Leased Employees in Qualified Retirement Plans
By Ethan Heck, QKA
Who are leased employees?
Leased employees are employed by a leasing organization while performing services for a recipient employer. Leased employees are not considered common law employees of the recipient employer, but for plan purposes, they frequently must be treated that way. Leased employees are treated as employees of the recipient employer under the following conditions.
The recipient employer enters into an agreement with the leasing organization to pay in exchange for services provided by leased employees.
Leased employees perform services for the recipient employer on a substantially full-time basis for at least one year.
NOTE: “Substantially full-time” can be measured as working 75 percent of the customary hours for that position, with a minimum of 500, and maximum of 1,500 hours.
Leased employees’ services are performed under the primary direction or control of the recipient employer.
Is the recipient employer’s qualified retirement plan required to cover leased employees?
Generally, yes. Most leased employees who meet all three conditions detailed above will be considered eligible upon meeting any of the recipient employer plan’s age and service requirements. Because leased employees are not treated as employees of the recipient employer until the “substantially full-time” requirement is met, any hours worked prior to this time do not count for recipient employer plan eligibility. Plan administrators should track leased employees who are likely to meet the “substantially full-time” requirement to ensure timely delivery of enrollment materials and required notices. Covering leased employees who meet the above definition is the rule, not the exception.
A plan could be designed to entirely exclude leased employees as a class, but this would likely affect the Internal Revenue Code Section (IRC Sec.) 410(b) minimum coverage test because there is not a statutory class exclusion for leased employees. Generally, 70 percent of nonhighly compensated employees must benefit from the plan compared to highly compensated employees to meet minimum coverage standards. Many leased employees could be nonhighly compensated employees. This class exclusion should be examined thoroughly before implementing any changes to the plan document to avoid minimum coverage testing issues.
A less common scenario where leased employees could be excluded from the recipient employer’s plan without affecting minimum coverage testing is when leased employees must make up 20 percent or less of the recipient employer’s nonhighly compensated workforce. The leasing organization must provide a money purchase pension plan with the following “safe harbor” benefits.
Nonintegrated employer contribution rate of at least 10 percent of compensation
The presence or absence of this “safe harbor” plan is outside of the recipient employer’s direct control. Because it is so rare, it should not be counted on as an easy way out of covering leased employees.
If leased employees are covered, how does the recipient employer make contributions?
Recipient employers will often pay the leasing organization, which in turn pays the leased employees. It may not be immediately apparent how to determine the compensation to be used for the recipient employer’s contribution allocations. Compensation for allocation purposes is determined as the portion of each leased employee’s total compensation received from, or on behalf of, the leasing organization that is attributable to the performance of services to that recipient employer. This is fairly straightforward for employer contributions other than elective deferrals, but plans with a cash or deferred arrangement (CODA), like a 401(k) plan, can add one more complication when the leasing organization actually pays leased employees. The IRS has not addressed this specifically with any written guidance, but there are generally two reasonable solutions.
The recipient employer withholds the appropriate amount from fees paid to the leasing organization to account for elective deferrals, and the leasing organization reduces employees’ pay accordingly.
The leasing organization withholds the appropriate amount from leased employees’ pay and sends this amount to the recipient employer to be deposited into the plan.
A recipient employer should plan on which method they will use to meet their contribution obligations, and coordinate with the leasing organization to ensure the timely receipt and/or deposit of leased employees’ elective deferrals.