ARTICLE | September 04, 2025

You may think you don’t own a particular business interest, but the IRS might disagree. Under what’s known as the constructive ownership rules, the tax code can attribute ownership to you based on family relationships or the way entities are structured. 

This isn’t just a technical issue for large conglomerates. Attribution rules show up in everyday tax situations, especially for business owners with family ties, legacy trusts, or layered ownership structures. The rules are complex, but the consequences are simple: if constructive ownership applies and you didn’t plan for it, you could lose access to exclusions, deductions, or favorable tax treatment. These rules can also trigger compliance failures or create unexpected tax liabilities, making them very important to understand. 

What are attribution rules?

Attribution rules, also referred to as constructive ownership rules, are designed to look beyond formal ownership to determine who really has control or economic benefit in a business interest. Under these rules, you may be treated as owning stock or partnership interests held by certain family members, trusts, or other entities.

In other words, ownership is not always about what’s on paper. The IRS looks through corporate structures, family trees, and related-party arrangements to decide whether someone is effectively a stakeholder.

The high stakes: why this matters more than you think

Attribution rules affect a range of tax provisions. Some of the most financially significant include:

• Section 1202: Constructive ownership can disqualify shareholders from the QSBS gain exclusion, eliminating up to $15 million in potential gain exclusions per business.
• Section 267: Losses on sales between related parties are denied. If attribution creates a related-party relationship, what appears to be a deductible loss may be permanently disallowed.
• Section 414: Retirement plan coverage and nondiscrimination testing must account for employees of commonly controlled entities. Attribution can bring an otherwise unrelated business into a testing group.
• Section 1361: S-corporation status can be compromised if constructive ownership results in more than 100 shareholders, disqualified shareholders, or multiple classes of stock.
• Section 318: Stock attribution plays a role in corporate redemptions, controlled foreign corporation status, and other international tax provisions.
• M&A due diligence: Transactions can be delayed or derailed when attribution issues are discovered late in the process.

These rules are designed to prevent taxpayers from shifting ownership in ways that appear to comply with the law but don’t reflect the substance of the arrangement.

How attribution works

Attribution rules don’t follow a single template. The definition of “constructive ownership” depends on which section of the tax code you’re dealing with. Each one defines family relationships, ownership thresholds, and even how ownership is traced through multiple entities differently. 

That said, most attribution rules fall into two general categories: family-based and entity-based. 

Family-based attribution

The tax code assumes that family members act in coordination, and it applies attribution accordingly. Specifically, ownership can be attributed between spouses, parents and children, and grandparents and grandchildren. However, not all family relationships are treated the same across the code. For example, siblings are not considered related parties for attribution under Section 318, but they are for Section 267. Cousins, aunts, and uncles are generally excluded, though there are exceptions in certain estate and trust contexts. 

If any of the direct family relationships exist, the IRS may treat your relative’s interest as your own, even if you had no involvement in the business.

Let’s say David owns 100% of MedTech Solutions. For estate planning, he gifts 20% to each of his two adult children and 10% to his spouse. Unfortunately, David still constructively owns 100%:

• Direct ownership: 50%
• Spouse attribution: 10%
• Children attribution: 20% + 20% = 40%
• Total constructive ownership: 100%

As a result, any related-party transactions are still subject to Section 267 (meaning losses are disallowed), and David remains a 100% owner for controlled group purposes.

Entity-based attribution

Attribution can also apply through corporations, partnerships, LLCs, trusts, and estates.

If you own 50% or more of a corporation or partnership, you are treated as owning a proportionate share of the business interests that entity owns. Similarly, if you are a beneficiary of a trust or an estate, your ownership may include a portion of the interests held by that trust or estate.

These rules can move in different directions:

• Upward: Your ownership may be attributed to an entity you control.
• Downward: Interests held by an entity may be attributed back to you.
• Sideways: Interests may shift across family members or related entities, creating control relationships that otherwise wouldn’t exist.

Let’s say Jennifer owns 60% of ABC Corp. Her wholly-owned LLC owns the remaining 40%. This means Jennifer constructively owns 100% of the corporation. If she reduced her LLC ownership below 50%, the attribution would break, potentially changing the tax treatment of corporate transactions. This fluidity creates opportunities for planning, but also risks if these relationships go unrecognized.

The key rules you need to know

A few sections of the Internal Revenue Code apply attribution rules with particular frequency and impact:

Section 267: Disallowed losses

Section 267 prevents you from deducting losses on sales to related parties. Sell stock to your spouse at a loss? No deduction. Your corporation sells property to your 60%-owned subsidiary at a loss? Also disallowed.

Planning point: Time sales transactions carefully and consider the related-party definitions before recognizing losses.

Section 318: Stock attribution for corporate actions

This section defines how ownership is attributed for corporate transactions. It is particularly relevant for C-corporation redemptions, passive foreign investment company (PFIC) determinations, and the classification of controlled foreign corporations. The 50% attribution test often determines whether a redemption qualifies for sale treatment.

Section 414: Retirement plan controlled groups

Section 414 creates controlled group definitions for retirement plan purposes. Companies under common control must be treated as a single employer for coverage testing requirements, contribution limits, and top-heavy testing. A seemingly unrelated family business can suddenly make your company part of a controlled group.

Section 1361: S-Corporation limits

S-corporations face strict eligibility requirements, and attribution can create hidden compliance risks. Constructive ownership may cause an S-corp to exceed the 100-shareholder limit, bring in an ineligible shareholder, or create what appears to be a second class of stock, any of which can invalidate the S-election.

One important exception to be aware of is the family aggregation rule under Section 1361(c)(1). For purposes of the 100-shareholder limit, certain family members can elect to be treated as a single shareholder if specific requirements are met. This election is not automatic. It must be filed with the IRS and properly maintained. Without it, each family member’s ownership is counted separately.

Additionally, if attribution causes ownership to be treated as flowing through an ineligible entity (such as a partnership or nonresident alien), the S-election can be jeopardized even if the shareholder list looks compliant at first glance.

International complications

Attribution rules also affect international tax provisions such as Subpart F (controlled foreign corporation status), Global intangible low-taxed income inclusions (GILTI), and related-party transaction rules for transfer pricing. 

Attribution in practice: common pitfalls

Surprise controlled group

A business owner may assume they’re operating independently, but attribution can tell a different story. Suppose an individual owns 60% of Company A directly. Their spouse owns 15% through an LLC, and their adult child owns 10%, received as a prior gift. When attribution rules under Section 1563 and Section 414 are applied for retirement plan purposes, ownership from the spouse and child may be constructively attributed to the individual.

In this case, the total attributed ownership reaches 85%, crossing the 80% threshold that defines a parent-subsidiary or brother-sister controlled group for qualified plan testing. The result: Company A may now be part of a controlled group, requiring it to aggregate employees and plan coverage with another entity – often one the owner didn’t realize was related under the tax code.

If this attribution is missed, the company’s retirement plan could fail IRS coverage or nondiscrimination testing, leading to disqualification risks, corrective contributions, or costly administrative fixes.

QSBS disqualification during sale

A business owner planning to exclude $8 million of gain under Section 1202 may be blindsided when their spouse’s interest in a related company is attributed back to them. This can trigger affiliated group status and invalidate the exclusion – often too late to adjust.

Retirement plan coverage failures

A company may fail its 401(k) coverage testing when attribution causes employees from the owner’s spouse’s business to be included in the calculation. This often results in costly corrections and, in some cases, the need to retroactively fund additional contributions.

Real estate recapture

When two brothers own separate real estate LLCs and one sells property to the other, attribution can cause the IRS to treat the transaction as occurring between related parties. This may convert what would have been capital gain into ordinary income.

Planning opportunities and risk management

Attribution issues often come down to one thing: awareness. Before executing any major transaction or making structural changes to a business, it’s worth examining how ownership is allocated and how the IRS might view it.

Start by mapping your ownership across individuals and entities, including spouses, children, and any trusts or partnerships. Consider preparing a visual chart to help identify relationships that could trigger attribution. If you’re making gifts or shifting ownership as part of an estate plan, assess how those transfers might shift constructive ownership.

Keep records that document the rationale for ownership structures and how decisions were made. This includes corporate minutes, shareholder ledgers, trust documents, and buy-sell agreements.

In particularly complex or high-dollar scenarios, it may be worth requesting a private letter ruling from the IRS. While expensive and time-consuming, a ruling can provide clarity and help avoid multimillion-dollar mistakes.

And finally, attribution planning works best when coordinated across your advisory team. Your estate planning attorney, ERISA counsel, tax professional, and investment advisor all bring a piece of the puzzle.

When to take a closer look

Attribution rules deserve attention if:

• You own multiple businesses or have family members who do
• Your business is preparing for a sale or corporate reorganization
• You’re implementing or updating a retirement plan
• You’ve made significant gifts or transferred ownership within the family
• You haven’t reviewed your entity structure recently

These rules don’t just apply at the moment of a transaction; they can reach back across years of decisions and across generations of ownership.

Prevention is cheaper than correction

Violating attribution rules, even unintentionally, can cost millions in lost tax benefits, penalties, and restructured transactions. Disqualifying a Section 1202 exclusion, triggering S-corp termination, or failing a retirement plan test all come with real, immediate financial consequences.

While these risks are significant, they are also largely avoidable. Attribution planning, when addressed early, can preserve key tax strategies, support corporate governance, and help ensure compliance with both federal and international rules. In most cases, the cost of reviewing and adjusting your structure is minor compared to the potential exposure.

Keep in mind that each section of the code applies attribution rules differently. No single framework applies across all planning scenarios, which is why context-specific analysis is key. 

If you’d like to evaluate your exposure to constructive ownership, please contact our office for a personalized review. 

This article provides general information and is not a substitute for professional tax or legal advice. Please consult with a qualified advisor for guidance specific to your situation.