Controlled Corporate Groups

If a business grows substantially, it may want to continue growing by creating new business entities that are separate from the original business, which has several advantages:

Because corporations are subject to a progressive tax, a business can save considerably on taxes, if it is not part of a controlled corporate group, by forming multiple entities that each have a lower amount of income which would ordinarily be subject to a lower tax rate. In the case of a controlled corporate group, however, the progressive tax rate applies to the total income of the group.

For instance, if a restaurant owner already owns 1 restaurant that earns $100,000 in income, then the owner must pay $22,250 in taxes on that income. If the owner opened another restaurant that earned the same income and that operated under the same corporation, then an additional $39,000 of taxes must be paid, so operating the other restaurant as a separate corporation would save $39,000 − $22,250 = $16,750. Substantially more can be saved if more restaurants are opened that are operated as separate corporations, but these savings cannot be realized if the restaurants are part of a controlled corporate group, since the progressive tax rate would apply to their total income.

There are other disadvantages of being part of a controlled group:

Types of Controlled Corporate Groups

The tax code defines a group of corporations with a significant common ownership as a controlled corporate group, of which there are several different categories.

A brother-sister group is formed when 2 or more corporations with fewer than 6 shareholders, who are individuals, estates or trusts, satisfy the following 2 requirements:

  1. The stock of the group of corporations is owned or controlled by shareholders who own at least 80% of either the total outstanding stock or the voting power.
  2. The shareholders have an identical ownership, where the lowest ownership percentage of all owners in each corporation totals more than 50% of the voting power or value.
Example: Brother-Sister Controlled Group
Corporation 1 Corporation 2 Identical Ownership
Shareholder 1 20% 40% 20%
Shareholder 2 25% 15% 15%
Shareholder 3 25% 15% 15%
Shareholder 4 12% 15% 12%
Total Percentage 87% 85% 62%

As can be seen in the above table, the shareholders own more than 80% of both corporations and their identical ownership also exceeds 50%. Therefore, the corporations form a brother-sister group. The above assumes that the shareholders are unrelated, otherwise constructive ownership rules would apply, listed in IRC §1563(e), that attribute ownership in the following cases:

A controlled group can also be considered a parent-subsidiary group which is a chain of corporations in which the parent corporation owns at least 80% of either the voting power or value of another corporation within the group and all corporations within the group collectively satisfy the 80% rule as it is applied to each corporation within the group, where at least 80% of the voting power or value is owned by other corporations within the group.

A controlled corporate group can also be a combined group, consisting of 3 or more corporations where at least 1 corporation serves as the parent of a parent-subsidiary group and also is a member of a brother-sister group. So if you own 100% of the stock of ABC Corporation and DEF Corporation, and DEF Corporation owns 90% of the stock of GHI Corporation, then they would form a combined group. Note that the above brother-sister example does not satisfy the parent-subsidiary relationship, since the individual shareholders own most of the stock, not any of the corporations.