Marginal Tax Rate
February 23, 2024
Prohibited Transactions for Retirement Plans
February 23, 2024

February 24, 2024 | read

Affiliated Service Groups

Brandon Hall

Affiliated Service Groups

To prevent business owners from adopting a 401(k) plan through a newly established and wholly owned entity, IRC Section 414(m) was enacted. Section 414(m) was enacted to prevent circumvention by expanding the idea of “control” to separate, but affiliated, entities. This section stipulates that all employees of the members of an affiliated service group shall be treated as if a single employer employed them.

An affiliated service group is a group of related employers and refers to two or more organizations that have a service relationship and, in some cases, an ownership relationship, described in IRC Section 414(m). An affiliated service group can fall into one of three categories:

  • A-Organization groups (referred to as “A-Org”), consists of an organization designated as a First Service Organization (FSO) and at least one “A organization”,
    • A First Service Organization (“FSO”) in one in which the principal business of the organization is the performance of services.
  • B-Organization groups (referred to as “B-Org”), consists of a FSO and at least one “B organization”, or
  • Management groups.

An “A” Organization refers to a corporation, partnership, or other organization. To be an A-Org, an organization must satisfy a two-part test:

  1. Ownership Test: The organization is a partner or shareholder in the FSO (regardless of the percentage interest it owns in the FSO) determined by applying the constructive ownership rules as specified in IRC Section 318(a), and
  2. Working Relationship Test: The organization “regularly performs services for the FSO,” or is “regularly associated with the FSO in performing services for third parties. Facts and circumstances are used to determine if a working relationship exists.

To be a B-Org, the organization must meet the following requirements:

  1. A significant portion of its business must be the performance of services for a FSO, for one or more A-Org’s determined with respect to the FSO, or for both,
  2. The services must be of a type historically performed by employees in the service field of the FSO or the A-Org’s, and
  3. Ten percent or more of the interests in the organization must be held, in the aggregate, by persons who are highly-compensated employees (pursuant to IRC § 414(q)) of the FSO or A-Org.

Performance of services defined

If use of capital is not a material income-producing factor for the organization, then the principal business of an organization will be considered the performance of services.

Capital is a material income-producing factor if a substantial portion of the gross income of the business is attributable to the employment of capital in the business as reflected by a substantial investment in inventories, plant, machinery or other equipment. Note that capital is a material income-producing factor for banks, however, is not a material income-producing factor for businesses that generate fee-based revenues, commissions, or compensation for personal services of an individual.

Regardless of factors related to use of capital, an organization engaged in any one or more of the following fields is a service organization:

  • Health
  • Law
  • Engineering
  • Architecture
  • Accounting
  • Actuarial science
  • Performing arts
  • Consulting
  • Insurance

See Controlled Groups and Can I Have a solo 401(k) if I Have Employees for more information.

Have questions?

Our Tax Smart Investor Plus subscription includes Live Q&As where you can get your questions answered by our seasoned tax experts.