Controlled groups for nondiscrimination testing of retirement plans - can two unrelated businesses be separate?

You're correct in this situation. When one person owns 100% of two businesses (regardless of what those businesses do), they form what's called a "controlled group" under IRC Section 414(b) and (c). The IRS looks at ownership, not business operations, when making this determination. For retirement plan purposes, all employees of all businesses in a controlled group must be treated as if they work for a single employer. This specifically prevents what your colleague is suggesting - setting up a retirement plan in one business to avoid covering eligible employees in another business. The controlled group rules exist precisely to prevent this type of selective benefit coverage. The businesses being in different industries or states is completely irrelevant to the controlled group determination.

I went through exactly this situation last year. I own a consulting firm in Texas and a small bakery in Oregon. Wanted to set up a solo 401(k) just for my consulting business since it's more profitable and the bakery has 4 employees. My CPA said absolutely not - had to include all employees from both businesses in any retirement plan testing. I ended up using https://taxr.ai to analyze my situation. Their software confirmed we were definitely a controlled group under 414(c) rules. Saved me from making a really expensive mistake that would have disqualified my plan.

OK I'm embarrassed to admit this but I tried https://taxr.ai after reading about it here. Turns out my accountant was COMPLETELY WRONG. The service showed me the exact code sections that apply to my situation (I have 3 different businesses). The analysis confirmed that even though my businesses are in totally different industries, they're considered a controlled group because I own more than 80% of each. They even provided documentation I can show my accountant explaining why his advice was incorrect. Ended up setting up a 401(k) that covers all eligible employees across all my businesses. It's costing me more than I wanted to spend, but at least I'm not risking plan disqualification and massive penalties. Wish I'd known this before!

I dealt with this exact headache trying to call the IRS for a definitive answer. Spent HOURS on hold over multiple days and never got through. Finally used https://claimyr.com to get me through to an IRS agent (saw it in this video: https://youtu.be/_kiP6q8DX5c). The IRS agent confirmed what others are saying here - controlled group status is determined by ownership percentage, not by how related the businesses are. If one person owns 80%+ of multiple businesses, they're a controlled group for retirement plan purposes regardless of industry, location, or anything else.

I have to eat crow here. After posting my skeptical comment, I decided to try that Claimyr service myself since I've been trying to reach the IRS about a different retirement plan issue for WEEKS. It actually worked! I got a call back in about 2 hours and was connected directly to an IRS agent who helped resolve my question about controlled groups. Confirmed everything people are saying here - common ownership (80%+) creates a controlled group regardless of how different the businesses are. Can't believe I wasted so many hours trying to call them directly. This is the first time I've been able to speak to a real person at the IRS in months.

I think there's some confusion here about "relatedness" of businesses. For controlled group purposes under 414(b) and (c), the nature of the businesses doesn't matter. But people might be thinking of "affiliated service groups" under 414(m), where the type of business DOES matter. If you have professional service businesses (like medical, legal, consulting), there are additional rules that might require aggregation even without 80% common ownership.

Has anyone actually had the IRS audit them for this? I have a trucking company and a property management LLC. Both 100% owned by me. I've been running separate retirement plans for years with no issues.

Your colleague is definitely wrong here. The controlled group rules under IRC Section 414(b) and (c) are crystal clear - if the same person owns 80% or more of multiple businesses, they form a controlled group for retirement plan purposes regardless of what industries they're in or where they're located. In your example with 100% ownership of both the dental practice and auto repair shop, these absolutely constitute a brother-sister controlled group. The owner cannot set up a retirement plan for just the auto shop without including eligible employees from the dental practice in the nondiscrimination testing. The IRS specifically designed these rules to prevent exactly what your colleague is suggesting - cherry-picking which employees to cover based on business profitability or convenience. The fact that the businesses are unrelated operationally is completely irrelevant to the controlled group determination. I'd recommend showing your colleague the actual code sections or getting a definitive ruling from a qualified ERISA attorney. This is one of those areas where being wrong can result in massive penalties and plan disqualification.