What is a legally related group?
Updated over a week ago

A legally related group is a group of business entities that are generally treated as one employer for the purposes of employment status, 401(k) compliance testing, compensation, eligibility, and vesting.

The reason these groups exist is because the IRS wants to prevent situations in which a plan sponsor avoids compliance testing and allocates employee benefits in an unequal manner by grouping otherwise eligible employees under separate entities.

As a 401(k) plan sponsor, you have a duty to ensure that employees have an equal opportunity to participate in any 401(k) plan offered. Therefore, it’s important to understand whether your company is part of a legally related group. As a base-line rule, the related group must generally ensure that at least 70% of non-highly compensated employees (NHCE) are covered under a 401(k) plan to the same extent as highly compensated employees (HCE).

At Guideline, we require all members of a legally related group to have a 401(k) plan with us so we can properly service the group as a whole. In addition, each plan of the legally related group must have the same plan design and be considered together for profit sharing and other discretionary contributions.

In addition, it is important to note that, for 401(k) plan purposes, the employees of a legally related group are evaluated at the group level to determine employment status. This means if employees move between entities of a legally related group, there is not a termination of employment for 401(k) plan purposes, and service with any entity of the related group counts for 401(k) eligibility and vesting rules.

For example, if a 401(k) plan has a 6-month service requirement and an employee works for 3 months at Entity A of the related group and transfers to a different entity in that group, Entity B, that employee would become eligible for the plan after 3 months of service at entity B. If the employee defers into the 401(k) while at Entity B and goes back to Entity A, there is no termination of employment, and that employee is not eligible for a distribution from the plan based on termination of employment (even if Entity A marks the employee as “terminated”).

Types of legally related groups

A legally related group can be either a controlled group or an affiliated service group.

Controlled groups

Generally, if your company is related to another company by a minimum level of ownership, it may be considered a controlled group. There are 3 principal types of controlled groups:

  • Parent/child groups

  • Brother/sister groups

  • Combined groups

You can learn more about each controlled group here.

All three types of controlled groups typically require at least 80% of shared ownership between the entities to create a controlled group. Be aware that attribution rules (including family attribution) apply when determining ownership and complex ownership structures can make the determination complex.

Affiliated service groups

An affiliated service group is a group of employers generally related by service that must be treated as one employer for 401(k) purposes. An affiliated service group may or may not have common ownership.

The IRS determination of an affiliated service group is somewhat complicated, but there are some key variables they look for, including:

  1. Business relationship: Does one entity provide services to a second entity that would typically be performed by the second entity’s employees? Or, do the entities join together to provide services to the same client?

  2. Common ownership: Is there any common ownership between the entities, even if it’s not enough to make a controlled group?

  3. Management: Does one entity provide management oversight over the other entity?

Here are some common examples of affiliated service groups:

  • Partner A, Partner B, and Partner C each form their own professional corporation. Each corporation then provides services to ABC Law Firm.

  • Doctors A, B, and C each form their own medical practices, but each own equal shares of a central billing office. The billing office solely serves these 3 practices.

  • Company A’s principal business is to provide management services to Company B.

You can find more details on affiliated service groups here.

Where ownership matters to the affiliated service group determination (it doesn’t always apply), attribution rules will also apply when determining ownership.

Exemptions to legally related group rules

In certain circumstances, larger employers with distinct divisions operating in different industries with more than 50 employees can be qualified as separate lines of business (QSLOB), which can be evaluated independently, despite having overlapping ownership. For example, a conglomerate like General Electric might operate multiple distinct divisions that maintain separate retirement plans.

Another exemption is when the businesses are owned by spouses, and they are not involved in each other’s businesses. To be exempt, all of the following must apply:

  • Each spouse has no involvement in the other’s business

  • Neither spouse is a board member, employee, fiduciary, or participates in the management of the other’s business

  • Not more than 50% of the income from either business is from passive income, such as royalties, rents, dividends, interest, or annuities

  • Spouse’s ownership is not subject to restrictions that benefit the spouse or minor children

QSLOB determinations are complex and require notification to the IRS. You should consult with legal or financial professionals when making the determination.

What happens if my company is part of a legally related group?

If your company is in a legally related group with another business (as a controlled group, or affiliated service group), compliance testing will be conducted at the group level as though the related entities were one.

Guideline, or any other organization that is performing testing for companies in the legally related group, will need employee data, including each employee's salary, age, and contribution amounts, as well as year-end contribution balance, for each company in the legally related group.

Whether your plan passes compliance testing will depend in part on the coverage and participation of employees in the legally related companies. This creates challenges if one company in the group offers a more generous 401(k) plan than another, has higher participation rates, or even just has a different ratio of highly compensated and non-highly compensated employees.

If any tests fail, plan corrections will need to be made. This is why Guideline requires all members of a legally related group to have a 401(k) plan at Guideline with the same plan design in order to service any plan of the legally related group.

You can report legally related entities to Guideline so we can help ensure your plan complies with IRS requirements. If you believe that related companies may not have been included in compliance testing for the prior year, please notify us immediately.

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