributed to more than one family member.
The 50% rule explained
In the cases above, 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%. For example, if you own 20% of a company, and your over 21 years of age child also owns 20%, then the stock does not get attributed since total ownership is only 40%. However, if you own 30% and your over 21 years of age child also owns 30%, then the stock is attributed since total ownership is over 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.
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.
Affiliated service group rules
Even if you pass the parent-subsidiary and brother-sister rules, you could still fall under the affiliated service group rules. The affiliated services rule acts like a catch-all rule so that business owners cannot work around the brother-sister and parent-subsidiary rules through the use of a service-based business.
If one company provides services for another company, they could be considered an affiliated service group and be subject to controlled group rules. If the service being provided is management services, then it could be considered an affiliated service group even if there is no common ownership.
There are three types of affiliated service groups:
- A-Organization (A-Org), consists of a First Service Organization (FSO) and at least one A-Org.
- B-Organization (B-Org), consists of a First Service Organization (FSO) and at least one B-Org.
- Management groups
What is a First Service Organization (FSO)?
An FSO is a company who provides any of the following services as their principal business, and receives compensation based upon providing these services:
- Health
- Law
- Engineering
- Architecture
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Insurance
What is an A-Organization?
An A-Org is also a service organization that is a partner or shareholder in the FSO and meets the following requirements:
- Both organizations are service organizations.
- Is a partner or shareholder in the FSO.
- Regularly perform services for the FSO, or is regularly associated with the FSO in performing services for third parties.
For example, you own 100% of a medical practice, and have some ownership of a massage therapy business down the street. You regularly refer your medical practice patients to the massage therapy business. This would be considered an affiliated service group. Both organizations are service businesses that you have ownership in, and they regularly work together to perform services for third parties. The medical practice would be the A-Org and the massage therapy business would be the FSO.
What is a B-Organization?
A B-Org is also a service organization that is a partner or shareholder in the FSO and meets the following requirements:
- Both organizations are service organizations.
- The performance of services for the FSO, one or more A-Orgs, or both, makes up a significant portion of its business (at least 10% of gross revenue). Significant portion testing is based on facts and circumstances.
- The services must be of a type historically performed by employees in the service field of the FSO or the A-Org.
- At least 10% of the interests in the B-Org must be held (in the aggregate) by highly compensated employees of the FSO or the A-Org. A highly compensated employee is any employee who is at least a 5% owner at any time during the year, regardless of compensation.
For example, you own 100% of your medical practice, and have a 15% stake in an accounting firm. Your medical practice regularly engages the services of the accounting firm, making up for 15% of their total gross income. This would be considered an affiliated service group. You are a highly compensated employee in your medical practice, have at least a 10% ownership in the accounting firm, and at least 10% of the accounting firm’s revenue comes from servicing your medical practice.
What is a management group?
With a management group, there are no ownership requirements like for an A-Org or B-Org. Controlled group rules could apply even if there is no common ownership and the following requirements are met:
- Regularly performs management services for another company.
- Receives over 50% of its income from managing the other company.
Management services include business planning, the management of daily operations, personnel, employee compensation and/or benefits, and any other standard management activities.
For example, you run an online writing business that employs writers to create digital content for other businesses. Your friend owns a management company that employs the managers and designers of your online writing business. The management company performs management activities for your writing company, and you are their only client. Even if there is no common ownership, both businesses would be considered as part of an affiliated service group because they meet the two requirements. The management company regularly performs management services for your online writing business, and over 50% of the management company’s revenue comes from your online writing business since it’s their only client.
Conclusion
Controlled group rules are extremely complex and many business owners don’t even realize they’re subject to controlled group rules through attribution or an affiliated service. If you only have one business, these rules don’t apply to you. But if you’re a business owner with interest in multiple businesses, it’s important to understand controlled group rules and seek the help of a plan provider, tax expert, attorney, or financial advisor.