Who's the Employer

A Guide to Employee and Aggregation Issues Affecting Qualified Plans

Private Letter Ruling 8851079

This ruling is a fascinating demonstration of several easily misunderstood points dealing with controlled groups.  It deals with the application of the exclusion rules and attribution rules affecting ESOPS (and, for that matter, other qualified plans).  It does so in the context of IRC 409(l)(4)(A), which is similar to IRC 414(b).  Thus, these conclusions would hold for general retirement plan issues For normal income tax issues, there would not be attribution from a retirement trust to its beneficiaries.  Notice that it holds that the 5 common owners for purposes of the excluded stock rules do not have to be the same as the 5 owners used for purposes of determining effective control or a controlling interest.  Moreover, the stockholder whose stock is to be excluded can be counted in determining the 5 common owners. 

I make two other comments in the ruling.  Those appear in blue.

Date: September 30, 1988

Refer Reply to: E:EP:R:9

LEGEND:
Company M = * * *
Company N = * * *
Company O = * * *
Plan X = * * *
Individual A = * * *
Individual B = * * *
Individual C = * * *
Individual D = * * *
Individual E = * * *

Dear * * *
This is in response to a ruling request dated March 3, 1988, as supplemented and amended by your letters dated July 15, 1988 and September 9, 1988, which you submitted on behalf of Company M as their authorized representative. The ruling request concerns the effect upon the controlled group status of Companies N and O, with Company M, as it applies to the definition of employer securities, if shareholders complete a proposed sale of Company M stock to Plan X, an employee stock ownership plan (ESOP).
You submitted the following facts:
Company M amended Plan X to meet the ESOP requirements on October 1, 1984, and received its most recent favorable determination letter on June 5, 1985. Employees of Companies M, N, and O are eligible to participate in Plan X.
Company M has no authorized class of stock other than the voting common stock currently issued and outstanding. Company M's stock is not readily tradable on any established securities market. Prior to completion of the proposed sale described below, the ownership of Company M stock is as follows:

Company N has no authorized class of stock other than the voting common stock currently issued and outstanding. The outstanding stock of Company N is held as follows:

Company O has no authorized class of stock other than the voting common stock currently issued and outstanding. The outstanding stock of Company O is held as follows:

Plan X is in the process of purchasing an additional 12 percent of the voting common stock in Company M ("proposed sale"). Plan X is purchasing this stock in approximately equal amounts from Individual A, Individual A's spouse, and Individual E. This purchase will be at the fair market value of such stock as determined by an independent appraisal, pursuant to a contract entered into on February 8, 1988.
Based on these facts you have requested a ruling that, after the proposed sale, Company N and Company O will be members of a controlled group with Company M within the meaning of Code section 1563(a) (determined without regard to subsection (a)(4) and (e)(3)(C) of section 1563) for purposes of defining employer securities under section 409(1).
Section 409(1)(2) of the Code defines employer securities when there is no employer issued common stock which is readily tradable on an established securities market. This definition provides, in relevant part, that an employer security is common stock issued by the employer (or by a corporation which is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of: (A) that class of common stock of the employer (or of any other such corporation) having the greatest voting power; and (B) that class of common stock of the employer (or of any other such corporation) having the greatest dividend rights.
Code section 409(1)(4)(A) provides that for purposes of defining employer securities, a "controlled group of corporations" has the meaning given this term by section 1563(a) (determined without regard to subsections (a)(4) and (e)(3)(C) of section 1563).
Section 1563(a)(2) of the Code provides that two corporations are members of a brother-sister controlled group if five or fewer persons who are individuals, estates or trusts own (within the meaning of subsection (d)(2)) stock possessing --
(A) at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of the stock of each corporation, and
(B) more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each person only to the extent such stock ownership is identical with respect to each such corporation.
Section 1563(d)(2) of the Code provides that for purposes of determining whether a corporation is a member of a brother-sister controlled group of corporations, stock owned by a person who is an individual, estate or trust means (A) stock owned directly by such person, and (B) stock owned with the application of subsection (e). Section 1563(e) provides constructive ownership or attribution rules for stock owned by related parties. Section 1563(e)(3)(C) provides that stock held by a qualified employees' trust is not to be attributed to the beneficiaries of that trust. However, under section 409(l)(4)(A), section 1563(e)(3)(C) is to be disregarded. Therefore, the stock owned by a qualified trust is attributed to the beneficiaries in accordance with the normal rules of section 1563(e)(3), with the result that stock owned by a trust is attributed to any beneficiary with five percent or more of an actuarial interest, to the extent of such actuarial interest, assuming maximum exercise of discretion in favor of such beneficiary and maximum use of stock to satisfy the beneficiary's rights. Section 1563(e)(5) provides, with several exceptions not relevant to this ruling request, that an individual shall be considered as owning stock owned directly or indirectly, by or for his or her spouse. Section 1563(e)(6)(A) states that an individual shall be considered as owning stock owned, directly or indirectly, by or for his or her children who have not attained the age of 21 years.
Section 1563(c)(1)(C) of the Code provides that "stock" does not include stock which is treated as "excluded stock". Section 1563(c)(2)(B)(i) provides, in part, that for purposes of subsection (a)(2), if five or fewer persons who are individuals, estates or trusts own (within the meaning of subsection (d)(2)) 50 percent or more of the total combined voting power of all classes of stock in a corporation, then stock in such corporation held by an employees' trust described in section 401(a) which is exempt from tax under section 501(a) shall be treated as excluded stock if such trust is for the benefit of the employees of such corporation.
In applying both the controlled group test and the excluded stock test, the ownership rules of section 1563(d)(2) and 1563(e) are to be applied. These rules require the attribution of ownership of the stock of Company M, Company N and Company O between the following stockholders:
1. Stock in Company M owned by the spouse of Individual A is attributed to Individual A, and vice versa, because they are husband and wife and they are both stockholders in Company M.
2. Stock in Company M owned by the spouse of Individual C is attributed to Individual C, and vice versa, because they are husband and wife and they are both stockholders in Company M.
3. Stock in Company M owned by the spouse of Individual D is attributed to Individual D, and vice versa, because they are husband and wife and they are both stockholders in Company M.
4. Stock owned by the child of Individual A is attributed to Individual A, because the child is under the age of 21.
5. 1.68 percent of Company M's stock owned by Plan X is attributed to Individual A because he or she has a five percent or more interest in Plan X. It has been represented that no other Company M stock held by Plan X should be attributed to any person because no other participant has five percent or more interest in Plan X.
Therefore, following the application of the attribution rules, the shareholders control the following shares of Company M.

The test for control of Company M under section 1563 of the Code begins with the excluded stock test under section 1563(c)(2)(B)(i). This test requires that five or fewer stockholders own more than 50 percent of the stock of Company M. Following the proposed sale, by including Plan X as a stockholder and applying the attribution rules under section 1563(e), the 50 percent control test is met as follows:

NOTE:  In the foregoing table the 1.68% attributed from Plan X to Individual A is being counted twice.  I believe that is erroneous, but it does not affect the conclusion.

Because five or fewer stockholders control 50 percent or more of the voting common stock, the stock in Company M held by Plan X, which is described in section 401(a) of the Code and maintains a trust which is exempt from tax under section 501(a), shall be treated as excluded stock for purposes of section 1563(a)(2).
Therefore, under section 1563(a)(2) of the Code, following the application of the attribution and exclusion rules under section 1563, Companies N and O are members of a controlled group with Company M because the same five or fewer shareholders own stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote, and more than 50 percent of the total combined voting power of all classes of stock entitled to vote of each corporation, taking into account the stock ownership of each person only to the extent such stock ownership is identical with respect to each corporation as follows:

NOTE:  Although the ruling does not go this far, it should be noted that M, N, and O are a single controlled group on these facts, not two overlapping groups.

Accordingly, based upon Company M's representations and the applicable law, we conclude that, for purposes of defining employer securities under Code section 409(1), after the sale of Company M's stock to Plan X, Company N and Company O will be members of a controlled group with Company M within the meaning of Code section 1563(a) (determined without regard to subsection (a)(4) and (e)(3)(C) of section 1563).
This ruling is limited to a determination of the controlled group status of Companies N and O with Company M. This ruling does not address whether and to what extent the common stock of Company M is an employer security as defined under Code section 409(1). This ruling is also based upon the assumptions that Plan X is established and maintained in conformance with section 4975(e)(7) such plan is qualified under section 401(a), and the related trust is tax exempt under section 501(a).
This letter is sent to you, as the authorized representative of Company M, pursuant to the power of attorney on file with this office. A copy of this letter has been forwarded to Company M.

Sincerely yours,

Joyce E. Floyd
Acting Chief, Employee Plans
Rulings Branch

Copyright © 2005, S. Derrin Watson.  All rights reserved.