In Employee Plan News (December 20, 2011), the Internal Revenue Service (the "IRS") provided some thoughts on leased employees. Here is what the IRS said.
EPCU Project on Leased Employees. The Employee Plans Compliance Unit (the "EPCU") has completed a project to determine if plan sponsors properly considered leased employees for qualified plan purposes. When leased employees aren't considered, they may be improperly excluded from the plan, the plan's testing and limitations may be incorrect, and the plan may discriminate in favor of highly compensated employees. In general, the results of the project were that :
-- approximately 65% of the employers surveyed did not actually have any leased employees , and didn't fully understand what it means to be a leased employee for purposes of the qualified plan rules; and
-- approximately 25% of the employers surveyed correctly applied the leased employee rules, or used the Employee Plans Compliance Resolution System (the "EPCRS") to correct plan errors that occurred when they didn't properly apply the rules (it is not clear what happened to the final 10% of surveyed employers).
Overview of Leased Employee Rules. Generally, a leased employee is defined by the Internal Revenue Code, Treasury Regulations and other IRS guidance as an individual whose services are purchased from a leasing organization and provided to a recipient company. For retirement plan purposes, the recipient company must treat a leased employee the same as a common law employee. This means that if a leased employee meets the age and service requirements of the plan, he or she must be allowed to participate in the plan. However, a sponsor may specifically exclude leased employees from participating in the plan, but must still consider them when performing the plan's coverage and nondiscrimination testing.
Who is a Leased Employee?
To be considered a leased employee, an individual must meet four requirements:
1. Agreement - The leased employee's services must be detailed in an agreement between the recipient company and the leasing organization. The agreement requires the recipient company to pay a fee to the leasing organization for the leased employee's services.
2. Service - The leased employee's services to the recipient company must be on a substantially full-time basis, for at least one year. The leased employee meets this requirement if, during the year, he or she is credited with the lesser of 1,500 hours of service or 75% of the hours of service (not less than 500) that are customarily performed by an employee of the recipient in the same position. If the leased employee works for a company that's related to the recipient company sponsoring the plan, then work with the related company is considered for both the one year and the1,500 hour requirements. If an individual was previously a common law employee of the recipient company before becoming a leased employee, that service is also considered for the one year and the1,500 hour tests.
3. Direction or Control - The recipient company must have primary direction or control over the services performed by the leased employee. Several factors are considered when determining primary direction and control:
• when, where and how the leased employee is to perform the service;
• whether the service must be performed by a particular person;
• whether the recipient company supervises the leased employee's service; and
• whether the employee must perform service in the order set by the recipient company.
It is irrelevant whether the recipient company has the right to fire the leased employee or that the leased employee works for other companies.
4. Common Law Employer - Based on facts and circumstances, the leasing company must be the common law employer of the leased employee.
Plan Requirements. When a recipient company maintains a qualified plan, their leased employees are required to be treated as common law employees for the following plan purposes:
• Eligibility - IRC section 410(a)
• Coverage - IRC section 410(b)
• Nondiscrimination - IRC section 401(a)(4)
• Vesting - IRC section 411
• Contributions and Benefits - IRC section 415
• Compensation - IRC section 401(a)(17)
• Top-Heavy Rules - IRC section 416