Tax planning often results in some entity restructuring or an overhaul of a company's entire ownership structure. It's important to consider and weigh the impact of constructive ownership and attribution rules as it may have downstream impacts based on industry, long term objectives, business succession planning, estate planning, control and governance matters, and corporate exit strategy.

‍Controlled Group Membership: Determining Ownership Control

Determining a corporation's membership in a controlled group considers both direct and indirect stock ownership, including:

• Stock subject to purchase options: An option to acquire stock counts as ownership for control group purposes. This includes chained options (options to acquire options).
• Stock attributed from partnerships, estates, and trusts: A shareholder with a 5% or more interest in these entities is attributed their respective shares of owned stock.
• Additional attribution for brother-sister groups:
• Stock attributed from other corporations (5% or more ownership).
• Stock owned by spouse and lineal family members.

Attribution Principles

• Attribution doesn't diminish underlying ownership. Example: Option holders and option owners keep their respective ownership percentages.
• Constructive ownership can exist without direct ownership.
• Overlapping attribution rules prioritize options.

Option Details

• Only existing, non-contingent options count for control group analysis.
• Options take precedence over other attribution rules in overlapping cases.

Partnership Attribution

• Partners with a 5% or more capital or profit interest are attributed their respective shares of partnership-owned stock.
• Unequal interests apply the larger proportion for attribution.

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Attribution from Estates, Trusts, and Corporations

Beneficiary Ownership

1. 5% Actuarial Interest: Beneficiaries with at least a 5% actuarial interest in estate/trust stock are deemed owners to that extent.
2. Trustee Discretion: If trustees can distribute stock, the beneficiary's interest assumes maximum discretion in their favor.
3. No Interest: Beneficiaries excluded from receiving any stock or proceeds have no actuarial interest. (Specific bequests exclude other potential beneficiaries.)
4. Income Beneficiaries: Trust beneficiaries with income rights hold an interest even if they won't receive the stock itself.

Estate as Owner — Decedent's estate, managed by an executor, is deemed owner of property used to pay expenses/liabilities, even if legal title passes to heirs.

Beneficiary Definition — Beneficiaries include those entitled to decedent's property by will or inheritance laws. They cease to be beneficiaries once everything is received and no future claims exist (except remote cases related to debt or administration).

Grantor Trusts — Stock indirectly owned by a grantor through a grantor trust is considered owned by the grantor.

Employee Trusts — Trusts for qualified pension, profit-sharing, or stock bonus plans are exempt from attribution. Employees do not constructively own stock held by such trusts.

Brother-Sister Groups — For these groups, a person's ownership in one corporation is attributed proportionally to their value-based ownership (5% minimum) in another corporation. Only value, not voting power, is considered.

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Scenario One

Brown owns 60% of corporation P's outstanding stock (60 shares out of 100).Smith owns 4% of P's stock (4 shares).Corporation X owns 36% of P's stock (36 shares).P owns 50 shares of corporation S's stock (both directly and indirectly).Attribution:

Brown: Owns 30 shares of S stock indirectly through P (proportionally to his P ownership: 60% * 50 shares).X: Owns 18 shares of S stock indirectly through P (proportionally to its P ownership: 36% * 50 shares).Smith: Doesn't own enough P stock (less than 5%) to trigger attribution for S stock owned by P.Spousal Attribution:

If Smith's wife owned 1 share of P stock, their combined ownership would reach 5% (5 shares).This would trigger attribution of 2.5 shares of S stock for each of them (proportionally to their combined P ownership: 5/100 * 50 shares).Key Points:

Corporate attribution rules consider indirect ownership through other corporations.A 5% ownership threshold in another corporation triggers attribution.Spousal ownership can combine to meet the threshold for attribution.Attributed shares are added to the direct ownership for further attribution calculations.

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‍Spousal Attribution Rules for Brother-Sister Controlled Groups

General Rule

• In determining brother-sister controlled groups, stock owned directly or indirectly by a spouse is generally attributed to the other spouse.
• However, this doesn't apply to those legally separated, under a decree of separate maintenance, or with a divorce decree in place.

Exception for Separate Business Affairs

• Attribution between spouses is not applied when:
• They have separate business affairs conducted through distinct corporations.
• The individual in question:
• Doesn't own any stock of the corporation directly at any time during the tax year.
• Isn't a director, employee, or participant in its management during the year.
• Doesn't receive more than 50% of gross income from royalties, rents, dividends, interest, or annuities from the corporation.
• The stock isn't subject to transfer restrictions favoring the individual or their children under 21.‍

Scenario Two

• X corporation has only 100 outstanding shares of a single class of stock.
• Harold owns 25 of those shares throughout the tax year.
• Wanda, Harold's wife, does not directly own any X stock, nor has she been involved in X's management or subject to stock restrictions favoring her.
• X corporation's income from passive sources like rent and dividends is less than 50%.

Issue — Is Wanda considered the constructive owner of Harold's X corporation stock for controlled group purposes under spousal attribution rules?

Resolution — No, Wanda is not considered the constructive owner of Harold's X corporation stock under the given circumstances. Here's why:

• General Rule: Spouses are typically attributed each other's stock ownership for controlled group determination.
• Exception for Separate Business Affairs: This attribution doesn't apply if specific criteria are met, indicating independent business activities:
• No direct stock ownership by the spouse (Wanda) in X corporation throughout the year.
• No involvement by the spouse (Wanda) in X's management as a director, employee, or participant.
• Less than 50% of X's income derived from passive sources like rent and dividends.
• No substantial restriction on the disposition of Harold's X stock in favor of Wanda or their young children.

In this case, all the exception criteria are met

• Wanda doesn't own any X stock directly.
• She isn't involved in X's management.
• X's income primarily comes from non-passive sources.
• No restrictions favor Wanda regarding Harold's X stock.

Therefore, spousal attribution doesn't apply, and Wanda isn't considered the constructive owner of Harold's X corporation stock.

Key Points

• Spousal attribution can affect controlled group determinations, but exceptions exist.
• Demonstrating separate business activities and meeting specific criteria can negate attribution.
• In this scenario, Wanda's lack of direct ownership, management involvement, and indirect benefits through X's income and stock restrictions excludes her from constructive ownership.

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Family Attribution Rules for Brother-Sister Controlled Groups

Spousal Attribution

• Stock attributed to a spouse through spousal rules doesn't count as the original spouse's ownership. Only the recipient spouse is considered the constructive owner.

Children and Grandchildren

• Minors: You own stock owned by your children under 21, including adopted children.
• Young Adults: If you're under 21, you constructively own stock owned by your parents.
• Adults: You own stock owned by your parents, grandparents, grandchildren, and children above 21 only if:
• You own more than 50% of the corporation's voting power or total value.
• This 50% ownership includes attribution from other rules (except family attribution).

Siblings

• Ownership by siblings doesn't affect whether a corporation is in a brother-sister controlled group.

Community Property

• Consider community property laws when determining ownership under attribution rules.
• Example: A son-in-law's stock, partially owned by his wife under community property, was constructively owned by the mother-in-law due to attribution.

Key Points

• Spousal attribution only affects the receiving spouse, not the original owner.
• Minor children's and young adults' holdings are attributed to their parents.
• Adults' family attribution requires controlling majority ownership.
• Sibling ownership doesn't trigger controlled group membership.

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Family Attribution in Z Corporation: A Breakdown

Scenario Three

• Mason owns 40 shares of Z corporation's 100 shares (40%).
• His son Martin (20) owns 30 shares (30%).
• His son Adam (30) owns 20 shares (20%).
• Remaining shares belong to someone unrelated.

Family Attribution

Mason

• Owns 40 shares directly.
• Attributed Martin's 30 shares due to his minority.
• Owns more than 50% (70 shares) constructively, triggering further attribution.
• Therefore, also attributed Adam's 20 shares.
• Total ownership for Mason: 90 shares

Martin

• Owns 30 shares directly.
• Attributed Mason's 40 shares due to his minority.
• Total ownership for Martin: 70 shares

Adam

• Owns 20 shares directly.
• Doesn't meet the 50% ownership threshold for further attribution from Mason.
• Total ownership for Adam: 20 shares

Key Points

• Minor children's shares are attributed to their parents.
• Adult children's shares are attributed only if the parent owns over 50%.
• Family attribution doesn't chain between siblings.
• Direct ownership determines further attribution eligibility.

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Reattribution of Stock Ownership

Stock attributed to one person can usually be attributed again to another person, with exceptions. Corporate attribution rules can apply to stock already attributed through spousal rules. Stock attributed through spousal or family rules generally can't be reattributed through the same rules again. The option rule (right to acquire stock) takes precedence over other attribution rules.

Scenario Four

• Martin, a minor, directly owns some shares in Z corporation.
• Due to family attribution rules, Martin also constructively owns the shares his father directly owns in Z.
• Martin's brother, Adam, also owns shares in Z directly.

Key Point

Martin only constructively owns his father's Z shares, not his brother's. Family attribution doesn't chain between siblings. This means:

• Martin's total ownership includes his direct shares and his father's attributed shares.
• Adam's ownership only includes his own direct shares.

Reasoning

The attribution rules aim to prevent tax avoidance by hiding actual ownership behind family relationships. Chaining attribution between siblings could unfairly penalize Martin for his father's ownership, as he has no control over his brother's shares.

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Conflicts in Stock Ownership

Special rules resolve conflicts when stock is owned directly or indirectly by multiple people.

Priority

• Direct ownership over constructive ownership.
• If conflict persists, ownership goes to the person with the highest stock value (not voting power) after applying attribution rules.
• If still unresolved, the corporation can elect its controlled group by filing a statement with its tax return.
• If no election is made, the IRS decides the group.

Scenario Five

• Smith owns all of Y and Z corporation's stock.
• Jones owns all of X corporation's stock and has an option to buy Y corporation's stock from Smith.
• Resolution — Y corporation's stock is treated as owned by Smith due to his direct ownership, making Y and Z a brother-sister controlled group.
• Conclusion — If Smith owned Z corporation's stock for less than half of the tax year, Y corporation's stock would be treated as owned by Jones, forming a controlled group with X corporation.

Scenario Six

• Harold owns all of M corporation's stock.
• Wanda, his wife, owns all of N corporation's stock.
• They operate separate businesses, negating spousal attribution.
• Harold owns 60% and Wanda owns 40% of P corporation's stock.
• Conclusion — P corporation's stock is attributed solely to Harold because he owns the largest percentage of its value. This creates a brother-sister controlled group consisting of M and P corporations.

Key Points

• Direct ownership takes priority over constructive ownership.
• When multiple attribution rules apply, stock value (not voting power) determines ownership priority.
• Separate business operations can override spousal attribution.

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Visit the Cruncher Accounting, PC website and schedule a consultation if you need assistance with planning around corporate reorganizations and assessing tax implications of restructuring a business entity.

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