Small business owners often wear multiple hats—and sometimes, those hats include ownership in more than one business. If that sounds like you, it’s essential to understand the IRS controlled group rules. Why? Because owning multiple businesses (or having family members who do) can trigger complex 401(k) compliance requirements that, if ignored, may lead to steep IRS penalties.
This post will explain what a controlled group is, how to identify one, the risks of getting it wrong, and how changes made by SECURE 2.0 Act of 2022 (SECURE 2.0) affect spouses with separate businesses.
A controlled group exists when two or more businesses are sufficiently related through common ownership or control. Internal Revenue Code (IRC) §1563 outline the controlled group rules. They aim to prevent business owners from dividing employees across multiple businesses to avoid 401(k) nondiscrimination requirements.
The IRS considers a controlled group of businesses to be a single employer for 401(k) plan purposes. That means the entire workforce of a controlled group must be included when conducting annual coverage testing.
When a 401(k) plan fails coverage testing due to an overlooked controlled group member, the consequences can be serious and escalate over time.
For controlled group purposes, ownership is generally defined in terms of stock ownership for corporations or capital/profit interest for partnerships. The specific definition depends on the type of entity involved.
When determining ownership, you must apply the attribution rules under IRC §1563(e). Attribution treats a person as owning an interest they do not directly hold—typically due to a family or business relationship.
Individuals can be attributed ownership through:
The two most common types of controlled groups are “parent-subsidiary” and “brother-sister”:
Below is an example of a brother-sister controlled group. In this case, three individuals—Brad, Steve, and Eric—are common owners of both Businesses A and B. John and Rick are disregarded because they do not have ownership in both businesses. Brad, Steve, and Eric meet the common ownership threshold (≥80% combined ownership in each business) and the identical ownership threshold (>50% identical ownership between the businesses).
|
Owner |
Business A Ownership |
Business B Ownership |
Identical Ownership (lesser of A or B) |
|
Brad |
40% |
20% |
20% |
|
Steve |
10% |
30% |
10% |
|
Eric |
30% |
40% |
30% |
|
John |
20% |
0% |
0% |
|
Rick |
0% |
10% |
0% |
|
Ownership |
100% |
100% |
60% |
For small business owners, family members are the most common source of attributed ownership. This attribution can unintentionally create a controlled group—even when ownership is legally separate. Below is a summary of the family attribution rules under IRC §1563(e):
|
Family Member |
Attribution Rule |
|
Spouse |
Is generally attributed their spouse’s ownership unless the spousal exception applies. To qualify for the exception, all of the following conditions must be met throughout the entire year:
|
|
Parent |
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 business |
|
Children |
A minor child (under age 21) is always attributed the ownership of a parent |
|
|
An adult child (21 or older) is attributed a parent's ownership only if the adult child owns (directly or by other attribution) more than 50% of the business. |
|
Grandparent |
Is attributed a grandchild's ownership (regardless of age) only if the grandparent owns (directly or by other attribution) more than 50% of the business. |
|
Grandchild |
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 business. |
|
Siblings |
Are never attributed the ownership of other siblings |
The SECURE 2.0 Act of 2022 (SECURE 2.0) simplified the family attribution rules by removing two overrides to the spousal exception. The change makes it easier for spouses with separate businesses to maintain standalone 401(k) plans – each tailored to meet the goals of the respective business – without running afoul of the coverage testing rules.
In community property states like California and Texas, married couples must split all assets acquired during marriage. Prior to SECURE 2.0, these laws prevented spouses with unrelated businesses from qualifying for the spousal exception.
Starting in 2024, community property laws are disregarded for purposes of determining whether the spousal exception is met.
Prior to SECURE 2.0, attribution from a minor child to both parents created an automatic ownership nexus that nullified the spousal exception.
Starting in 2024, minor children are disregarded when determining whether the spousal exception applies.
A common reason for 401(k) coverage test failure is accidentally excluding employees from a business that should have been treated as part of the controlled group. When a business fails to recognize this relationship, it may improperly exclude employees from plan participation—putting the plan at risk.
The consequences of a failed coverage test depend on when the issue is corrected:
Controlled group rules are one of the most misunderstood—and risky—areas of 401(k) compliance for small business owners. The SECURE 2.0 Act offers new flexibility for certain family-owned companies, but getting the analysis wrong can still lead to serious compliance failures.
If you have any ownership in more than one company—or your spouse or child does—don't guess. Work with your retirement plan provider or an ERISA attorney to confirm your status and stay compliant.