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R=(CC or ASG)²: The Risk of Relativity

Although the title of this article may be a bit tongue in cheek, the business risks to a law firm (or its clients) of unknowingly being considered a “related” employer for employee benefit plan purposes is no laughing matter. And with reporting requirements for Applicable Large Employers (ALEs) under health care reform legislation (ACA) looming in January 2016 (and for which Congress just increased applicable penalties for failure to file under the Trade Preferences Extension Act of 2015), the stakes have never been higher. Properly determining a law firm or other business’s status as a related employer, both for purposes of ACA and also for other benefits related requirements, is critically important.

Decoding the Formula

In the formula in the title, R stands for risk—the risk that a law firm or other employer will be required to be aggregated with a different employer for purposes of determining compliance with the myriad of rules and regulations that apply to employee benefit plans such as health insurance plans, 401(k) plans and pension plans. CC stands for “Controlled Group” (or trade or business under common control). ASG stands for “Affiliated Service Group” which is a type of aggregation that specifically applies to service businesses such as law firms. And “squared” demonstrates that the risk of noncompliance increases dramatically if there are related employers, especially if the employers are (or on an aggregated basis become) subject to the ACA’s employer mandate.

Gravitational Pull: Why Worry About Related Employer Status?

Employee benefit plans are subject to a myriad of statutory and regulatory requirements that require aggregation of an employer with other related companies for some purposes (but just to make it fun, not for all purposes). These rules apply to most of the more common employee benefit plans, including, for example:

  • Group health plans (insured and uninsured)

  • 401(k) plans

  • Pension plan (including cash balance plans)

  • Cafeteria plans (aka flex plans or arrangements)

  • Group term life insurance

  • Dependent care assistance programs

  • Health savings accounts

  • Deferred compensation plans, including some severance arrangements (if subject to Code Section 409A)

Types of Related Employers

Related employer status can be based on two or more trades or businesses being in the same “controlled group/group of businesses under common control” (IRC Section 414(b) and 414(c)) or being in the same “affiliated service group” (IRC Section 414(m)). The statutes have a broad reach—for example, some private equity funds are treated as a trade or business for this purpose. Controlled or commonly controlled companies include those in a parent-subsidiary group and those in a “brother-sister group” (or combination of the two). They can include non-profit or tax exempt companies and governmental agencies, as well as for profit companies. In making these determinations, certain stock/ownership attribution rules apply (e.g., ownership of spouses is attributed to other spouses), further complicating the analysis.

Black Holes: The Risks of Inadvertent Related Employer Status

If an employer such as a law firm is required to be treated as related to another employer for benefit plans purposes (or thinks it is required to be related, but in fact is not), the costs and penalties under applicable law can be draconian. For example:

Qualified retirement plans (401(k), pension/cash balance, or similar): If an employer is required to be treated as related to another, the retirement plans of each must test for discrimination on an aggregated basis. If these tests are not passed, the plans will lose their tax-favored and tax-exempt status, i.e., the employer may lose its tax deduction for plan contributions, trust investment gains will be taxable to the trust and distributions to employees will not be eligible to be rolled over to an IRA or other plan. If not corrected (the IRS has voluntary correction programs to address these types of failures), the plan becomes a black hole of adverse tax consequences. In addition, funding liability for defined benefit pension plans applies to all members of a controlled group. As if that were not enough, a host of other retirement plan rules apply on a related-employer basis: dollar limits on contributions may apply on an aggregated basis, distributions from a 401(k) plan may not be allowed if a controlled group member also sponsors a plan, employees may be entitled to service credit in the plan from the other employer, etc.

Health and welfare plans/ACA: Under ACA, a business’s status as an “applicable large employer” that is subject to ACA’s employer mandate is made based on whether or not there are at least 50 full time equivalent employees of all related employers (e.g., two related employers with 25 full-time equivalent employees each will each be subject to ACA’s employer mandate). Failure by an ALE to offer minimum value affordable health coverage to full-time employees can result in significant penalties to employers. And, starting in early 2016, all ALEs will be required to file Form 1094-C with the IRS. Form 1094-C specifically requires that the ALE self-identify (under penalty of perjury) the names and employer identification numbers of all of its “related” employers on the form itself. In addition, some health and welfare plans are subject to discrimination tests, similar to qualified plans that must be applied on an aggregated basis. Unlike a qualified plan, however, these failures generally result in adverse tax consequences to only the higher-paid employees, such as the partners in a law firm.

Deferred compensation plans: If a deferred compensation plan, including, for example, a severance arrangement in an employment agreement, is subject to IRC Section 409A, certain requirements must be applied on a related-employer basis. Failure to satisfy Code Section 409A can have devastating tax consequences for the affected employee: immediate income inclusion, a 20 percent federal penalty tax (and in California, for example, an additional 5 percent penalty tax), and in some cases an additional penalty tax based on a deemed interest rate.

There is no “conservative” approach to determining related-employer status. For example, if an employer is not sure if it is related to another employer, but decides to “play it safe” and treat the other employer as related, but then finds out it is not, costly mistakes may still have been made. For example, if a group health plan covers employees of two or more employers who are not in the same controlled group (but who might be in the same affiliated service group), the plan becomes a “multiple employer welfare arrangement” or “MEWA.” MEWAs are subject to additional reporting requirements and may also be subject to state insurance laws in some situations. And if a pension plan covers two or more unrelated employers, it requires special language in the plan document applicable to “multiple employer plans” as well.

Practical Tips to Avoid Liability Law firms and other businesses can take steps to avoid the “risks of relativity.” Here is a checklist of actions to take:

  1. Educate yourself and your partners and management staff about these issues.

  2. Hire and consult with competent employee benefits advisors (ERISA counsel, third-party administrator, consultants, brokers—note some advisors ask the employer to list related employers on their client intake forms, putting the burden on the employer, not the advisor, to be aware of and make this determination).

  3. Gather the information needed to analyze and analyze (or have your consultant analyze) related-employer relationships.

  4. Analyze and reach a conclusion as to which employers are “related” for benefits purposes.

  5. Review the impact on the firm’s/businesses’ employee benefit plans, and take corrective actions if needed (which may include plan amendments, voluntary corrections under the IRS Employee Plans Compliance Resolution System, additional plan contributions and benefits for some employees, amended filings, etc.

  6. Important: repeat as needed (and at least annually) because related-employer status can change based on admission of new partners, marriages or divorces, minor children reaching age 21, new business relationships, mergers and acquisitions, deaths, retirements and even new legal developments. For example, if a controlled group analysis was performed before the Supreme Court’s recent ruling upholding same-sex marriage, a same sex couple might have been treated as single with no stock attribution. Now that same couple will be spouses and stock attribution will apply, possible resulting in controlled group status.


Although the related-employer rules for employee benefit plans have been in place for many years, ACA has raised the stakes for getting this one right. Other recent developments in the law such as the recognition of same sex marriage in many states for the first time may also come into play. Now is the time for law firms and their clients to take action to review their status as related employers for employee benefit plan purposes and address the “risks of relativity.”

Originally published by the American Bar Association in Law Practice Today (October, 2015). Reprinted with permission.

© Boutwell Fay LLP 2015, All Rights Reserved. This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of December 31, 2015.

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