Source: https://www.irs.gov/newsroom/faqs-regarding-the-aggregation-rules-under-section-448c2-that-apply-to-the-section-163j-small-business-exemption
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FAQs Regarding the Aggregation Rules Under Section 448(c)(2) that Apply to the Section 163(j) Small Business Exemption | Internal Revenue Service
These FAQs provide an overview of the aggregation rules that apply for purposes of the gross receipts test under Internal Revenue Code (Code) section 448(c) (section 448(c) gross receipts test), and that apply in determining whether a taxpayer meets the small business exemption under section 163(j) of the Code. Please refer to the Code and Income Tax Regulations for the aggregation rules.
Generally, section 163(j) limits deductions for business interest expense for tax years beginning after December 31, 2017 (section 163(j) limitation). Taxpayers who qualify for the exemption under section 163(j)(3) (small business exemption) are not subject to the section 163(j) limitation. A taxpayer qualifies under the small business exemption if the taxpayer is not a tax shelter (as defined in section 448(d)(3)), and meets the section 448(c) gross receipts test.1 A taxpayer meets the section 448(c) gross receipts test if the taxpayer has average annual gross receipts for the past three taxable years of not more than $25 million, which is adjusted annually for inflation. For taxable years beginning in 2019 and 2020, the inflation adjusted average annual gross receipts amount is $26 million.2
To determine whether the section 448(c) gross receipts test is met, the aggregation rules under section 448(c)(2) apply. Generally, the aggregation rules combine the gross receipts of multiple taxpayers if they are treated as a single employer under the controlled group rules of sections 52(a) or 52(b), under the affiliated service group rules of section 414(m), or under the rules of section 414(o)3. The application of these rules is designed to prevent taxpayers from circumventing the section 448(c) gross receipts test by dividing into multiple related entities that individually could meet the section 448(c) gross receipts test.
In general, the section 448(c) gross receipts test only applies to corporations and to partnerships with a C corporation partner 4; but, for purposes of the small business exemption, all taxpayers are subject to the section 448(c) gross receipts test. Taxpayers that would not otherwise apply the section 448(c) gross receipts test should apply it as if they were a corporation or a partnership5, but should treat themselves as the type of entity that they actually are when applying sections 52(a), 52(b), 414(m), and 414(o) of the Code 6. For example, a taxpayer that is a partnership without a corporate partner should still apply the section 448(c) gross receipts test for purposes of section 163(j), but apply the partnership definition of controlling interest for purposes of the aggregation rules under §1.52-1(c)(2)(iii) and (d)(2)(iii) of the Income Tax Regulations.
The FAQs are divided into three parts and provide a general overview of the aggregation rules that apply under (i) section 52(a) to corporations; (ii) section 52(b) to partnerships, trusts, estates, corporations, or sole proprietorships; and (iii) section 414(m) to organizations (defined in section 414(m)(6)(A) as a corporation, partnership6, or other organization).
1Section 163(j)(3); § 1.163(j)-2(d)(1).
2Rev. Proc. 2018-57, 2018-49 I.R.B. 827; Rev. Proc. 2019-44, 2019-47 I.R.B. 1093.
3Section 448(c)(2).
4§ 1.448-1T(f).
5Section 163(j)(3); § 1.163(j)-2(d)(2).
6 See T.D. 9905, at pmbl. part III(B). In particular, sections 52(a) and 52(b) employ different ownership thresholds for different types of entities (corporations, partnerships, trusts or estates, and sole proprietorships) in testing for effective control, controlling interests, etc. In addition, brother-sister aggregation applies only when the same five or fewer persons that are individuals, trusts, or estates are in effective control of and own controlling interests in a group of organizations.
Part 1: Aggregation Rules That Apply When All Entities Considered for Aggregation are Corporations
Q-1. What aggregation rules apply when all entities considered for aggregation are corporations?
A-1. The aggregation rules under section 52(a), which refer to the rules in section 1563 of the Code, apply when all of the taxpayers are corporations. Under these rules, taxpayers may be required to aggregate as a parent-subsidiary controlled group, a brother-sister controlled group, or a combined group of corporations 7.
7Section 1563(a).
Q-2. What is a parent-subsidiary controlled group?
A-2. A parent-subsidiary controlled group is one or more chains of corporations where:8
There is a common parent corporation; and
The common parent corporation owns more than 50 percent of the total-
combined voting power of all classes of stock entitled to vote of at least one of the other corporations, or
value of shares of all classes of stock of at least one of the other corporations.
If these requirements are satisfied, the parent-subsidiary controlled group will also include any corporation that is owned more than 50-percent (taking into account the total combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock) by any other corporation that is a member of the group.
Example9: As illustrated in the table below, P Corporation owns 80 percent of the total combined voting power of all classes of stock entitled to vote of T Corporation. T Corporation owns 80 percent of the total value of shares of all classes of stock of X Corporation.
P 80 --
Analysis: P is the common parent of a parent-subsidiary controlled group consisting of member corporations P, T, and X. The result would be the same if P, rather than T, owned the X stock.
8Section 1563(a)(1), as modified by section 52(a)(1) (which substitutes “more than 50 percent” for “at least 80 percent” each place it appears in section 1563(a)(1)).
9§ 1.1563-1(a)(2)(ii), Ex. 2.
Q-3. What is a brother-sister controlled group?
A-3. A brother-sister controlled group is two or more corporations where both of the following requirements are satisfied:10
80 Percent Ownership Requirement: Five or fewer persons who are individuals, estates, or trusts own at least 80 percent of —
the total combined voting power of all classes of stock entitled to vote of each corporation, or
the total value of shares of all classes of the stock of each corporation; and
Identical Ownership Requirement: The same five or fewer persons, taking into account ownership only to the extent that it is identical with respect to each corporation, own 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, or
value of shares of all classes of stock of each corporation, taking into account the stock ownership of each person.
Example:11 The only outstanding class of stock of each of corporations P, W, X, Y, and Z, is owned by the following unrelated individuals:
P (%) W (%) X (%) Y (%) Z (%)
B 45 49 0 0 0 0 (if considering all corporations)
45 (if considering only Corporations P and W)
C 0 0 45 0 0 0
D 0 0 0 45 0 0
E 0 0 0 0 45 0
Corporations P, W, X, Y, and Z are not members of a brother-sister controlled group. However, Corporations P and W are members of a brother-sister controlled group.
Analysis for all five corporations:
Identical Ownership Requirement: The identical ownership requirement is met because more than 50 percent of the outstanding stock of each corporation is owned by Individual A, taking into account only the identical ownership. Individual A's identical ownership in each corporation is 51 percent. The other individuals do not meet the Identical Ownership Requirement because they do not own stock of some of the corporations.
80 Percent Ownership Requirement: The 80 Percent Ownership Requirement is not met because the same five or fewer individuals do not own at least 80 percent of the combined voting power or value of shares in the corporations. Individual A is the only common owner of the corporations, so only A is considered for purposes of the "same five or fewer" requirement. A only owns 55 percent of the stock of Corporations P, X, Y, and Z, and only 51 percent of the stock of Corporation W. Since A does not own 80 percent of the stock of each corporation, this requirement is not met.
Analysis for Corporations P and W:
Identical Ownership Requirement: The Identical Ownership Requirement is met for Corporations P and W because more than 50 percent of the outstanding stock of each corporation is owned by Individual A and Individual B. Individual A's identical ownership in each corporation is 51 percent, and Individual B's identical ownership is 45 percent, totaling 96 percent.
80 Percent Ownership Requirement: The 80 percent ownership requirement is met because collectively, Individuals A and B own 100 percent of Corporation P (A owns 55 percent and B owns 45 percent) and Individuals A and B own 100 percent of Corporation W (A owns 51 percent and B owns 49 percent).
10Section 1563(f)(5).
11§ 1.1563-1(a)(3)(iii), Ex. 1.
Q-4. What is a combined group of corporations?
A-4. A combined group of corporations is three or more corporations, each of which is a member of either a parent-subsidiary or a brother-sister controlled group, and at least one of which is both the common parent of a parent-subsidiary controlled group and also a member of a brother-sister controlled group.12
12 Section 1563(a)(3).
Q-5. How is ownership determined for purposes of a parent-subsidiary or brother-sister controlled group?
A-5. In determining whether a corporation is a member of a controlled group, "stock owned by a corporation" means stock of a corporation owned directly by another corporation and stock of the corporation that is constructively owned by the other corporation. The following constructive ownership rules apply: 13
Options: If any person has an option to acquire stock of a corporation, the stock is considered to be owned by the person.
Attribution from partnerships: Stock of a corporation owned, directly or indirectly, by or for a partnership is considered to be owned by any partner having an interest of 5 percent or more in either the capital or profits of the partnership in proportion to his interest in capital or profits, whichever proportion is the greater.
Attribution from estates or trusts:
Stock of a corporation owned, directly or indirectly, by or for an estate or trust is considered to be owned by any beneficiary who has an actuarial interest of 5 percent or more in the stock, to the extent of such actuarial interest.
Stock of a corporation owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under subpart E of part I of subchapter J of chapter 1 of the Code (relating to grantors and others treated as substantial owners) is considered as owned by such person.
Additional constructive ownership rules that apply only to brother-sister controlled groups are:
Attribution from corporations: Stock of a corporation owned, directly or indirectly, by or for another corporation is considered to be owned by any person who owns 5 percent or more in value of the other corporation's stock in the same proportion of the value of the stock of the other corporation that the person owns relative to the value of all the stock of the other corporation.
Spouse: Subject to several exceptions, an individual is considered to own stock of a corporation owned, directly or indirectly, by or for his or her spouse.14
Children, grandchildren, parents, and grandparents:
An individual is considered to own stock of a corporation owned, directly or indirectly, by or for his or her children (including adopted children) who have not attained the age of 21, and, if the individual has not attained the age of 21, the stock of the corporation owned, directly or indirectly, by or for his or her parents.
An individual who owns more than 50 percent of (1) the total combined voting power of all classes of stock entitled to vote, or (2) the total value of shares of all classes of stock of a corporation, is considered to own the stock of the corporation owned, directly or indirectly, by or for his or her parents, grandparents, grandchildren, and children (including adopted children) who have attained the age of 21.
13Section 1563(e).
14See section 1563(e)(5)(A)—(D) for the exceptions.
Part 2 - Aggregation Rules That Apply to Trades or Businesses That are Partnerships, Trusts, Estates, Corporations, or Sole Proprietorships
Q-6. What are the aggregation rules that apply to partnerships, trusts, estates, corporations, or sole proprietorships?
A-6. The aggregation rules under section 52(b) and § 1.52-1(b) apply to partnerships, trusts, estates, corporations, or sole proprietorships. Under these rules, taxpayers may be required to aggregate as a parent-subsidiary group, brother-sister group, or a combined group under common control.
Q-7. How are the parent-subsidiary group rules different for partnerships, trusts, estates, corporations, or sole proprietorships?
A-7. Generally, the parent-subsidiary group rules under section 52(b) are the same as the aggregation rules that apply to corporations under section 52(a). There must be a common parent organization and such organization must own:15
For a corporation, more than 50 percent of the total —
combined voting power of all classes of stock entitled to vote of the corporation, or
value of the shares of all classes of stock of the corporation;
For a trust or estate, an actuarial interest of more than 50 percent of the trust or estate;
For a partnership, more than 50 percent of the profit interest or capital interest of the partnership; and
For a sole proprietorship, the individual must be the sole proprietor.
For an example, see A-2, but assume that at least P, T, or X is not a corporation. The analysis is the same.
Q-8. How are the brother-sister group rules different for trades or businesses that are partnerships, trusts, estates, corporations, or sole proprietorships?
A-8. Instead of the 80 Percent and Identical Ownership Requirements that apply to corporations, a brother-sister group exists among organizations conducting trades or business if two or more such organizations satisfy the following requirements:16
Controlling Interest Requirement: Five or fewer persons who are individuals, estates, or trusts own a "controlling interest" of each organization; and
Effective Control Requirement: The same five or few persons considered for purposes of the Controlling Interest Requirement must be in "effective control" of each organization, taking into account the ownership of each person only to the extent that person's ownership is identical with respect to each organization.
A "controlling interest" means:17
For a corporation, ownership of at least 80 percent of the total—
For a trust or estate, ownership of an actuarial interest of a least 80 percent of the trust or estate;
For a partnership, ownership of at least 80 percent of the profit interest or capital interest of the partnership; and
"Effective control" means:18
For a corporation, ownership of more than 50 percent of the total —
For a trust or estate, ownership of an actuarial interest of more than 50 percent of the trust or estate;
For a partnership, ownership of more than 50 percent of the profit interest or capital interest of the partnership; and
For a sole proprietorship, ownership of the sole proprietorship.
The Controlling Interest and Effective Control Requirements under section 52(b) apply in the same way as the 80 Percent and Identical Ownership Requirements apply to corporations under section 52(a). (See Part 1.) For an example, see A-3, but assume instead that P, W, X, Y, and Z are a combination of different organizations, rather than just corporations. The analysis is the same.
1552-1(c)(2).
16§ 1.52-1(d)(1).
17§ 1.52-1(d)(2).
18§ 1.52-1(d)(3).
Q-9. Are the rules that apply to a combined group under common control under section 52(b) the same as the aggregation rules that apply to corporations under section 52(a)?
A-9. Yes. A combined group under common control is a group of three or more organizations, where each organization is a member of either a parent-subsidiary or brother-sister group under common control, and at least one organization is the common parent organization of a parent-subsidiary group and also a member of a brother-sister group.19 (See Part 1).
Q-10. How is ownership determined for purposes of a parent-subsidiary or brother-sister group under common control?
A-10. In determining whether an organization is a member of a parent-subsidiary or brother-sister group under common control, ownership means direct ownership of stock of a corporation or an interest in an organization, as well as constructive ownership. The constructive ownership rules that apply to parent-subsidiary and brother-sister groups under common control are:20
Options: If a person has an option to acquire any outstanding interest in an organization, the interest is considered as owned by that person.
There are additional constructive ownership rules that only apply to brother-sister groups:
Attribution from partnerships: An interest owned, directly or indirectly, by or for a partnership is considered to be owned by any partner having an interest of 5 percent or more in either profits or capital of the partnership in proportion to such partner's interest in the profits or capital, whichever proportion is greater.
Attribution from estates and trusts: An interest in an organization owned, directly or indirectly, by or for an estate or trust is considered to be owned by any beneficiary of the estate or trust who has an actuarial interest of 5 percent or more in the organization interest, to the extent of the actuarial interest.
Attribution from corporations: An interest owned, directly or indirectly, by or for a corporation is considered to be owned by any person who owns 5 percent or more in value of the stock of the corporation in that proportion which the value of the stock which the person so owns bears to the total value of all the stock of the corporation.
Spouse: Subject to certain exceptions, an individual is considered to own an interest that is owned, directly or indirectly, by or for his or her spouse.21
An individual is considered to own an interest, directly or indirectly, by or for the individual's children (including adopted children) who have not attained the age of 21, and if the individual has not attained the age of 21, an interest owned, directly or indirectly, by or for the individual's parents.
If an individual is in effective control of an organization, then the individual is considered to own an interest in the organization that is owned, directly or indirectly, by or for the individual's parents, grandparents, grandchildren, and children (including adopted children) who have attained the age of 21.
19§ 1.52-1(e).
20Ownership for purposes of § 1.52-1 is determined by either direct ownership, or with application of constructive ownership rules under § 1.414(c)-4. For parent-subsidiary groups, only the rules under § 1.414(c)-4(b)(1), relating to options, are applied. For brother-sister groups, all constructive ownership rules of § 1.414(c)-4 apply. Compare §§ 1.52-1(c)(1)(i) and (ii) with § 1.52-1(d)(1)(i). See T.D. 8179, 84 FR 33002 (7/11/19).
21See § 1.414(c)-4(b)(5)(ii) for the exception.
Part 3 – Aggregation Rules That Apply to Affiliated Service Groups
Q-11. What are the aggregation rules that apply to affiliated service groups?
A-11. Section 414(m) was added to the Code in order to aggregate certain organizations that did not have sufficient common ownership or control to form a controlled group under section 414(b) or (c).22 There are three types of affiliated service groups described in section 414(m). The two types of affiliated service groups described under section 414(m)(2) require a combination of common ownership and performance of services among entities. The third type of affiliated service group described under section 414(m)(5) requires no common ownership, and aggregates employers based on the performance of management services of one entity provided to another entity (and related entities).
Section 414(m)(2) Affiliated Service Groups
Under section 414(m)(2), an affiliated service group is a group consisting of a "service organization" (referred to as the first organization),23 and either an "A organization" or a "B organization." An organization means a corporation, partnership, or other organization, for purposes of section 414(m).24
Definition of an A organization: An "A organization" is any service organization which (i) is a shareholder or partner in the first organization, and (ii) regularly performs services for the first organization or is regularly associated with the first organization in performing services for third parties. The first organization and the A organization must each be a service organization.
Example of an A organization affiliated service group: Corporation Y and Corporation Z form Partnership X (the first organization), the principal business of which is the performance of services. Corporations Y and Z (and other related service organizations) and Partnership X would constitute an affiliated service group if Corporations Y and Z regularly provide services to Partnership X or are regularly associated with Partnership X in performing services for third parties.
Definition of a B organization: A "B organization" is any other organization if (i) a significant portion of the business of such organization is the performance of services (for the first organization, for an A organization, or for both) of a type historically performed in such service field by employees, and (ii) 10 percent or more of the interests in such organization is held by persons who are highly compensated employees25 of the first organization or an A organization.
Example of a B organization affiliated service group: C is an individual partner in Partnership Z (the first organization), the principal business of which is the performance of services. C and the other partners in Partnership Z own at least 10 percent of Corporation X, of which a significant portion of its business is the performance of services for Partnership Z, and the services performed are of a type historically performed in the service field by employees. Based on the preceding facts, Partnership Z and Corporation X would be in an affiliated service group.
Section 414(m)(5) Management Affiliated Service Group:
The third type of affiliated service group is described in section 414(m)(5). A management affiliated service group consists of (1) an organization (management organization) whose principal business is performing, on a regular and continuing basis, management functions for one organization (or for that organization and its related organizations); and (2) the recipient organization and any of its related organizations for which the management organization performs such management functions.26
The Department of the Treasury and the Internal Revenue Service continue to review and consider issues relating to the affiliated service group rules under section 414(m). A guidance project regarding the aggregation rules under section 414(m) is listed on the 2019-2020 Priority Guidance Plan (Part 6, Employee Benefits, Retirement Plans, item 13). As guidance is published, this FAQ will be updated with additional information.
22The constructive ownership rules of section 318(a) apply for purposes of determining ownership under section 414(m). See section 414(m)(6)(B).
23A “service organization” is defined in section 414(m)(3) as an organization the principal business of which is the performance of services.
24See section 414(m)(6)(A).
25A highly compensated employee includes any employee who was a 5-percent owner at any time during the year or the preceding year. See, generally, section 414(q)(1)(A).
26Organizations are considered related if they meet the definition of “related persons” described in section 144(a)(3).