What is a Trade or Business and Why Does It Matter?
If an employer withdraws from a multiemployer plan and is assessed withdrawal liability, all members of the employer’s controlled group are liable for that assessment. The controlled group rules look at the extent of common ownership among various trades or businesses, whether or not incorporated. The determination of controlled group status can be complicated and I will not discuss those complexities in this blog post. Instead, I want to talk about the trade or business requirement. In Central States, Southeast and Southwest Areas Pension Fund v. Ray C. Hughes, Inc., the U.S. District Court for the Northern District of Illinois concluded that various related companies were part of a controlled group and therefore liable for the withdrawal liability of one of the companies. The court noted that to be a trade or business, the taxpayer’s activity had to be different from “investment activities or hobbies.”
The business in question was a corporation established for estate planning purposes that held securities and notes – “well recognized passive investments” – and a single piece of real estate. The court looked at the company’s articles of incorporation which stated that its purpose in part was carrying on a general trucking and contracting business and looked at its tax returns where the corporation noted its principal business activity as “lessor.” The company’s ownership of the land was intentional and it made improvements to the land over time. It built a commercial office building on the property and leased the offices. Its activities were continuous and regular; it earned rental income and claimed business related deductions on its income tax return. The company had no employees but paid a management fee to a company to manage the property. That management company was also the company that had withdrawn from the pension fund. Because services were required with respect to the property, the company that owned the property was considered to be in a trade or business despite the relatively passive nature of its investments.
This trade or business issue also arises with respect to hedge funds. Hedge funds with portfolio companies sometimes take the position that they are not in a trade or business, but rather are passive investors in their portfolio companies, so that even companies that are 100% owned by the hedge fund are not part of a controlled group of trades or businesses. Hedge fund operators may wish to review closely this withdrawal liability decision to determine whether their activities, including the receipt of management fees from its portfolio companies, call into question whether the hedge fund itself is conducting a trade or business. If the hedge fund is considered to be in a trade or business then all its portfolio companies could be considered part of a controlled group of trades or businesses. A conclusion that the portfolio companies were part of a single controlled group would have implications for the benefit plans of all portfolio companies. Under the controlled group rules all members of the controlled group are treated as a single employer so separate benefit plans of the different companies would need to be tested together for certain purposes. A conclusion that a hedge fund’s portfolio companies are part of a single controlled group could create tax problems for the benefit plans of the hedge fund, the portfolio companies and all the participants.
Contact Benefits Notes for more information.