Leased Employees: Common Law Status And The Irs

Employee leasing is a popular concept, with an increasing number of companies entering into co-employment arrangements with Professional Employer Organizations (PEOs) to provide workers. However, this has led to confusion over the employment status of leased employees, who may be mistakenly labelled as such when they are, in fact, common-law employees. This is an important distinction to make, as it determines which entity is considered the employer for tax and benefit purposes, including eligibility for retirement plans. So, can a leased employee be a common-law employee?

Common-law employer

Employee leasing is a popular concept. A leased employee receives a paycheck from a "staffing firm" but performs services for a "recipient company". The question arises: which entity is considered the "common-law employer" for retirement plan purposes?

A common-law employer is a person or company that has full control over the employee's activities, including the type of work done and how it is carried out. They have the power to assign wages, determine employee benefits, and terminate employees. A common-law employee must perform their work within the guidelines and restrictions provided by the employer.

A leased employee will be considered a common-law employee of the recipient company if certain conditions are met. These include the worker being assigned long-term to the recipient company, performing services for them on a substantially full-time basis, and their work being supervised and performed under the primary direction of the recipient company.

The Internal Revenue Service (IRS) states that under common-law rules, anyone who performs services for an entity is an employee if that entity controls what will be done and how it will be done. This is the case even if the employee has freedom of action. The substance of the relationship, not the label, governs the worker's status. All information that provides evidence of the degree of control and independence must be considered when determining whether an individual is an employee or an independent contractor.

The common-law control test is used to determine whether a worker is an employee. This involves examining the degree of control the employer has over the employee's activities. Even with all the facts, it can still be difficult to determine whether an individual is an employee or an independent contractor.

Retirement plan coverage

Retirement plans are a crucial aspect of financial planning, and understanding the coverage rules for leased employees is essential. While leased employees are not considered common-law employees of the recipient employer, they are often treated as such for retirement plan purposes. This is a complex issue, and financial advisors play a crucial role in guiding employers and employees through these intricacies.

The IRS has specific rules and regulations regarding retirement plans for leased employees, but there is no one-size-fits-all solution. The determination of retirement plan coverage depends on various factors, including the nature of the employment relationship and the structure of the leasing arrangement.

To start with, a leased employee is typically employed by a leasing organisation or a Professional Employer Organisation (PEO) while providing services to a recipient employer. The leasing organisation manages payroll, paperwork, and human resources for the employees working for their client companies. This arrangement can offer benefits such as reduced legal liabilities, improved productivity, and better employee benefits for the recipient employer.

Now, coming to the retirement plan coverage for leased employees, there are a few scenarios to consider:

• Exclusion of Leased Employees: A retirement plan can be designed to entirely exclude leased employees as a class. However, this could affect the Internal Revenue Code Section (IRC Sec.) 410(b) minimum coverage test. Generally, to meet minimum coverage standards, 70% of non-highly compensated employees (non-HCEs) must benefit from the plan compared to highly compensated employees (HCEs). If leased employees constitute a significant portion of the non-HCEs, their exclusion may cause issues with meeting these standards.
• Safe Harbor Provision: Leased employees can be excluded from the recipient employer's retirement plan if they make up 20% or less of the recipient employer's non-highly compensated workforce. In this case, the leasing organisation can provide a money purchase plan with a 10% employer contribution that is immediately 100% vested.
• Treatment as Common-Law Employees: In some cases, leased employees may be treated as common-law employees of the recipient employer for retirement plan purposes. This typically occurs when the leased employee works full-time (at least 1,500 hours in a year or 75% of the average hours worked by a similar position) under the primary direction and control of the recipient employer for at least one year. In this scenario, the leased employee would be covered by the recipient employer's retirement plan.
• Coordination Between Organisations: When leased employees are included in the recipient employer's retirement plan, coordination between the recipient employer and the leasing organisation is crucial. The recipient employer can withhold fees paid to the leasing organisation for elective deferrals, or the leasing organisation can withhold the appropriate amount from leased employees' pay and send it to the recipient employer for deposit into the plan.

It is important to note that the IRS has not provided specific written guidance on this topic, and each situation may vary based on the specific circumstances and plans involved. Consulting with a financial advisor or tax professional is always recommended to ensure compliance with applicable laws and regulations.

Employee leasing

The leasing company is the official employer, and it can maintain relationships with workers even after they have been let go by their former employer. This can lead to situations where employees are assigned to positions that directly compete with their former employer, potentially endangering trade secrets.

However, one of the main challenges of employee leasing is determining which entity is considered the "common-law employer" for purposes of the retirement plan. Under common-law rules, anyone who performs services for an organization is an employee if the organization can control what will be done and how it will be done. This determination is crucial because it affects eligibility for retirement benefits and tax liabilities.

A leased employee is typically defined as someone who receives a paycheck from a staffing firm but performs services for another company (the recipient company). A leased employee will be considered a common-law employee of the recipient company if certain conditions are met, such as long-term assignment and supervision by the recipient company.

To summarize, employee leasing offers benefits such as quick access to qualified workers and competitive benefits typically available only at larger companies. However, it also presents challenges in determining the "common-law employer" for retirement plans and potential issues with trade secrets.

Third-party payer

A leased employee is a person who receives a paycheck from one employer, a "staffing firm", but is performing services for another company, a "recipient company". A leased employee will be considered a common-law employee of the recipient company if certain conditions are met. For instance, the worker is assigned to the recipient company on a long-term basis.

The Internal Revenue Service (IRS) has outlined rules for common-law employees, which state that anyone who performs services for a company is considered an employee if the company has control over what will be done and how it will be done. This is true even if the employee has freedom of action. The substance of the relationship, not the label, governs the worker's status.

While the PEO may claim to be a “co-employer", the client remains the common-law employer and is responsible for withholding, reporting, and paying employment taxes. The IRS is not bound by any agreement that purports to transfer the employment tax obligations of the common-law employer to a third party. However, there are limited circumstances where a third party that is not the common-law employer may be treated as such for the purposes of satisfying employment tax obligations.

In conclusion, a leased employee can be a common-law employee, and third-party payers are often used by common-law employers to outsource some of their payroll and tax duties. However, the common-law employer typically remains responsible for employment taxes and related reporting.

Staffing firm

Employee leasing is an arrangement between a business and a staffing firm, which supplies workers on a project-specific or temporary basis. These employees work for the client business but are paid by the leasing agency, which also handles all HR administration associated with their employment.

A leased employee is a person who receives a paycheck from a staffing firm but performs services for another company, known as the recipient company. The leasing company is the official employer of the leased employees, and it can continue relationships with workers after they have been let go by the recipient company.

A leased employee can be considered a common-law employee of the recipient company if certain conditions are met. These include the worker being assigned long-term to the recipient company, the recipient company making hiring and firing decisions, and determining the worker's rate of pay. The worker's services must also be provided under an agreement between the recipient company and the staffing firm, and the worker must have performed these services for the recipient company on a substantially full-time basis for at least one year.

It is important to note that the rules regarding leased employees and common law employees were put in place to prevent manipulation of eligibility for retirement benefits. Companies that utilize staffing firms should pay close attention to the employment status of their workers to ensure compliance with regulations.

In the context of 401(k) plans, the classification of leased employees is crucial. If a worker is determined to be a leased employee, they may need to be offered the opportunity to participate in the plan. However, if a worker is a common law employee, they should be offered the plan as per the company's regular eligibility requirements.

Frequently asked questions