1. Controlled Groups June 2015 Presented by Idan Cohen, E.A.

2. 2 Background Qualified Research Expenses for the R&D credit start from Conception of Idea and end just prior to Commercial Production. Qualifying costs include wages, contractor costs and supplies and materials.  Controlled group provisions first introduced into the Internal Revenue Code in 1964 to provide tax incentives for small businesses operating as corporate entities.  I.R.C. § 1563 provides the rules on controlled group of corporations. ‒A controlled group is a combination of two or more corporations or trades or businesses that are under common control. ‒If a controlled group exists, all members of the controlled group are treated as a single taxpayer.  Today, the Code includes various ownership tests to determine if a controlled group exists for purposes of applying certain Code sections. Examples include: ‒Research credit ‒ERISA ‒ACA

3. 3 Rules and Examples: Parent-Subsidiary Group  Rule – I.R.C. § 1563(a)(1) A parent-subsidiary controlled group exists if: ‒One organization (parent) owns at least 80% of one or more other organization (subsidiaries), and ‒If a subsidiary owns at least 80% of a third organization, the third organization is included in the parent-subsidiary controlled group.  Notes ‒Parent-subsidiary controlled groups involve ownership of organizations by other organizations. ‒Ownership by individuals is not considered in this category. Special Rule for Research Credit Section 41(f)(5) provides, in part, that for purposes of the research credit, a "controlled group of corporations" has the same meaning given to such term by §1563(a), except that "more than 50 percent" shall be substituted for "at least 80 percent" each place it appears in §1563(a)(1).

4. 4 Rules and Examples: Parent-Subsidiary Group (cont’d) Qualified Research Expenses for the R&D credit start from Conception of Idea and end just prior to Commercial Production. Qualifying costs include wages, contractor costs and supplies and materials. Yellow Red Green Brown 90% 80% 65% Controlled Group Parent Subsidiary

5. 5 Rules and Examples: Parent-Subsidiary Group (cont’d) Qualified Research Expenses for the R&D credit start from Conception of Idea and end just prior to Commercial Production. Qualifying costs include wages, contractor costs and supplies and materials. Red Green YellowBrown 90% 80% 65% 80% Purple Subsidiary Parent Controlled Group

6. 6 Rules and Examples: Parent-Subsidiary Group (cont’d) Orange Red Green YellowBrown 55% 100 % 80% Purple Subsidiary Parent Controlled Group Parent 100 % 40% Controlled Group Subsidiary

7. 7 Rules and Examples: Brother-Sister Group  Rule – I.R.C. § 1563(a)(2) A brother-sister controlled group is a group of two or more corporations, in which five or fewer common owners: ‒Own directly or indirectly a "controlling interest" of each corporation in the group, AND ‒Have "effective control" over each of these corporations, where: ‒Controlling interest ("Ownership Test")- generally means 80% or more of the stock of each corporation; AND ‒Effective control ("50% Test")- generally means more than 50% of the stock of each corporation, but only to the extent such stock ownership is identical with respect to such corporation.  Notes ‒Brother-sister controlled groups involve ownership by "common owners" of organizations. ‒A "common owner" must be an individual, a trust, or an estate.

8. 8 Rules and Examples: Brother-Sister Group (cont’d) No Controlled Group Brown Red 5% 15% 0% DCB A 25% 35% 10% 0% 50% E 20% 40%

9. 9 Rules and Examples: Brother-Sister Group (cont’d) Green Red 5% 0% DCB A 25% 20% 30% 25% 50% E 20% 25%

10. 10 Rules and Examples: Combined Group  Rule – I.R.C. § 1563(a)(3) A combined group consists of 3 or more organizations that are organized as follows: ‒Each organization is a member of either a parent-subsidiary or brother-sister group; and ‒At least one corporation is the common parent of a parent-subsidiary; and is also a member of a brother-sister group.

11. 11 Rules and Examples: Combined Group (cont’d) BrownRed 70% B A Green 30% 20% 80% 85% Brother- Sister Group Parent- Subsidiary Group Subsidiary Parent Brother Sister Combined Group