We have a client whose employees are part of a PEO. The PEO maintains a 401(k) plan and the employees participate in that plan. The owners of the company have their own 401(k) and a cross-tested plan (which covers all employees). The question we have been asked is can the owners have the PEO employees participate in the owners' 401(k) plan instead of the PEO 401(k) plan without severing the PEO relationship. If yes, the PEO employees would have access to a larger number of funds then currently offered by the PEO's plan. What issues do we need to be concerned with?

Usually, the question is the other way around (can they participate in the PEO plan/are they PEO employees?) and you will get some disagreement.

Your question is essentially whether employees can participate in their Employer's plan, and the answer is "Yes."

There shouldn't be any problems getting a plan written to include what you acknowledge are employees. There will be issues about whether they can roll over or transfer their balances to the new plan, as there may not be a distributable event.