3929 / What special rules apply to leased employees for purposes of the requirements that apply to qualified plans?

For the IRC’s qualification requirements, an employer generally treats any individual who is a leased employee as though that individual were the employer’s own employee. To the extent that contributions or benefits provided for a leased employee by the organization from which the employee is leased are attributable to services performed for the employer, these contributions or benefits are treated as if they were provided by the employer under a qualified plan.¹ These two requirements have the effect of requiring most leased employees who have met a recipient plan’s eligibility provisions to be included in the recipient’s plan as an employee of the recipient.

A leased employee is an individual who is not an employee of the recipient employer and who performs services for a recipient employer, if (1) the individual’s services are provided to the recipient under one or more agreements with a leasing organization, (2) the individual has performed services for the recipient or related employer on a substantially full-time basis for a period of at least one year, and (3) the services are performed under the primary direction or control of the recipient employer.² For purposes of this definition, the term employee means a common law employee as determined under the generally applicable standard for determining worker classification (see Q 8723).3

The fact that an individual is a leased employee does not automatically mean he or she must be a participant in a plan maintained by the employer. A plan may exclude a leased employee from participation in the plan when the plan can satisfy coverage and nondiscrimination testing by including the leased employee with no benefits or the benefits provided by the leasing company plan. At least two circuit courts have held that ERISA does not per se require the inclusion of leased employees in an employer’s plan.4 In addition, the IRS addressed this issue in Notice 84-11,5 stating that leased employees should be treated as employees, but the plan’s failure to include them as participants in the plan does not result in disqualification of the plan. Despite its issuance prior to TRA ’86, Notice 84-11 was cited favorably in Bronk v. Mountain States Tel. & Tel., Inc.,6 as controlling authority on this issue.

The determination of whether services are performed under the primary direction or control of the recipient is based on the facts and circumstances. A finding will be made if the service recipient exercises the majority of direction and control over the individual; for example, whether the individual is required to comply with the recipient’s instructions as to when, where, and how the services are to be performed; whether the services will be performed by a particular person; whether the individual is subject to the recipient’s supervision; and whether the services must be performed in a particular order or sequence set by the recipient.

The recipient may be a single employer or a group consisting of employers required to be aggregated under the controlled group, common control, or affiliated service group rules ( Q 8964, Q 3935).7 Employers are related if a loss on a sale of property between them would be disallowed as a deduction under IRC Sections 267 or 707(b) or they are members of the same controlled group of corporations, using a 50 percent rather than 80 percent ownership test.8

Safe Harbor

Even though an individual is a leased employee, he or she may be disregarded by the employer for purposes of determining qualification if the individual is covered by a qualified money purchase pension plan maintained by the leasing organization and the following requirements are satisfied:

(1)  The plan provides for employer contributions by the leasing organization at a nonintegrated rate which is not less than 10 percent.

(2)  The plan provides for immediate participation on the first day an individual becomes an employee of the leasing organization unless (x) the individual’s compensation from the leasing organization in each plan year during the four year period ending with the plan year is less than $1,000, or (y) the individual performs substantially all of his or her services for the leasing organization.

(3)  The plan provides for full and immediate vesting of all contributions under the plan.

(4)  Leased employees do not constitute more than 20 percent of the recipient’s nonhighly compensated work force. 9

This safe harbor applies only for purposes of the leased employee provision; it does not permit an employer to disregard a common law employee who otherwise meets the definition of a leased employee. 10

A recipient’s nonhighly compensated work force is the aggregate number of individuals who are not highly compensated ( Q 3930) but who are common law employees of the recipient and have performed services for the recipient on a substantially full-time period of at least one year or who are leased employees with respect to the recipient. 11

A money purchase pension plan of a leasing organization is not qualified if it covers any individuals who are leased by the leasing organization to the recipient but who are not themselves employees of the leasing organization. That is because the plan would not meet the “exclusive benefit” rule ( Q 3839).12