It is common for employers to contract with one or more third parties (sometimes referred to as “leasing companies”) to provide individuals to perform services for the employer. Various issues may arise regarding the treatment of such individuals under a retirement plan maintained by the employer.
Such individuals are not typically eligible to participate in the 401(k) or other retirement plan maintained by the employer. This is because plans commonly exclude from participation any individual who is not reported on the payroll records of the employer as a common-law employee.
This does not necessarily mean, however, that such individuals are excluded from the group of individuals that must be considered in determining whether the plan satisfies the Tax Code’s minimum participation and coverage requirements. Such individuals may fall into any one of several different categories.
If an individual is properly characterized as a common-law employee of the employer and would be deemed to have satisfied the plan’s age and service requirements for participation, he or she must be taken into account for purposes of coverage and participation testing.
The status of an individual as a common-law employee is determined based on a multiple factor test applied by the IRS and the courts. If an employer has the right to tell the individual what to do, how, when and where to do the job, the individual is likely a common-law employee.
If the individual is a common-law employee of the leasing company rather than of the plan sponsor, he or she is characterized as a “leased employee.” Leased employees must be taken into account under the plan sponsor’s plan for purposes of coverage and participation testing only if they have provided services to the plan sponsor on a substantially full-time basis for a period of one year or more. Although an individual will not be treated as a leased employee if the leasing company covers the individual under a retirement plan of its own meeting certain specific standards, this is rarely the case.
Finally, an individual may be treated as a co-employee and treated for benefits purposes as an employee of the plan sponsor. This typically involves an arrangement with a professional employer organization (PEO) created to outsource certain payroll and other functions and to gain access to more economical health insurance plans. The retirement plan may be maintained either by the employer or by the PEO.
Most employers are aware that the employer and any other entity that is part of a “controlled group” with the employer, such as a subsidiary, are treated as a single employer for purposes of applying the retirement plan coverage and participation rules. It is less commonly understood that a controlled group may include foreign (non-U.S.) companies as well. Non-resident aliens with no U.S. source income are typically excluded from consideration for this purpose. This may eliminate most concerns about the need to consider employees of the foreign companies. It is important to note, however, that U.S. citizens or resident aliens working abroad, and non-resident aliens that do have U.S. source income, are not so excluded and must be taken into account for purposes of participation and coverage testing.