by John P. Dedon
The Patient Protection and Affordable Care Act, commonly called Obamacare, scheduled to go into effect in 2014, has business owners scrambling to either comply, face penalties, or reorganize to avoid it. Businesses with more than 50 employees are subject to the new rules and penalties. Based alone on the number of calls that I have received from business owners concerned that they no longer will be able to compete with smaller companies, the law is a real concern to businesses with more than 50 employees.
How to avoid compliance? The business needs to have no more than 50 employees. And of course, the drafters of the legislation knew many businesses would consider dividing lines of businesses or companies to come under 50 employees. Take these examples:
1) Paul Proprietor owns 10 fast food franchises employing 90 employees – 5 franchises in Richmond and 5 franchises in Virginia Beach. If he divides his company in half, and forms NewCo, each group will have 45 employees. However, Paul Proprietor can’t own NewCo. But can his wife, or a trust, or his children? How about key employees?
2) Assume Paul does transfer his 5 Virginia Beach franchises to family members under 1) above. Can Paul retain control by subcontracting the services so that Virginia Beach, now owned by NewCo, receives its work and payments from Paul’s old company in Richmond? If a subcontracting arrangement does not work, can Paul receive a management fee or employment contract with NewCo?
The analysis and answers to these questions are not the province of health-care lawyers, but tax lawyers, because Obamacare references Internal Revenue Code Sections; namely section 414, which takes you to section 1563. According to Odin, Feldman & Pittleman tax attorney Ben Kinder, “these sections have been around a long time, and pertain to ERISA. While there is some guidance, this area of law is complex, dense, and gives wide discretion to the IRS.”
Some of the rules are straightforward, and some turn on facts and circumstances. There are three methods to determine who makes up a “single” employer. The first two methods, labeled “parent-subsidiary” and “brother-sister,” are relatively straightforward rules. In brief, the parent-subsidiary relationship exists when a company owns at least 80 percent of another company.
The brother-sister relationship exists when the same small group of people (five people or less) controls multiple organizations. If you “divide” your company but do not avoid being a Parent-Subsidiary or a Brother-Sister, then you will be deemed to still be a single employer.
Determining “control” under both these two tests (parent-subsidiary and brother-sister) can be complicated, and often involves issues of attribution or constructive ownership. Constructive ownership is when taxpayers are considered to own interests that are actually owned by another, due to their relationship with that person. For example, a 45-year-old man and his 10-year-old son will constructively own each other’s stock.
The rules are even more complicated under the third method, which is Section 414(m) and “Affiliated Service Groups.” According to Kinder, the purpose of these rules is to group together organizations that provide services for, or with, each other, as well as combining an organization that principally provide management functions with another organization that receives those services. The IRS broadly defines “services” and “management” to include a very wide range of activities. Additionally, Affiliated Service Groups are subject to much broader constructive ownership rules than parent-subsidiary and brother-sister relationships. These rules ultimately prevent companies from dividing into two “separate” parts (such as, payroll and labor) in order to stay under the 50 employee threshold. Working together, or sharing management functions, would combine NewCo and OldCo together under section 414(m). NewCo and OldCo cannot share customers, employees, contracts, etc. But even if the companies do not work together, they can be combined based on constructive ownership.
So how do these rules affect Paul and his fast food franchises? Assuming no shared management or work, Paul’s wife can own NewCo only if the following conditions are met:
• Paul has no ownership interest in NewCo, and his wife has no ownership interest in OldCo;
• Paul does not work for NewCo and his wife does not work for OldCo; and
• OldCo and NewCo make 50 percent or less of their money from passive income (e.g., investments).
Paul’s children typically can own part of NewCo as long as the following conditions are met:
• The children are at least 21 years old; and
• None of the children own 50 percent or more of NewCo.
Key employees that are unrelated to Paul also can own NewCo (again, as long as OldCo and NewCo do not work together). Thus, Paul could sell ownership of part of his business.
A Trust can also own NewCo, but all beneficiaries are generally treated as owning a pro rata share of the Trust. For example, if a Trust owns 100 percent of NewCo and the equal beneficiaries are Paul’s wife and son, then his wife and son each own 50 percent of NewCo.
Paul will also be greatly restricted in dividing Richmond and Virginia Beach under the rules of section 414(m). The IRS would likely consider Paul’s old company and NewCo to be performing services with each other if he subcontracts services. Also, if Richmond and Virginia Beach share functions, such as marketing, contracts with vendors, handling payroll, or other connections, they would be integrated and viewed as a single employer.
However, if Paul is the sole owner of OldCo and a family member (other than his wife), or a former employee, is the sole owner of NewCo, and there is no subcontracting arrangement or any sort of connection with each other, then Paul may be able to work for NewCo. However, OldCo should make sure that Paul is actually an employee, and not de facto running NewCo, to avoid any substance-over-form argument from the IRS.
These examples illustrate the extreme measures required for Paul to divide his company to avoid the 50-employee threshold. For most business owners, dividing companies to avoid Obamacare will not be a viable option.
John P. Dedon is a principal in the firm with the Trust, Estate & Tax Planning practice group of Odin, Feldman & Pittleman. Dedon blogs about estate planning issues for Virginians and U.S. citizens at http://www.dedononestateplanning.typepad.com.Tweet
There are no comments for this entry