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Employee Plans News - December 20, 2011 - EPCU Project on Leased Employees

The Employee Plans Compliance Unit 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.

The project goals were to:

  • provide plan sponsors an overview of how the plan must treat leased employees,
  • learn if sponsors were correctly considering leased employees for plan purposes, and
  • determine whether leased employees were due additional plan benefits.

The Project Process
EPCU sent contact letters to a sample of plan sponsors listing pension feature code ‘3F’ on their Form 5500, Annual Return/Report of Employee Benefit Plan, filings. Code 3F indicates that the ”Plan sponsor(s) received services of leased employees, as defined in Internal Revenue Code section 414(n), during the plan year.” EPCU asked sponsors how they treated leased employees in their retirement plan.

Project Results
Approximately 65% of sponsors in the sample did not actually have any leased employees and instead:

  • didn’t fully understand what it means to be a leased employee for plan purposes as defined in IRC section 414(n);
  • used pension feature code ’3F’ when they actually meant to indicate ‘3E’ (prototype plan); or
  • selected pension feature code ‘3F’ because on prior year Forms 5500, ’3F’ stood for some pension feature code other than for leased employees.

The responses also showed that in 25% of sample cases, sponsors correctly applied the leased employee rules, or used the Employee Plans Compliance Resolution System (EPCRS) to correct plan errors that occurred when they didn’t properly apply the rules.

Some plans incorrectly applied the leased employee rules and EPCU advised those plan sponsors to correct these errors. Unlike an EP audit, errors discovered during the compliance check process may still be corrected through EPCRS because the plan isn’t under examination. EPCU referred plans that didn’t respond to the compliance check letters to EP Examination to be evaluated for an audit.

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 plan, but must still consider them when performing the plan’s coverage and nondiscrimination testing.

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 requiring 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 and at least 1,500 hours during any 12-month period. The 1,500 hour requirement is reduced to 75% of the hours (but no less than 500 hours) if a typical employee in the same job position would generally work the same amount of hours in a 12-month period.

Related Service – 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.

  1. 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‘s irrelevant whether the recipient company has the right to fire the leased employee or that the leased employee works for other companies.

  1. 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

Contact the EPCU
Email us your questions about this project and please include the words “Leased Employee” in the subject line.

Page Last Reviewed or Updated: 07-Nov-2013