26 CFR §1.414(r)-3

1. (a)General rule. A separate line of business is a line of business (as determined under § 1.414(r)-2) that is organized and operated separately from the remainder of the employer. Paragraph (b) of this section sets forth the rules for determining whether a line of business is organized and operated separately from the remainder of the employer. Paragraph (c) of this section provides certain supplementary rules necessary to apply the requirements of paragraph (b) of this section, as well as examples illustrating the application of those requirements. Paragraph (d) of this section provides an optional rule for lines of business that are vertically integrated.
2. (b)Separate organization and operation
   1. (1)In general. A line of business is organized and operated separately from the remainder of the employer for a testing year only if it satisfies all the requirements of paragraphs (b)(2) through (b)(5) of this section for the testing year.
   2. (2)Separate organizational unit. The line of business must be formally organized as a separate organizational unit or group of separate organizational units within the employer. For this purpose, an organizational unit is a corporation, partnership, division, or other unit having a similar degree of organizational formality. This requirement must be satisfied on every day of the testing year.
   3. (3)Separate financial accountability. The line of business must be a separate profit center or group of separate profit centers within the employer. This requirement must be satisfied on every day of the testing year. In addition, the employer must maintain books and records that provide separate revenue and expense information that is used for internal planning and control with respect to each profit center comprising the line of business.
   4. (4)Separate employee workforce. The line of business must have its own separate employee workforce. A line of business has its own separate workforce only if at least 90 percent of the employees who provide services to the line of business, and who are not substantial-service employees with respect to any other line of business, are substantial-service employees with respect to the line of business. See paragraph (c)(2) of this section to determine how the percentage in the preceding sentence is calculated for the testing year.
   5. (5)Separate management. The line of business must have its own separate management. A line of business has its own separate management only if at least 80 percent of the employees who are top-paid employees with respect to the line of business are substantial-service employees with respect to the line of business. See paragraph (c)(3) of this section to determine how the percentage in the preceding sentence is calculated for the testing year.
3. (c)Supplementary rules
   1. (1)In general. This paragraph (c) provides certain supplementary rules necessary to apply the requirements of paragraph (b) of this section, as well as examples illustrating the application of those requirements.
   2. (2)Determination of separate employee workforce. The percentage in paragraph (b)(4) of this section is the fraction (expressed as a percentage)—
      1. (i)The numerator of which is the number of substantial-service employees with respect to the line of business within the meaning of § 1.414(r)-11(b)(2); and
      2. (ii)The denominator of which is the total number of employees who provide services to the line of business within the meaning of paragraph (c)(5) of this section and who are not substantial-service employees with respect to any other line of business.
   3. (3)Determination of separate management. The percentage in paragraph (b)(5) of this section is the fraction (expressed as a percentage)—
      1. (i)The numerator of which is the number of employees who are both top-paid employees and substantial-service employees with respect to the line of business within the meaning of § 1.414(r)-11(b)(3) and (2), respectively; and
      2. (ii)The denominator of which is the total number of top-paid employees with respect to the line of business within the meaning of § 1.414(r)-11(b)(3).
   4. (4)Employees taken into account. For purposes of applying this paragraph (c), only employees who are employees on the first testing day are taken into account. For this purpose, there are no excludable employees except nonresident aliens described in section 410(b)(3)(C). Consequently, all other employees who are employees on the first testing day are taken into account, including collectively bargained employees. For the definition of first testing day, see § 1.414(r)-11(b)(7).
   5. (5)Services taken into account
      1. (i)Provision of services to a line of business. An employee provides services to a line of business if more than a negligible portion of the employee's services contributes to providing the property or services provided by the line of business to customers of the employer. All of the services of each employee who provides services to the employer contribute, whether directly or indirectly, to the provision of property or services to customers of the employer, and therefore each employee who provides services to the employer must be treated as providing more than a negligible portion of the employee's services to one or more lines of business operated by the employer.
      2. (ii)Period for which services are provided. Only services performed by an employee during the testing year that contribute to providing the property or services provided by a line of business to customers are taken into account. An employee's services during the testing year are considered to contribute to providing the property or services provided by a line of business to customers of the employer if—
         1. (A)The employee's services during the testing year contribute to providing such property or services to customers of the employer during the testing year; or
         2. (B)It is reasonably anticipated that the employee's services during the testing year will contribute to providing such property and services to customers of the employer after the close of the testing year.
      3. (iii)Optional rule for employees who change status
         1. (A)In general. Solely for purposes of the separateness rules of this section and the assignment rules of § 1.414(r)-7, if an employee changes status as described in paragraph (c)(5)(iii)(B) of this section, an employer may, for up to three consecutive testing years after the base year (within the meaning of paragraph (c)(5)(iii)(B) (1) or (2) of this section), treat the employee as providing the same level of service to its lines of business as the employee provided in the base year.
         2. (B)Change in employee's status. An employee changes status as described in this paragraph (c)(5)(iii)(B) if—
            1. (1)For a testing year (the base year), the employee was a substantial-service employee with respect to a qualified separate line of business of the employer (prior line of business) and, for the immediately succeeding testing year, the employee is not a substantial-service employee with respect to that prior line of business; or
            2. (2)For a testing year (the base year), the employee was a residual shared employee and, for the immediately succeeding testing year, the employee is a substantial-service employee with respect to a qualified separate line of business.
            3. (6)Examples of the separate employee workforce requirement. The following examples illustrate the application of the separate employee workforce requirement in paragraph (b)(4) of this section and the supplementary rules of this paragraph (c). Unless otherwise specified, it is assumed that the employees and their services described in these examples are taken into account under paragraphs (c) (4) and (5) of this section for the testing year and that the employer does not use the option under § 1.414(r)-11(b)(2) to treat employees who provide less than 75 percent of their services to a line of business as substantial-service employees with respect to the line of business.
            4. (7)Examples of the separate management requirement. The following examples illustrate the application of the separate management requirement in paragraph (b)(5) of this section and the supplementary rules of this paragraph (c). Unless otherwise specified, it is assumed that employees who provide services to a line of business are not substantial-service employees with respect to any other line of business and that, in determining the top-paid employees with respect to a line of business, the employer is using the option under § 1.414(r)-11(b)(3) to disregard all employees who provide less than 25 percent of their services to that line of business.
4. (d)Optional rule for vertically integrated lines of business
   1. (1)In general. If two lines of business satisfy the requirements of this paragraph (d) with respect to a type of property or service for a testing year, the employer is permitted to apply the optional rule in this paragraph (d) for the testing year.
   2. (2)Requirements. Two lines of business satisfy the requirements of this paragraph (d) with respect to a type of property or service only if—
      1. (i)One of the lines of business (the upstream line of business) provides a type of property or service to the other line of business (the downstream line of business);
      2. (ii)The downstream line of business either—
         1. (A)Uses, consumes, or substantially modifies the property or service in the course of itself providing property or services to customers of the employer; or
         2. (B)Provides the same property or service to customers of the employer at a different level in the chain of commercial distribution from the upstream line of business (e.g., retail versus wholesale); and
      3. (iii)The upstream line of business either—
         1. (A)Provides the same type of property or service to customers of the employer, and at least 25 percent of the total number of units of the same type of property or service provided by the upstream line of business to all persons (including customers of the employer, the downstream line of business, and all other lines of business of the employer) are provided to customers of the employer by the upstream line of business, when measured on a uniform basis; or
         2. (B)Provides to the downstream line of business property consisting primarily of a type of tangible property (i.e., goods, not services) that it produces or manufactures, and some entities outside the employer's controlled group that are engaged in a similar business as the upstream line of business provide the same type of tangible property to unrelated customers (i.e., customers outside those entities' respective controlled groups).
   3. (3)Optional rule
      1. (i)Treatment of employees. For purposes of determining the lines of business to which an employee provides services under paragraph (c)(5) of this section, an employee is not treated as providing services to the downstream line of business if—
         1. (A)The employee is considered to provide services to the downstream line of business under paragraph (c)(5) of this section (applied without regard to the optional rule in this paragraph (d)); and
         2. (B)The employee is so considered solely because the employee's services contribute to providing the property or service from the upstream line of business to the downstream line of business.
      2. (ii)Purposes for which optional rule applies. If an employee applies the optional rule in this paragraph (d), the treatment specified in paragraphs (d)(3)(i) (A) and (B) of this section applies for all the following purposes and only for the following purposes—
         1. (A)The separate employee workforce and separate management requirements of paragraphs (b)(4) and (b)(5) of this section;
         2. (B)The 50-employee requirement of § 1.414(r)-4(b); and
         3. (C)The determination of the employees of a qualified separate line of business under § 1.414(r)-7.
   4. (4)Examples. The following examples illustrate the application of the optional rule in this paragraph (d).