Leased Employee Rules: The Complete Guide

Employee leasing is a widely used practice. In this arrangement, a Professional Employer Organization (PEO) or leasing company manages payroll, paperwork, human resources and other benefits for employees who work for one of their client companies.

The primary issue is determining who the actual employer is when the employee is working for a company that is not responsible for their paycheck. To determine this for retirement plan purposes, it is essential to identify the “common-law employer” of the employees.

Let’s take a closer look at leased employees and how you determine who the common law employer is.

How to determine the common-law employer

A leased employee is someone who is paid by a staffing firm but works for another company, known as the recipient company. The question is, which company is the actual employer for the retirement plan? The recipient company is considered the common-law employer of the leased employee if all of the following conditions are met:

• The recipient company is responsible for hiring and firing the worker.
• The worker is assigned to the recipient company on a long-term basis.
• The worker’s services are provided under an agreement between the staffing firm and the recipient company.
• The recipient company determines the worker’s pay rate.
• The worker has worked full-time for the recipient company for at least one year, which means 1,500 hours of service in a year or a number of hours that is at least 75% of the average number of hours an employee in a similar position works.
• The worker’s job is supervised and performed primarily under the direction of the recipient company.

Retirement plan rules for common law employees

If the worker is considered the common-law employee of the recipient company, then the worker is covered under the recipient company’s retirement plan for testing purposes as outlined below:

• Workers would be counted in the coverage tests for the recipient company’s retirement plan once the worker is classified as a “leased” employee.
• Participation and coverage requirements (§401(a)(3), §401(a)(26), and §410)
• Leased employees, as a specific class, can be excluded from participation, but not when the coverage testing fails (can’t be more than 30% of the total workforce)
• Leased employees can be excluded under a Safe Harbor provision when the leased employees represent less than 20% of the recipient company’s non-highly compensated workforce OR the staffing company provides a money purchase plan that has a 10% employer contribution that is immediately 100% vested.
• Vesting provisions and requirements (§401(a)(7), and §411)
• Nondiscrimination rules (§401(a)(4))
  • The Actual Deferral Percentage test and Actual Contribution Percentage tests for 401(k) plans are included under this provision.
• Contribution and employee benefit limits (§401(a)(16) and §415)
  • A worker may be covered under the staffing company’s retirement plan, only if the recipient company has co-sponsored the staffing company’s plan.
  • Any contributions made to a retirement plan maintained by the staffing company will count as contributions to the recipient company’s retirement plan, but not vice versa.
• Compensation limits (§401(a)(17))
  • All compensation that was earned by the worker/employee while working for the recipient company.
• Top heavy rules (§416)
• Exclusive benefit rule (§401(a))
• SEP and SIMPLE rules (§408(k))
• Deduction limits (§404)

An employer is ultimately responsible for paying its workers’ wages and taxes, and cannot contract away this responsibility to another organization to avoid liability. This means that even if an employee is paid through a leasing company, they must still be included when calculating participation in a company’s retirement plan.

Independent Contractors

Independent contractors can sometimes fall under the leased employee rules. Most outside professionals who own their own business (e.g., attorneys, CPAs, physicians, computer programmers, and engineers) would typically not be considered leased employees because they do not fall under the “primary direction and control” of the employer.

Official IRS rules regarding leased employees are outlined in Internal Revenue Code §414(n) and Notice 84-11.  Also, Revenue Procedure 2002-21 addresses Professional Employer Organizations (PEOs).

Benefits of leased employees

Hiring leased employees offers several advantages to businesses. Some of these benefits include:

1. Cost Savings: Leasing companies can provide employee benefits at a lower cost due to their larger workforce and negotiating power. Additionally, the leasing company handles payroll, taxes, and other administrative tasks, which can free up resources for the employer and reduce their overhead expenses.
2. Access to Specialized Skills: Leased employees can provide specialized expertise and skills that the employer may not have in-house. This allows the employer to access the talent they need without having to hire full-time employees, which can be particularly beneficial for short-term projects or fluctuating business demands.
3. Reduced Legal Liabilities: When an employer hires a leased employee, the leasing company becomes the legal employer, handling employment-related legal issues and lawsuits. This can protect the employer from costly legal liabilities and reduce their exposure to employment-related risks.
4. Improved Productivity and Flexibility: Leased employees are often highly motivated to perform well, as their continued employment may depend on their performance. Additionally, employers can easily scale their workforce up or down as needed to meet fluctuating business demands, providing greater flexibility.
5. Better Employee Benefits: Leasing companies can offer more comprehensive and competitive benefits packages due to their larger employee pool. This can help employers attract and retain top talent, as employees may have access to better healthcare, retirement plans, and other benefits.

In summary, the key benefits of hiring a leased employee include cost savings, access to specialized skills, reduced legal liabilities, improved productivity and flexibility, and the ability to offer better employee benefits. These advantages can be particularly valuable for small and medium-sized businesses that may not have the resources or expertise to handle all aspects of human resources and employee management in-house.

Final thoughts

The rules were established to avoid the manipulation of eligibility for retirement benefits. There are many intricacies involved, and it requires careful consideration to determine whether leased employees can be considered common-law employees.

It’s not recommended to try to navigate these regulations on your own. One of our pension consultants can review your situation and provide you with guidance. You may also want to have an ERISA attorney review your situation.