What is Attribution?
Attribution is an artificial concept used for tax purposes to prevent tax avoidance. This artificial concept treats a person/taxpayer as the direct owner of an asset or business even though he or she has no legal ownership of the asset or business.
What Are Attribution Rules?
It is anti-avoidance rules to prevent taxpayers from creating structures with the principle purpose of avoiding tax. Attribution rules and their application are very prevalent in family-held businesses.
Attribution of Ownership In Retirement Plans
If you own a 401(k) plan, it is of the utmost importance to ascertain and understand the plan’s ownership structure (i.e. what assets it invests in). The reason why it is important to ascertain this information is to make a determination on the control as well as who the Highly Compensated Employee (HCE) and key employee of the plan is. The only way to make these determinations is to apply the family attribution rules correctly.
Definition of Disqualified Persons
Section 4946 of the IRC, specifically refers to the following categories of persons as designated as disqualified persons:
- substantial contributors;
- foundation managers;
- more-than-20% owners of a corporation, partnership, trust, or unincorporated enterprise that is a substantial contributor to the foundation;
- family members of substantial contributors, foundation managers, and more-than-20% owners;
- corporations, partnerships, trusts, or estates more than 35% of that are owned by substantial contributors, foundation managers, more-than-20% owners, and their family members.
What is a CFC?
Section 957 of the IRC defines a CFC as any foreign corporation of which more than 50% of the stock by vote or value is owned, directly, indirectly (through certain foreign entities), or constructively, by U.S. shareholders.
General Rules for Family Attribution
Non-Resident Alien Exception to Family Attribution
As an exception to the general Family Attribution rules, if any stock is owned by a non-resident alien (NRA), that NRA’s stock ownership is exempt for purposes of determining a US person’s constructive ownership.
What Are The Rules For Attribution For Determining Parent/Subsidy & Brother/Sister Controlled Groups?
IRC 1563 sets out the attribution rules for determining Parent/Subsidy and Brother/Sister Controlled Groups.
A parent-subsidiary controlled group involves a chain of corporations in which the common parent corporation owns 80% or more of the voting power and value of the stock of one corporation, and one of the other corporations owns 80% of the voting power or value of another.
A brother-sister group involves two or more corporations if five or fewer persons (individuals, estates, or trusts) own more than 50% of the voting power or more than 50% of the value of each (taking into account only the stock ownership that is identical with respect to each corporation.
The corporation to shareholder attribution rules apply only for the purpose of determining stock ownership in brother-sister controlled groups.
Example of Family Attribution
Chantelle and her family members are originally from South Africa but she now resides in the United States. Her parents, Leon and Elsabe own 90% of the shareholding in a South African Company. Even though Chantelle doesn’t own any direct portion of the company, under the IRS rules, she may be considered to have constructive ownership of the shares that are attributed to her through her family members (her parents).
Other Notable Attribution Rules Provisions
- Section 1563 which relates to controlled groups.
- Attribution applies to parents and children if the children are under 21.
- An exception for controlled groups in relation to the non-involvement of spouses. Minors can however reintroduce a controlled group. The minor child of the spouses would have 100% ownership of both companies and when the child turns 21, the controlled group would be broken, and most notably, the parents do not need to be married for attribution to apply.
Ownership Attribution Basics
Internal Revenue Code Section 267(c)
Used to determine those individuals or taxpayers who are prohibited from engaging in certain transactions involving plan assets.
Internal Revenue Code Section 318
The constructive stock ownership rules are set out in this section and provide rules for determining the circumstances in which stock ownership will be attributed from one person or entity to another.
Internal Revenue Code Section 1563
Used to identify related companies that are part of a controlled group.
Constructive Ownership & Attribution
1.958-2 Constructive Ownership of Stock
The IRS released final regulations 1.958-2, which limits the application of Section 318(a)(3) constructive ownership rules, as to whether a foreign corporation is a CFC.
The rules define related persons under IRC Section 954(d)(3) for certain CFCs. This definition is intended to avoid CFCs being inadvertently regarded as related persons. The regulations also make provision that stock in a CFC owned by a non-resident alien won’t be attributed to a US shareholder in the same CFC due to downward-attribution rules.
The final regulations impact US taxpayers who own stock in CFCs and may have previously been considered to own other CFCs through the constructive ownership rules.
They don’t have significant relationships with each other.
The U.S. Person Through, Which There is Constructive Ownership Files Form 5471
This basically means that the person who has an attribution/constructive ownership group must file a form 5471.
Why Does Family Attribution Matter For Testing Purposes?
“Attributing interest to family members increases the number of Highly Compensated Employees (HCE) and key employees you will include in testing. This could increase or decrease the HCE average deferral percentage (ADP) which may impact your ADP results.”
- I’m already overwhelmed. Can you give me the short version of these rules?
- Yes. Ownership is attributable to the following family members: spouses, parents, children (adopted included), and grandparents, but not grandchildren.
- That sounds pretty comprehensive. Are there any exceptions?
- Yes. Family attribution does not apply to your grandchildren.
- There is no attribution from an individual to his or her grandchildren.
- Yes. Family attribution does not apply to your grandchildren.
- I don’t see brothers and sisters listed. Is there attribution between siblings?
- Are same-gender marriages subject to the spousal attribution requirement?
- How are the spousal attribution rules impacted when a couple is going through a divorce?
- Attribution rules apply until there is a legal separation.
- If I own a business and my spouse doesn’t work for the company, is he or she still attributed to my ownership?
- In terms of the section 318 rules, there is no exception to the spousal attribution requirement, so spouses are always attributed to each other’s ownership under that section.
- However, in terms of the section 1563 rules, attribution does not apply if certain conditions are met.
- Shifting gears to parent/child attribution, do the rules apply when the child is an adult?
- Is there always attribution between parents and children under the age of 21?
- I think I have a headache after reading all of this. What should I do to find out how all of this applies to me?
- For an in-depth analysis and understanding of these attribution rules, and how they may be applicable to you feel free to reach out to our specialist at Asena Advisors. Please also visit our website, to learn more about how we can help navigate you through these rules to preserve your wealth.