A controlled group is a collection of two or more corporations whose stock is held substantially by five or fewer persons. These corporations are treated as a single entity under U.S. tax law for the purpose of computing income tax, the alternative minimum tax (AMT) exemption, the accumulated earnings credit, and the environmental tax exemption.
Types of Controlled Groups
Brother-Sister Groups
A brother-sister controlled group exists when two or more corporations are owned by five or fewer individuals, estates, or trusts. These individuals must collectively own at least 50% of the total voting power or total value of the stock of each corporation.
Parent-Subsidiary Groups
A parent-subsidiary controlled group is created when one corporation (the parent) owns 80% or more of the total voting power or total value of another corporation (the subsidiary).
Combined Groups
A combined group consists of three or more corporations, where each corporation is either:
- A member of a parent-subsidiary group.
- A member of a brother-sister group.
Special Considerations
Income Tax Computations
The Internal Revenue Service (IRS) imposes specific rules on controlled groups for computing income tax. These rules are designed to prevent tax evasion and ensure fair taxation.
Alternative Minimum Tax (AMT) Exemption
Controlled groups have special provisions for calculating the AMT exemption. This prevents corporations within the group from avoiding the AMT by redistributing income.
Accumulated Earnings Credit
Corporations in a controlled group must share the accumulated earnings credit. This is to prevent the deferral of taxes on undistributed earnings by distributing them among the group members.
Environmental Tax Exemption
Controlled groups share the exemption from environmental taxes, which ensures that the tax benefits are not disproportionately enjoyed by corporations within the group.
Examples
Example 1: Parent-Subsidiary Group
Company A holds 85% of the stock of Company B. Therefore, Company A and Company B form a parent-subsidiary controlled group.
Example 2: Brother-Sister Group
Five individuals own 80% of Company X and 90% of Company Y. These companies form a brother-sister controlled group as the same five individuals own more than 50% of each corporation.
Historical Context and Applicability
The concept of controlled groups was developed to close loopholes where corporations could avoid taxes by spreading profits and losses among closely held entities. The rules have evolved to include various tax exemptions and credits to balance the interests of businesses and tax enforcement agencies.
Comparisons
Controlled groups are often compared to affiliated groups in tax law. While both terms refer to collections of corporations, affiliated groups involve requirements related to consolidated tax returns under IRC Section 1504.
Related Terms
- Affiliated Group: Corporations eligible to file a consolidated tax return.
- Subsidiary: A corporation controlled by another corporation (parent).
FAQs
Q: Can a controlled group consist of more than two corporations? A: Yes, a controlled group can consist of multiple corporations under the parent-subsidiary or brother-sister definitions.
Q: Are non-profit organizations subject to controlled group rules? A: Generally, non-profit organizations are not subject to controlled group rules, but specific regulations may vary.
Q: How does being part of a controlled group affect tax returns? A: Corporations in a controlled group must apply special tax rules that could impact how they report income, taxes, and credits.
References
- Internal Revenue Code (IRC) Section 1563.
- IRS Publication 542, “Corporations.”
- Treasury Regulations (26 CFR).
Summary
Controlled groups are interconnected corporations treated as a single entity for tax purposes. Different types of controlled groups, such as brother-sister and parent-subsidiary groups, are subject to special rules and provisions that dictate how they compute taxes, exemptions, and credits. Understanding these rules is crucial for proper tax planning and compliance.
