A growing trend among U.S. companies is to lease employees rather than hire them outright -- more than 3% of U.S. workers fall into this category. But many companies are finding that leasing arrangements aren't quite as straightforward as they might have envisioned. Questions as simple as "Who really employs these workers?" take on new significance when issues like retirement planning are raised.
A recent suit against Microsoft Corp. has brought the issue of employee classification to the forefront.
While no employee leasing company was involved, freelancers and independent contractors were hired to do the same work Microsoft's regular employees were doing. Very little differentiated these workers from full-time employees, except their benefits weren't as good.
Even though the workers had signed agreements recognizing their status as independent contractors, the Internal Revenue Service found that these were really Microsoft's common law employees. The workers sued to be included in the company's benefit plans. While the case is still in litigation, the courts generally have sided with the employees' claims.
WHO PAYS FOR PENSIONS?
Although not in Microsoft's situation, leased employees are usually hired by a professional employer organization, not the company where they physically work every day.
For companies, employee leasing is a great arrangement. Workers are less expensive to recruit, hire and train. For leased employees, advantages include flexibility and a chance to receive higher benefits. Maybe.
Under the Employee Retirement Income Security Act, retirement plan participation must be limited to employees of the employer, so this is a key question. Should retirement benefits be provided for leased employees and, if so, should the professional employer organization or the client company provide them? These are all questions that companies with leased employees currently face.
When employee leasing started in the late 1970s, system abuses were rampant. Firms employing highly paid professionals would lease rank-and-file employees from a professional employer organization. Retirement benefits provided by the leasing company were often modest.
At the same time, highly compensated professionals would enjoy substantial retirement benefits in a separate employer-sponsored plan. ERISA strictly regulates contributions by highly paid individuals when lower-paid workers participate in the same plan, unless substantial benefits are also provided for the lower-paid workers. By claiming that the lower-paid workers were actually employees of the professional employer organization, companies circumvented this restriction.
As a result, when Congress passed the Tax Equity and Fiscal Responsibility Act in 1982, a provision was included that required companies to treat leased employees as their own. It wasn't until 1987 that the IRS published proposed regulations interpreting TEFRA.
During that time, legitimate leasing arrangements had become more and more prevalent, eliminating many of the abuses targeted by TEFRA's restrictions. Not only that, but many companies now wanted to provide benefits for leased employees but were unsure how to do so.
In 1993, the IRS withdrew its proposed guidelines and little new guidance has been offered since. Conflicting court decisions in this area also add to the confusion.
COMPANIES SEEK GUIDANCE
Given such mixed signals, it is no wonder that many companies need guidance on providing benefits for leased employees. At least one IRS official has recently acknowledged that the employee leasing industry has changed dramatically and that professional employer organizations can play a positive role. There are indications that the IRS plans to issue new guidelines in 1999. Also, legislation germane to this issue has been introduced in Congress (HR 1891).
What should be done in the meantime? There is no completely safe answer but, consider the following two scenarios:
1. If only a few of your employees are leased:
It's your choice whether to include leased employees in your corporate retirement plan. If you decide to include them, who could argue with that? But if you decide not to, you may still be on solid legal ground as long as your plan complies with the IRS's minimum coverage requirements.
In general, as long as your leased employee group does not constitute more than 30% of your total work force (even more in some cases), and your plan covers the balance of employees, these requirements will be met.
2. If most or all of your company's employees are leased:
If the professional employer organization provides benefits, the contract should substantiate that it employs and controls the employees.
Two key provisions under HR 1891 are that the professional employer organization pays employees' wages, employment taxes and benefits even if unreimbursed by the client company, and that the professional employer organization has authority to hire, reassign and terminate employees without client consent. Clearly, the intent is for the employment relationship to be legitimate.
If you want to provide your own level of pension benefits for leased employees, consider a multiple employer plan co-sponsored by the professional employer organization. In this case, you can fund benefits that differ from those normally provided by the professional employer organization, such as a richer 401(k) match or a profit sharing allocation. But this type of plan is usually more costly to administer because of additional reporting requirements and compliance testing.