Understanding "Leased
Employees"
Whenever I am working with someone new to employee benefits,
one of the first comments I hear is "this is like learning
another language." These novices are correct; employee benefits
is a language unto itself and one of the most confusing terms
is that of "leased employee." In the past several years,
an increasing number of companies have begun utilizing staffing
firms, also known as employee leasing companies or professional
employer organizations (PEOs) to provide workers. The workers
obtained through staffing companies are often mistakenly labeled "leased
employees" when they should have been identified as common
law employees. This article is designed to help you understand
(1) how to categorize workers obtained through a staffing company
and (2) what "leased employees" are.
Categorizing Workers
To clarify some of the confusing terminology, let's start with
the terms the Internal Revenue Service (IRS) uses in identifying
the participants in a staffing arrangement. There is the PEO,
which is the staffing company that enters into a service contract
to provide workers (Worksite Employees) to a client organization
(CO). The Worksite Employees are utilized as long term workers,
not merely as "temps" to replace a vacationing receptionist
or to perform short-term special projects. It is essential that
a CO determine whether or not the Worksite Employees are the
CO's common law employees. There is no simple test for making
this determination. However, in almost every court decision and
Revenue Ruling that has addressed this issue, the CO has been
held to be the true common law employer, and not the PEO.
Most of the decisions and rulings have utilized the 20-factor
test of common law employee status. This test was originally
used to distinguish between an independent contractor and an
employee. In looking at the factors that would make the CO the
true common law employer, there seems to be an emphasis on whether
the Worksite Employee is performing services of a kind normally
performed by an employee and is acting under the direction and
control of the CO. There is a notable exception for a traditional "temp" agency
that sends people to a variety of short-term assignments or a
nurses registry. However, the typical scenario where a company
leases most of its staff from a PEO almost always leaves the
company -- not the PEO -- as the common law employer.
In some circumstances, a co-employer relationship has been fashioned
between the PEO and CO. However, for employee benefits purposes,
there is no legal recognition of a co-employer relationship.
Therefore, one or the other, but not both, will be the common
law employer.
If the Worksite Employees are the common law employees of the
CO, then they must be counted for employee benefits purposes.
While companies can design their plan documents to exclude Worksite
Employees from participation, they should be careful of potential
nondiscrimination testing problems. This could be especially
problematic for companies that have a large portion of their
workforce comprised of non-highly compensated Worksite Employees.
For example, qualified retirement plans are subject to minimum
coverage testing. If the retirement plan excludes all Worksite
Employees and they are all non-highly compensated employees,
the plan could fail the test. Self-funded health plans under
Section 105(h) of the Internal Revenue Code of 1986, as amended
(Code) could also face testing failures for excluding these employees.
In addition to benefits issues for Worksite Employees, the issue
of payroll taxes can also be troublesome for companies utilizing
PEOs. If the CO is the common law employer, then it is also liable
for payroll taxes, even if the PEO is contractually obligated
to pay them. Earlier this year the IRS issued Information Release
2004-47 (April 5, 2004) warning COs of their potential liability
if a PEO fails to pay the required payroll taxes. In that Release
the IRS stated:
There are two primary categories
of third party payers – Payroll
Service Providers and Professional Employer Organizations.
Payroll Service Providers typically perform services for employers
such
as filing employment tax returns and making employment
tax payments. Professional Employer Organizations offer employee
leasing meaning
that they handle administrative, personnel, and payroll
accounting functions for employees who have been leased to
other companies
that use their services. Many of these companies provide
outstanding services to employers. Unfortunately, in some instances,
companies
of both types of services have failed to pay over to the
IRS the collected employment taxes. When these employment service
companies dissolve, millions in employment taxes can be
left
unpaid. Employers are urged to exercise due diligence in
selecting and monitoring a third party payer. For example,
when choosing
a third party payer, employers should look for one that
is reputable and uses the Electronic Federal Tax Payment System
(EFTPS). This
allows the business owner to verify payments made on their
behalf. Also, an employer should never allow their address
of record
with the IRS be changed to that of the third party payer.
In its
warning, the IRS cited both criminal prosecution and civil penalties
for failure to remit payroll taxes.
Leased Employees
Next, we address "leased employees." Code Section 414(n)
- which applies to employee benefits - defines the term "leased
employee" as one who is NOT the common law employee of the
entity for whom they are performing services AND who has performed
services on a substantially full-time basis for the recipient
employer/plan sponsor for a least one year. Thus, by definition,
a common law employee is not a leased employee. If a Worksite
Employee is the common law employee of the CO, then there is
no leased employee issue. Leased employee issues only arise where
there is a long-term temp worker. For example, Acme Widgets utilizes
T-Account, Inc., a staffing company, to handle its bookkeeping.
Assume that under the 20-factor test the Worksite Employees are
the common law employees of T-Account. These Worksite Employees
provide services to Acme for over one year. At the end of the
year, the Worksite Employees will be the "leased employees" of
the Acme. What does this require of the Acme?
Leased employees are treated as employees of the CO for both
retirement and certain welfare plans (not self-funded plans under
Code §105(h)). As stated above, a CO's benefits plans can
be designed to exclude leased employee from participation so
long as the nondiscrimination coverage tests are passed. Another
concern with leased employees is crediting service for those
who either participate in retirement plans as leased employees
or become the common law employees of the CO and then participate.
For purposes of both participation and vesting, the entire period
for which the leased employee has performed services for the
CO must be taken into account in accordance with Code Section
414(n)(4), whether or not the person was working full-time.
Returning to our example, Acme hires Debbie Credit, a Worksite
Employee from T-Account, as its head bookkeeper. All of Debbie's
service under the staffing/leasing contract with Acme, including
the time she was still a common law employee of T-Account, must
be credited for purposes of eligibility and vesting under Acme's
qualified retirement plans. Acme also decides to hire Bill Pei
as assistant bookkeeper. Bill has only worked at Acme for 3 months
so he is not a leased employee. Nevertheless, Code Section 414(n)(4)(B)
requires Acme to credit Bill's 3 months of service for vesting
and eligibility purposes.
In conclusion, companies utilizing staffing firms should pay
close attention to the employment status of the workers. The
employee benefit plans need to be reviewed to make certain that
they properly include and exclude the intended categories of
workers. Another important consideration is payroll taxes. COs
should make certain that PEOs are depositing the appropriate
taxes in a timely manner or else face the possible liability
themselves. Finally, if Worksite Employees are not the CO's common
law employees, then they may be leased employees and it is important
that records of their service be maintained for possible credit
under benefit plans.
