Is Your Company Part of a Controlled Group?  You Need to Know or Risk 401(k) Plan Disqualification Blog Feature
Eric Droblyen

By: Eric Droblyen on January 13th, 2016

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Is Your Company Part of a Controlled Group?  You Need to Know or Risk 401(k) Plan Disqualification

Plan Design | Controlled Groups | Plan Setup

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.

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Example of a brother-sister controlled group:


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:


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 contribution (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.

If you're still overwhelmed by all of the 401(k) plan options, download our free 401(k) Plan Design Checklist to gain a better understanding of the best fit for your company.

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About Eric Droblyen

Eric Droblyen began his career as an ERISA compliance specialist with Charles Schwab in the mid-1990s. His keen grasp on 401k plan administration and compliance matters has made Eric a sought after speaker. He has delivered presentations at a number of events, including the American Society of Pension Professionals and Actuaries (ASPPA) Annual Conference. As President and CEO of Employee Fiduciary, Eric is responsible for all aspects of the company’s operations and service delivery.

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