Who's the Employer

A Guide to Employee and Aggregation Issues Affecting Qualified Plans

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Notice 84-11

The following is the complete text of Notice 84-11, as originally published in 1984-2 CB 469 on June 26, 1984. Notes in [brackets] indicate provisions that are totally or partially obsolete because of subsequent legislation.

This Notice provides questions and answers relating to the employee leasing provision of section 414(n) of the Internal Revenue Code, as added by the Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248, 1982-2 C.B.462) (TEFRA).

Until applicable regulations are published, the guidance provided by these questions and answers may be relied upon to comply with the provisions of section 414(n). The Service will apply these rules in issuing determination letters, opinion letters, and other rulings with respect to qualified retirement plans. If future regulations are more restrictive than the guidance in this Notice, the regulations will be applied without retroactive effect. However, no inference should be drawn regarding issues not raised which may be suggested by a particular question or answer or as to why certain questions and not others are included.

The determination of whether an organization is a "leasing organization" for purposes of section 414(n) will be based upon the facts and circumstances of each case. Taxpayers that utilize the services of leased employees may request a determination as to whether their plan qualifies by following the determination letter procedure issued in Notice 83-12, 1983-2 C.B. 412 (relating to procedures for obtaining determination letters on the qualification of pension, profit-sharing, and stock bonus plans that have been amended to comply with the changes made by the Tax Equity and Fiscal Responsibility Act of 1982). With regard to item 5 of Notice 83-12 (relating to the requirement that the employer provide information regarding what retirement benefits are provided for leased employees), the employer must supply information regarding the leasing organization's retirement benefits only if the recipient is relying on such benefits for purposes of qualification of the recipient's plan.

Q-1. How did TEFRA change the law with regard to employee leasing?

A-1. TEFRA amended the Internal Revenue Code to provide that for purposes of certain employee benefit provisions, a "leased employee" generally shall be treated as an employee of the person for whom such leased employee performs services (the "recipient" of the services) even though such individual is a common law employee of the leasing organization.

Q-2. For purposes of which employee benefit provisions will a "leased employee" be treated as an employee of the recipient?

[NOTE: IRS 414(n) was amended to add 401(a)(17) and 401(a)(26) to the list of requirements in 1988.]

A-2. A leased employee will be treated as an employee of the recipient for purposes of the following employee benefit requirements:

(1) Section 401(a) (relating to the exclusive benefit rule);

(2) Sections 401(a)(3) and 410 (relating to minimum participation requirements);

(3) Section 401(a)(4) (relating to the requirement that contributions or benefits do not discriminate in favor of employees who are officers, shareholders, or highly compensated);

(4) Section 401(a)(7) and 411 (relating to minimum vesting standards);

(5) Sections 401(a)(16) and 415 (relating to limitations on contributions and benefits);

(6) Section 404 (relating to deductions for contributions);

(7) Section 408(k) (relating to simplified employee pensions); and

(8) Section 416 (relating to top-heavy plans).

Q-3. How do the provisions of section 414(n) relate to the "common law employee" rules?

A-3. The provisions of sections 414(n) operate independently of the "common law employee" rules. Thus, if an individual is considered an employee of the recipient under the common law rules, such individual is an employee of the recipient for all purposes and without regard to the provisions of section 414(n). For example, an individual who is a common law employee of an organization (a "recipient") will continue to be an employee if the recipient formally "leases" the individual from a separate entity that maintains a safe harbor plan described in section 414(n)(5). In such cases, the fact that the "leasing" organization maintains a safe harbor plan does not affect the treatment of the individual as a common law employee of the recipient.

Q-4. When is section 414(n) effective?

A-4. Section 4124(n) applies to taxable years of the recipient beginning after December 31, 1983.

Q-5. What is a leased employee for purposes of section 414(n)?

A-5. A leased employee is any person who performs services for a recipient if:

(1) such services are provided pursuant to an agreement between the recipient and any other person (the "leasing organization"),

(2) such person has performed such services on a substantially full-time basis for a period of at least one year, and

(3) such services are of a type historically performed in the business field of the recipient by employees. [WARNING: This is modified by Section 1454 of SBJPA, for years beginning after 1996.]

Q-6. Must the agreement referred to in paragraph (1) of A-5 between the recipient an the leasing organization be in writing?

A-6. No, an oral contract between the recipient and the leasing organization will satisfy the "agreement" requirement.

Q-7. What standards are used to determine if a person has performed services on a substantially full-time basis for a period of at least one year?

A-7. A person is considered to have performed services on a substantially full-time basis for a period of at least one year if: (1) during any consecutive 12-month period such person has performed at least 1500 hours of service for the recipient, or (2) during any consecutive 12-month period such person performs services for the recipient for a number of hours of service at least equal to 75 percent of the average number of hours that are customarily performed by an employee of that recipient in the particular position. The performance of services for a recipient includes the performance of services for an organization relative to the recipient in accordance with section 103(b)(6)(C). For example, assume that Corporation X leases Individual A from Leasing Company Y to perform bookkeeping duties. Leasing Company Y does not maintain a retirement plan. It is customary for bookkeepers who are employed by Corporation X to perform services 35 hours per week or 1820 hours per year. During the next consecutive 12-month period, A performs 1450 hours of service for X. A does not meet the first test of "substantially full-time" because A did not perform 1500 hours of service. However, A does meet the second test for "substantially full-time" because A performed services for a number of hours at least equal to 75 percent of the number of hours that are customarily performed by an employee in that particular position (.75 x 1820 hours = 1365 hours customarily performed). Therefore, A is a "leased employee" of Corporation X.

Q-8. For purposes of determining if an employee has performed services for the recipient on a substantially full-time basis for at least one year, does the one year period include service of the employee prior to the effective date of section 414(n)?

A-8. Yes. For example, in the case of a recipient that is a calendar year taxpayer if, as of January 12, 1984, an individual has been performing services for the recipient on a substantially full-time basis for one year or more and the other requirements of section 414(n)(2) are met, such individual is a "leased employee" as of January 1, 1984. In addition, any period of service performed by the employee as a common law employee of the recipient is taken into account for purposes of determining whether the employee has performed services on a substantially full-time basis for a period of at least one year. For example, assume that Individual B has been a common law employee of Corporation X for a period of 3 years. On April 1, 1984, B terminates his employment with X. On May 1, 1984, B is hired by and becomes a common law employee of Leasing Company Z. Leasing Company Z is not related to Corporation X. Z enters into a contract with Corporation X to provide leased employees. On May 2, 1984, Individual B is leased to Corporation X. Corporation X does not maintain direct control over Individual B's day to day activities sufficient for B to be considered a common law employee of X. Individual B is considered to be a leased employee of X for the purposes of section 414(n) as of May 2, 1984, because prior service performed by Individual B for the recipient as a common law employee is taken into account for purposes of determining whether an individual has performed services on a substantially full-time basis for a period of at least one year.

Q-9. Will a recipient's retirement plan be denied qualification if the plan covers an individual who would otherwise be a leased employee but for the fact that such individual does not meet the "substantially full-time" standard?

A-9. No. In the case where a recipient's retirement plan covers an individual who would be a leased employee for purposes of section 414(n), but such individual does not meet either of the tests in answer 7 for determining "substantially full-time," the plan will not lose its qualified status or otherwise be denied qualification.

[WARNING: Q&A 10 was made obsolete for years beginning after 1996 by Section 1454 of the Small Business Job Protection Act of 1996.]

Q-10. What is the meaning of the requirement that services be of a type historically performed in the business field of the recipient by employees?

A-10. Services will be considered of a type historically performed by employees in the business field of the recipient if it is not unusual for the services to be performed by employees of organizations in the recipient's business field in the United States.

Q-11. Are there any exceptions to the application of the provisions of section 414(n)?

A-11. Generally, no. Except as provided in section 414(n)(5) pertaining to safe harbor plans of leasing organizations), as long as the three requirements of section 414(n)(2) and questions and answers 1 through 10 are met, the provisions of section 414(n) apply. However, the service will consider suggestions made by the public regarding employee leasing arrangements that might be excepted from the provisions of section 414(n) in regulations.

Q-12. If, as of January 1, 1984, an individual is considered to be a leased employee, how are that individual's years of service determined for purposes of participation and vesting under the recipient's retirement plan?

A-12. For purposes of both participation and vesting, the entire period for which the leased employee has performed services for the recipient must be taken into account in accordance with section 414(n)(4), including periods before the effective date of section 414(n). Therefore, if the recipient is a calendar year taxpayer and the recipient's retirement plan requires one year of service before an employee may participate, and a leased employee began performing services for the recipient on January 1, 1981. However, because the individual does not become a leased employee until January 1, 1984, such leased employee need not begin to participate in the plan until January 1, 1984. Therefore, section 414(n) does not require the recipient to provide retroactive benefits for the leased employee for years of service prior to January 1, 1984.

Q-13. How does the plan maintained by the leasing organization treat the leased employee for purposes of the applicable pension requirements?

A-13. The leased employee continues to be the common law employee of the leasing organization. Therefore, for purposes of coverage, vesting, contributions and benefits, a plan maintained by the leasing organization must take into consideration all of the leased employee's service for the leasing organization (including periods during which the employee was leased by the leasing organization to a recipient) and compensation for services for or on behalf of the leasing organization.

Q-14. Must a leased employee participate in the plan maintained by the recipient?

A-14. No. Section 414(n)(1)(A) requires only that a leased employee be treated as an employee; it does not require that a leased employee be a participant in the recipient's qualified plan.

For example, assume that for 1984 Company X (a calendar year taxpayer) has 500 common law employees who have completed one or more years of service. In addition, X maintains a qualified profit-sharing plan in which 400 of these employees participate. The plan requires an employee to complete one year of service before participation, but does not impose a minimum age requirement. Also, section 414(n) requires that Company X treat 25 leased employees as its own employees for 1984.

Considering only the common law employees, X's plan satisfies the coverage requirements of section 410(b)(1) because it benefits 80 percent (400/500) of X's employees who have completed one or more years of service. But X-s plan also must consider the 25 leased employees in applying the coverage requirements of section 410(b)(1)(A). Thus, X's plan is not required to benefit any of the 25 leased employees for 1984. (But see question and answer 16, relating to plan amendments.)

Q-15. May leased employees who must be treated as employees of the recipient under section 414(n) be excluded as a class from participation in the recipient's plan?

A-15. Yes. A plan maintained by a recipient may exclude from participation all leased employees who must be treated as employees under section 414(n) so long as the plan otherwise satisfies either the percentage of the fair cross-section test of section 410(b)(1) by taking such leased employees into account.

Q-16. Must a plan maintained by a recipient be amended to provide explicitly for the treatment of leased employees who must be treated as employees under section 414(n)?

A-16. Yes. How leased employees will be treated under a recipient's plan depends on the terms of the plan. Therefore, if an organization utilizes the services of leased employees, the plan must specifically provide how leased employees will be treated under the recipient's plan.

Q-17. How does the plan maintained by the recipient determine the contributions or benefits to be provided on behalf of the leased employee?

A-17. For purposes of providing a leased employee with contributions or benefits that are based on compensation, a plan maintained by the recipient must determine the portion of the leased employee's total compensation received from or on behalf of the leasing organization that is attributable to the performance of services for the recipient. For purposes of providing a leased employee with contributions or benefits based on years of service, the principles of question and answer 12 are applicable.

[WARNING: THE FOLLOWING PROVISION WAS MADE OBSOLETE BY TRA 86]

Q-18. Section 414(n)(5) provides that section 414(n) shall not apply to any leased employee if such employee is covered by a "safe harbor" plan maintained by the leasing organization. Must the leasing organization cover all of its employees under a safe harbor plan?

A-18. Generally, no. A leasing organization need not cover every employee it leases under its safe harbor plan but may cover some employees and not others. However, the safe harbor plan is still required to qualify under the rules of section 401(a) and thus must satisfy the coverage rules of section 410(b) and the antidiscrimination rules of section 401(a)(4).

[WARNING: THE FOLLOWING PROVISION WAS MADE OBSOLETE BY TRA 86]

Q-19. If a plan maintained by a leasing organization provides a full and immediately vested 7- percent nonintegrated contribution for each year during which a common law employee of the leasing organization is considered a leased employee of a recipient, does such plan meet the immediate participation requirement of a safe-harbor plan?

A-19. No. In order to be treated as a safe harbor plan with respect to a leased employee, a plan maintained by a leasing organization must provide for immediate participation for such leased employee at the start of the 12-month period used to determine if the employee is a leased employee under section 414(n). For example, assume that a common law employee of the leasing organization begins performing services for a recipient on July 1, 1984. Between July 1, 1984, and July 1, 1985, the employee performs more than 1500 hours of service for the recipient. Therefore, as of July 1, 1985, the recipient must treat the employee as its own employee for purposes of the pension requirements listed in section 414(n)(3). If, as of July 1, 1984, the employee was a participant in the leasing organization's qualified plan, the leasing organization's plan will be considered to satisfy the immediate participation requirement for a safe harbor plan with respect to that employee. This is true even if the employee was hired by the leasing organization on January 1, 1984, and did not become a participant in the plan until July 1, 1984, the date on which the employee began providing services for the recipient. However, in no case does the immediate participation rule require that an individual be a participant in a safe harbor plan before the effective date of section 414(n). Therefore, in the case of a recipient that is a calendar year taxpayer if an individual is a leased employee as of January 1, 1984, (in accordance with the rules of answer 8), such individual need not become a participant in the safe harbor plan before January 1, 1984.

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