Fourth and Final Article in the Series
Key Takeaways
- A worker who is not your common law employee may still have to be treated as your employee for certain employee benefit plan purposes.
- The leased employee rules apply on an individual-by-individual basis, not just at the entity level.
- These rules can affect retirement plans and certain welfare benefit plans.
- A leasing organization’s retirement plan may help in some circumstances, but safe harbor relief is limited and does not apply to all benefit plans.
- Employers using staffing companies, leasing companies, or similar arrangements should review whether workers must be counted in benefit plan testing.
The controlled group and affiliated service group rules focus on whether multiple organizations must be treated as one employer. The leased employee rules ask a different question: can a worker who is paid by another company still have to be counted as your employee for benefit plan purposes?
That question matters for employers using staffing companies, leasing companies, long-term personnel arrangements, or workers who function like regular employees even though they are not on the recipient company’s payroll. Payroll status alone does not necessarily answer the employee benefit plan question.
The leased employee rules are applied worker by worker, which makes them different from the entity-level aggregation rules discussed earlier in this series. If the rules apply, the result can affect retirement plan testing, welfare benefit plan compliance, and the assumptions a business has made about who is covered and who is not.
Back to Dr. D
In the prior article, Dr. D was concerned that the dental practice and dental lab might have to be aggregated under the affiliated service group rules.
Now Dr. D has another issue.
Dr. D does not consider every member of the dental practice staff to be an employee of Dr. D’s professional corporation. Some of the staff are employed by a separate company, the Safe Harbor Employee Leased Labor Company, which we will call Shellco.
Dr. D does not own any interest in Shellco.
That means Dr. D’s dental corporation and Shellco may not have to be aggregated under either the controlled group rules or the affiliated service group rules.
But that does not end the analysis.
The Shellco employees who work in Dr. D’s dental practice may be treated as leased employees of Dr. D’s professional corporation. If so, they may have to be taken into account when testing the dental corporation’s employee benefit plans.
What Is an Employee Leasing Arrangement?
An employee leasing arrangement exists when one employer uses employees of another employer to perform services instead of directly hiring its own employees to perform those services.
Temporary personnel agencies are familiar examples. A business may use another company to provide a receptionist, administrative employee, accounting employee, or other worker.
Employee leasing arrangements can be attractive because another organization may handle payroll, payroll taxes, hiring, firing, discipline, benefits, workers’ compensation, and other employment-related responsibilities.
But for employee benefit plan purposes, the arrangement must still be reviewed carefully.
These structures were sometimes used to try to limit the number of people who had to be covered by a business owner’s retirement plan or to avoid the controlled group and affiliated service group rules. The leased employee rules were enacted to address those arrangements.
What Are the Leased Employee Rules?
The leased employee rules generally treat a common law employee of a leasing organization as the employee of the recipient organization for certain employee benefit plan purposes if the individual meets the definition of a leased employee.
A leased employee is a person who:
- Is not a common law employee of the recipient organization;
- Provides services to the recipient organization under an agreement between the leasing organization and the recipient organization;
- Provides services on a substantially full-time basis for at least one year; and
- Performs services under the recipient organization’s primary direction or control.
If those requirements are met, the individual may have to be treated as the recipient organization’s employee for employee benefit plan purposes.
Why This Is Different from Controlled Group and ASG Analysis
The leased employee rules are applied differently from the controlled group and affiliated service group rules.
Controlled group and affiliated service group rules generally ask whether organizations must be aggregated.
The leased employee rules ask whether a specific individual must be treated as an employee of the recipient organization.
That means the analysis is performed worker by worker.
Once an individual is treated as a leased employee of a recipient organization, that individual is also treated as an employee of all entities aggregated with the recipient organization under the controlled group or affiliated service group rules.
Can the Leasing Company’s Plan Help?
There is one helpful feature of the leased employee rules.
Benefits provided to the leased employee under the leasing organization’s plan may be treated as provided by the recipient organization.
In the right circumstances, that can help the recipient organization satisfy certain requirements even if it does not cover the leased employees directly under its own retirement plan.
However, this is not a complete solution, and it does not apply equally across all types of plans.
The Safe Harbor Problem
Assume the Shellco employees used by Dr. D would otherwise be treated as leased employees of Dr. D’s dental corporation.
Why did Shellco not warn Dr. D that this could create benefit plan issues?
When Dr. D and Shellco entered into their arrangement years ago, Shellco adopted a safe harbor plan for its employees. At that time, the leased employee rules included a special exception that could prevent Shellco’s employees from being treated as Dr. D’s leased employees for retirement plan purposes if certain requirements were met.
The original safe harbor exception provided that employees of the leasing organization would not be treated as employees of the recipient organization if they were covered by the leasing organization’s money purchase pension plan that provided:
- Immediate participation
- 100% immediate vesting
- A contribution of at least 7.5% of compensation
Dr. D and Shellco continued operating on the assumption that the leased employees were covered by Shellco’s plan and did not have to be covered by Dr. D’s more generous retirement plan.
But the law changed.
Congress later modified the safe harbor rule by:
- Increasing the required contribution rate to 10%; and
- Making the safe harbor unavailable if leased employees constitute more than 20% of the recipient organization’s nonhighly compensated workforce.
Shellco may have amended its plan to increase the contribution rate to 10%, but that is not the end of the inquiry.
Dr. D still needs to determine whether leased employees constitute more than 20% of the dental corporation’s nonhighly compensated workforce.
If they do, the safe harbor may not be available.
Safe Harbor Relief Is Limited
Even if the retirement plan safe harbor applies, it does not solve every benefit plan problem.
The leased employee safe harbor does not apply to welfare benefit plans.
That means Dr. D’s welfare benefit arrangements, such as a medical expense reimbursement plan subject to nondiscrimination testing, may still have to be reviewed.
If the leased employees are not properly taken into account, the tax consequences may affect Dr. D and other highly compensated individuals.
This is why relying on a leasing company’s plan documents or payroll structure without a benefit plan analysis can be risky.
Leasing the Owner Back to to the Business
Some arrangements attempted to avoid employee benefit plan rules in a different way.
Instead of leasing rank-and-file workers to a business, a leasing organization would lease the business owners back to their own businesses. The rank-and-file workers remained employees of the operating business, while the owners were treated as employees of the leasing organization and covered by a more generous retirement plan sponsored by the leasing organization.
On paper, the arrangement appeared to separate the owners from the employees for plan purposes.
The IRS and courts did not accept this approach where the owners were not common law employees of the leasing organization. In that case, the leasing organization’s plan covered individuals who were not its employees, creating an exclusive benefit rule problem and risking disqualification of the leasing organization’s retirement plan.
Leased Owners
Code section 414(o) gives the IRS authority to issue regulations necessary to prevent avoidance of certain employee benefit requirements through separate organizations, employee leasing, or other arrangements.
One proposed Treasury regulation that was not withdrawn addresses retirement plan benefits of so-called leased owners.
A leased owner is generally an individual who performs services for an organization in which the individual is a more than 5% owner, directly or by attribution, in a capacity other than as an employee of the recipient.
There are exceptions, including where both of the following are true:
- Less than 25% of the individual’s total hours worked for substantial compensation are for all recipients with respect to which the individual is a leased owner; and
- Less than 25% of the individual’s total compensation is derived from performing services for all such recipients.
However, that exception may not apply if the individual performs professional services for the recipient of the same type as the professional services performed by the recipient for third parties.
If an individual is a leased owner, the leased owner’s interest in the leasing organization’s retirement plan attributable to services performed for the recipient may be treated as provided under a separate retirement plan maintained by the recipient covering only the leased owner.
If the recipient also maintains a retirement plan in which the leased owner participates, the leased owner’s interest in the leasing organization’s plan attributable to services performed for the recipient may be treated as provided under the recipient’s plan.
If that treatment causes either the deemed plan or the recipient’s actual plan to fail the qualification requirements, the leasing organization’s plan may be disqualified.
Practical Warning Signs
The leased employee rules should be reviewed when:
- Workers are on-site or integrated into the business but paid by another company
- Workers perform services for the business on a long-term or substantially full-time basis
- The business directs or controls the day-to-day work
- A staffing or leasing company provides workers who function like regular employees
- A retirement plan excludes workers supplied by another company
- A welfare benefit plan covers only the direct payroll employees
- The business assumes the leasing company’s benefits solve the issue
These facts do not automatically mean a leased employee problem exists, but they should trigger a review.
What to Do
If a business uses individuals who are not treated as its employees to perform employee-type services, the first question is whether those individuals are actually common law employees of the business.
If they are not common law employees, the next question is whether they are leased employees for employee benefit plan purposes.
The review should include:
- The agreement between the recipient organization and the leasing or staffing organization
- The length of service of each worker
- Whether services are performed substantially full-time
- Who directs and controls the work
- Whether the leasing organization maintains a retirement plan
- Whether any safe harbor requirements are satisfied
- Whether leased employees exceed 20% of the recipient’s nonhighly compensated workforce
- Whether welfare benefit plans are affected
Employers should not assume that payroll status answers the employee benefit plan question.
Final Thoughts on Aggregation
The controlled group, affiliated service group, and leased employee rules show how complex employee benefit plan compliance can become when multiple businesses, service relationships, family ownership, or staffing arrangements are involved.
The most important practical step is full disclosure.
Business owners should tell their benefits counsel and other advisors about:
- All businesses they own
- Ownership interests held by family members
- Related professional or service entities
- Management companies
- Shared services
- Staffing, leasing, or PEO-style arrangements
- Retirement plans and welfare benefit plans maintained by related organizations
These issues are far easier to address when they are identified early.
The goal is to find and correct problems before they are discovered by the IRS, the Department of Labor, a plan participant, a terminated employee, or a plaintiff’s attorney.
Read the Full Series
This article is part of a series on employee aggregation rules for benefit plans.
