Small business taxpayer exceptions under tax reform — Gross receipt aggregation rules

by John Werlhof, CPA, Principal – CliftonLarsonAllen LLP

January 25, 2019

Small business taxpayer exceptions under tax reform

Small business taxpayers benefit from several tax reform provisions that simplify tax reporting. These include provisions that exempt small business taxpayers from the requirements to:

  • Use the accrual overall method of accounting[1]
  • Maintain inventories[2]
  • Capitalize certain costs under Sec. 263A[3]
  • Account for long-term contracts using the percentage-of-completion method[4]
  • Apply the business interest limitation[5]

For a business to be eligible for small business taxpayer treatment, the taxpayer must not be considered a tax shelter and can’t have average annual gross receipts of greater than $25 million. All persons treated as a single employer under Sec. 52(a), 52(b), 414(m) or 414(o) are treated as a single person for purposes of measuring gross receipts.[6] The following provides a high-level overview of situations in which two or more businesses are treated as a single employer under Sec. 52(a) and 52(b). A discussion of the tax shelter rules and the affiliated service group rules of Sec. 414 is beyond the scope of this discussion.[7]

The gross receipts of all organizations that are part of a “parent-subsidiary group,” a “brother-sister group” or a “combined group” under common control are required to be aggregated for purposes of applying the $25 million gross receipts test.[8] An organization can include a corporation, partnership, trust, estate or sole proprietorship that conducts a trade or business and can only be a member of one group. If an organization is a member of more than one group, the organization can attach a statement to its timely filed return indicating in which group it will be included. Otherwise, the IRS can choose the group in which the entity will be included.

A parent-subsidiary group under common control exists when a parent organization directly owns 50% or greater interest in an organization.[9] The group also includes all organizations where there’s a controlling interest by an organization in the group. For example, if Partnership X owns a 75% interest in Partnership Y, Partnerships X and Y would be members of a parent-subsidiary group, and their gross receipts would be required to be aggregated for purposes of the $25 million test. If Partnership Y, in turn, owned a 75% interest in Partnership Z, Partnerships X, Y and Z would all be members of a parent-subsidiary group.

A brother-sister group under common control exists when:[10]

  • The same five or fewer persons who are individuals, estates or trusts own, in combination, at least 80% of each of two or more organizations, and
  • The same five or fewer persons who are individuals, estates or trusts own, in combination, more than 50% of each of two or more organizations, taking into account their ownership only to the extent it is identical in each organization.

A person’s ownership counts for purposes of the 80% test only if the person owns an interest in each of the organizations. For example, the 80% test would not be satisfied in the following situation: neither Partner 2’s nor Partner 3’s ownership would be counted because the partners do not own an interest in each of Partnership A and B.

  Partnership A Partnership B
Partner 1 40% 40%
Partner 2 0% 60%
Partner 3 60% 0%


Here is another example that illustrates the application of the aggregation rules:

  Partnership X Partnership Y Common ownership
Partner 1 10% 35% 10% (lesser of 10% and 35%)
Partner 2 30% 20% 20% (lesser of 20% and 30%)
Partner 3 25% 20% 20% (lesser of 20% and 25%)
Partner 4 20% 5% 5% (lesser of 20% and 5%)
Partnre 5 5% 5% 5% (lesser of 5% and 5%)
Total 90% 85% 60%


In this example, Partnerships X and Y would constitute a brother-sister group under common control because the same five or fewer persons collectively own at least 80% of each of the two partnerships and more than 50% of both partnerships when taking into account their ownership only to the extent it’s identical.

A combined group under common control is a group of three or more organizations where:[11]

  • Each organization is a member of either a parent-subsidiary group under common control or a brother-sister group under common control; and
  • At least one organization is the common parent organization of a parent-subsidiary group and also a member of a brother-sister group.

To continue the example from the discussion of the rules for a brother-sister group, assume Partnership Y owned 75% of Partnership Z. In that case, Partnership Y would be the common parent of a parent-subsidiary group (the parent organization, Y, directly owns more than 50% of Z) and would also be a member of the brother-sister group with X. Accordingly, Partnerships X, Y and Z would be members of a combined group and the gross receipts of all three entities would be required to be aggregated for purposes of the gross receipts test.

The rules get very cumbersome when several related entities are involved because there are so many possible combinations of entities that could be part of a group under common control. There are several approaches to identifying entities whose gross receipts are required to be aggregated. An organizational chart with ownership percentages clearly identified or a table showing ownership of entities with common owners is extremely helpful. Once the data is collected, it may make sense to first identify parent-subsidiary controlled groups and then test for brother-sister controlled groups using different combinations of entities (perhaps starting with one brother-sister entity group and then testing additional entities). Identifying parent-subsidiary and brother-sister controlled groups is the starting point for identifying combined groups.

There are several nuances associated with the aggregation rules of Sec. 52(a) and Sec. 52(b).

  • Ownership of a partnership is determined by reference to the ownership of profits or capital.[12]
  • Ownership of a corporation is determined by reference to the ownership of the total combined voting power or value of all classes of stock.[13]
  • Ownership of a trust or estate is determined by reference to actuarial interest of each beneficiary. This is determined by assuming the maximum exercise of discretion by the fiduciary in favor of the beneficiary.[14]
    • Grantor trusts are disregarded; the grantor or deemed grantor is treated as directly owning the grantor trust’s assets.[15]
  • Limited attribution rules apply if the entities in the parent-subsidiary, brother-sister or combined group are all C and/or S corporations.[16] Otherwise, ownership is measured solely by reference to direct ownership.
  • It appears that gross receipts of two or more organizations are required to be aggregated if the organizations are under common control at any time during the year.[17]

The gross receipt aggregation rules look beyond the gross receipts of the tax return filer, which presents unique challenges for practitioners. For example, in some instances, the gross receipts of one entity will need to be aggregated with the gross receipts of an entity for which the practitioner does not prepare the tax return. Practitioners should ask their clients whether they are aware of any entities with common ownership or entities that may be part of an affiliated service group. If that possibility exists, the practitioner should analyze the relationships between the entities to understand whether aggregation is required.

John Werlhof, CPA, is a principal in CliftonLarsonAllen LLP (“CLA”)'s National Tax Office in Roseville, California. The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment or tax advice or opinion provided by the author or CLA to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of nontax and other tax factors if any action is to be contemplated. The reader should contact his or her tax professional prior to taking any action based upon this information. The author and CLA assume no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

 

[1]              Sec. 448(c)(1)
[2]              Sec. 471(c)(1)
[3]              Sec. 263A(i)(1)
[4]              Sec. 460(e)(1)(B)(ii)
[5]              Sec. 163(j)(3)
[6]              Sec. 448(c)(2)
[7]              For a discussion of situations in which two or more persons would be treated as a single employer under Sec. 414, see Daniel P. Michael, “Employer Beware: Affiliated Service Group Is a Single Employer for Benefit and Health Care Coverage Testing,” The Tax Adviser, Aug. 1, 2016.
[8]              Regs. Sec. 1.52-1(b)
[9]              Regs. Sec. 1.52-1(c)
[10]            Regs. Sec. 1.52-1(d)
[11]            Regs. Sec. 1.52-1(e)
[12]            Regs. Sec. 1.52-1(c)(2)(iii), -1(d)(2)(iii), and -1(d)(3)(iii)
[13]            Regs. Sec. 1.52-1(c)(2)(i), -1(d)(2)(i), and -1(d)(3)(i)
[14]            Regs. Sec. 1.52-1(c)(2)(ii), -1(d)(2)(ii), and -1(d)(3)(ii)
[15]            Sec. 671-678
[16]            Sec. 52(a), 1563(d) and 1563(e)
[17]            See Regs. Sec. 1.52-1(a)(1)(i), which applies if a group of businesses are under common control at any time during the year.