3935 / What is an affiliated service group?

For purposes of certain qualification requirements, as well as for the vesting requirements, top-heavy rules, Section 415 limits and the requirements for SEPs, all employees of the members of an affiliated service group generally are treated as employed by a single employer.¹

An affiliated service group is a group consisting of a service organization (referred to as "FSO" for "first service organization") and:

(1)  an additional service organization (referred to as an "A" organization) that is a shareholder or partner in an FSO and that regularly performs services for the FSO or that is regularly associated with the FSO in the performance of services for third parties, or

(2)  an organization (referred to as a "B" organization) if a significant portion of the organization's business is the performance of services for an FSO or for an A organization (or both) and the services are of a type historically performed by employees in the service field of the FSO or A organization; and

(3)  10 percent or more (in the aggregate) of the interests in the B organization is held by highly compensated employees of an FSO or an A organization or certain common owners.²

The term affiliated service group also includes a group consisting of (1) an organization the principal business of which is performing management functions for another organization on a regular and continuing basis, and (2) the organization for which the functions are performed.³

An organization is a service organization if its principal business is the performance of services in one of the fields enumerated in the regulations (e.g., health, law, etc.) or if capital is not a material income-producing factor for the organization.⁴

The performance of services for a first service organization or for an A organization (or both) will be assumed to constitute a significant portion of a B organization's business if 10 percent or more of its total gross receipts from all sources during the current year, or two preceding years, was derived from performing services for such organization or organizations. It will be assumed that the performance of services for such organization or organizations is not a significant portion of a B organization's business if less than 5 percent of its gross receipts derived from performing services during the current year and two preceding years was derived from performing services for such organizations.⁵ Services are of a type historically performed by employees in a particular field if it was not unusual for the services to be performed by employees of organizations in that service field in the United States on December 13, 1980.⁶

The principles of the constructive stock ownership rules of IRC Section 318(a) apply. Thus, ownership generally will be attributed to an individual from the individual's spouse, children, grandchildren and parents, between a partner and the partnership, between a trust or estate and its beneficiaries, and between a corporation and a more-than-50 percent shareholder, including a corporate shareholder.⁷

Two or more affiliated service groups will not be aggregated merely because an organization is an A organization or a B organization with respect to each affiliated service group. All organizations that are A organizations or B organizations with respect to a single FSO, together with that FSO, must be treated as a single affiliated service group.⁸

Taxpayers may rely on the proposed regulations covering service-type affiliated groups until final rules are published. Examples explaining the tests for a service-type affiliated service group can be found in Revenue Ruling 81-105.⁹