Under the IRS’ controlled group rules, two or more employers with common ownership are considered a single employer for purposes of 401(k) nondiscrimination testing. These rules often obligate all members of a controlled group to cover their employees with the same 401(k) plan in order to pass annual coverage testing. It’s very important to pass coverage testing each year – failing can mean plan disqualification by the IRS – so making an accurate controlled group determination, and covering the necessary number of employees within that group, is essential for every 401(k) plan.

The controlled group rules exist to prevent employers from subdividing their businesses into separate companies - one company employing highly compensated employees (HCEs) and another employing non-highly compensated employees (NHCEs) – in order to test each company independently for nondiscrimination. If this practice was allowed, employers could provide a generous retirement plan to HCEs and a lousy plan (or no plan at all) to NHCEs without consequences.

The controlled group rules are generally straight-forward and a good 401(k) provider can easily assist most employers in determining their controlled group status. However, when common ownership involves stock, trusts or estates, a qualified ERISA attorney may be required to make an accurate determination.

When do companies represent a controlled group?

Two or more employers represent a controlled group when a “parent-subsidiary” or “brother-sister” relationship exists:

  • A parent-subsidiary relationship exists when one company owns 80% or more of another company
  • A brother-sister relationship exists when two companies meet two thresholds.
    • Common Ownership - 5 or fewer individuals own 80% or more of each company; and
    • Identical Ownership - the common owners have identical ownership of more than 50%.

Example of a brother-sister controlled group:

Owner Company A Ownership Company B Ownership Identical (lesser of A or B) Ownership
Brad 40% 20% 20%
Steve 10% 30% 10%
Eric 30% 40% 30%
John 20% 20% 20%
Rick 0% 10% 0%
Ownership 80% 90% 60%

Explanation: Companies A and B have 3 common owners - Brad, Steve and Eric. John and Rick are disregarded from the brother-sister test because they don’t have ownership in both companies. Brad, Steve and Eric meet the common ownership test because they own >=80% of Companies A and B. They also meet the identical ownership test because their identical ownership is >50%.

What if owners are related?

Under the controlled group rules, certain family members are “attributed” the ownership of other family members. When these rules apply, any attributed ownership must be added to an individual’s direct ownership to determine whether or not a controlled group exists.

Below is a summary of the controlled group family attribution rules:


Is generally attributed their spouse’s ownership unless all of the conditions listed in IRC §1563(e)(5) are satisfied


Is always attributed the ownership of a minor child (under age 21)

Is attributed the ownership of an adult child (21 or older) only if the parent owns (directly or by other attribution) more than 50% of the company.


Are never attributed the ownership of other siblings


A minor child is always attributed the ownership of a parent

An adult child is attributed a parent’s ownership only if the adult child owns (directly or by other attribution) more than 50% of the company.


Is attributed a grandchild’s ownership (regardless of age) only if the grandparent owns (directly or by other attribution) more than 50% of the company.


A grandchild (regardless of age) is attributed a grandparent’s ownership only if the grandchild owns (directly or by other attribution) more than 50% of the company.

How is coverage testing passed?

To pass coverage testing, a 401(k) plan must satisfy either the ratio percentage or the average benefit test each year. The ratio percentage test is most commonly used. To pass this test, the following calculation must equal or exceed 70%:

(Eligible NHCEs covered by the plan / Eligible NHCEs employed by controlled group) / (Eligible HCEs covered by plan / Eligible HCEs employed by controlled group) => 70%


  • Eligible– employees (including leased employees) who have satisfied the plan’s age and service requirements
  • HCE– any employee with > 5% ownership in any employer of controlled group or income in excess of the HCE threshold during the prior year)
  • NHCE– any employee who is not an HCE

Not knowing your controlled group status can be a costly mistake

To correct a failed coverage test, the employer may adopt a corrective amendment, up to 9½ months following the close of the plan year in which the failure occurred, to retroactively expand plan coverage. However, since the new participants can’t retroactively make 401(k) deferrals, a qualified nonelective contributions (QNEC) must be made to the new NHCEs to remedy their missed deferral opportunity. Any missed employer contributions must also be made.

When a coverage failure is not corrected within 9½ months, it’s considered a demographic failure by the IRS. Demographic failures can only be corrected using the IRS’ Voluntary Compliance Program (VCP). When a VCP correction is necessary, employer fines can apply.

Not correcting a demographic failure can result in plan disqualification if the issue is uncovered by the IRS during an audit.

Bottom line – it can be costly to correct a failed coverage test due to a blown controlled group determination. A controlled group determination should be done each year when nondiscrimination testing is completed and during any changes in employer ownership. If you are unsure about your company’s controlled group status, consult your 401(k) provider or legal counsel.