Leased employees not allowed to participate in ESOP's?

[Brenda Wren]

Page 1.397 of Sal's book notes that since IRC 414(N) does not cross-reference IRS 409(I), the IRS apparently is of the view that leased employees may not participate in an ESOP maintained by the recipient organization. Am I reading this correctly that leased employees are simply ignored regardless of any coverage failures that would occur if included as not benefiting?

Leased employees are specifically excluded in the ESOP plan document, but I'm not sure if I should show them in the 410(b) test as included and not benefiting and if so, would they be required to be included to the extent necessary to pass 410(b) if it failed.

[Guest Sieve]

I, for one, have not heard of that rule. I don't have Tripodi handy, so I can't read and analyze the reference you are making. But, that conclusion seems strange to me, because IRC Section 414(n) doesn't cross reference 401(k), either, but leased employees certainly are treated as employees for purposes of a 401(k) plan and would have to be shown as non-exludables who do not benefit under the plan.

Nor can I find any rules that would exclude leased employees form consideration in coverage testing for an ESOP under IRC Section 410(b), or non-discriminating testing, or under the 4975-7 and -11 regs. Must be a rule out there that I don't know about (from some Rev. Rul., or Notice, or something).

I hope someone else is familiar with the rule and its treatment under IRC Sectin 410(b) to help you.

[Guest mjb]

Page 1.397 of Sal's book notes that since IRC 414(N) does not cross-reference IRS 409(I), the IRS apparently is of the view that leased employees may not participate in an ESOP maintained by the recipient organization. Am I reading this correctly that leased employees are simply ignored regardless of any coverage failures that would occur if included as not benefiting?

Leased employees are specifically excluded in the ESOP plan document, but I'm not sure if I should show them in the 410(b) test as included and not benefiting and if so, would they be required to be included to the extent necessary to pass 410(b) if it failed.

There is no section 409(I) of the IRC (not IRS). IRC 409(a)(1) states that a tax credit employee stock ownership plan shall meet the requirements of Section 401(a) which is consistent with IRC 414(n)(3)(A) which provides that the leased employee provisions shall apply to paragraph (3) of section 401(a) which cross references IRC 410.

[Guest Sieve]

Meaning that you think leased employees are treated as employees with regard to an ESOP? Or are not?

Of course, there are no more TRASOPs--the credit was repealed long ago (I think it was somewhere in IRC Section 21, or 41). However, some of the provisions of IRC Section 409 still are cross referenced with regard to ordinary ESOPs (by 401(a) and, I think, 4975 or its regs), but I don't recall 409(a) being referenced anywhere as applying to an ordinary ESOP. (See, e.g., IRC Section 401(a)(28)(A), which differentiates between an ordinary ESOP and an old TRASOP under IRC Section 409(a)). So, I don't understand your reference to 409(a)(1).

[Guest mjb]

Meaning that you think leased employees are treated as employees with regard to an ESOP? Or are not?

Of course, there are no more TRASOPs--the credit was repealed long ago (I think it was somewhere in IRC Section 21, or 41). However, some of the provisions of IRC Section 409 still are cross referenced with regard to ordinary ESOPs (by 401(a) and, I think, 4975 or its regs), but I don't recall 409(a) being referenced anywhere as applying to an ordinary ESOP. (See, e.g., IRC Section 401(a)(28)(A), which differentiates between an ordinary ESOP and an old TRASOP under IRC Section 409(a)). So, I don't understand your reference to 409(a)(1).

Since ESOPs are qualfied plans under IRC 401(a) then the leased employee rules would apply unless there is something peculiar to ESOPS that only allows employees who are paid by the employer to participate. As I noted there is no IRC 409(I) so I dont know what is the basis is for stating that leased employees can be excluded.

[Guest Sieve]

So, can I add you to the club of those willing, when appropriate, to challenge Tripodi? (assuming the OP properly attributed the statement to Sal) . . .

[BeckyMiller]

I wonder if the reference is to 409(l) (as in the letter that precedes m), rather than 409(i). The comment makes some sense in the context of the definition of a qualifying employer security. For a security to be a qualified employer security, the employee must be employed by a member of a 1563 controlled group. A leased employee, if treated as a bona fide employee of the leasing company, would probably not be employed by a member of such a group. As such, we get in the complicated situation of having to satisfy participation and coverage, but not being able to rely on many of the special ESOP provisions with respect to any securities that might be for the benefit of "leased" employees.

[Just Me]

Sal does refer to 409(l), not 409(i). His note says that the IRS appears to take the position that leased employees cannot participate in an ESOP sponsored by the recipient organization. He also references an ABA Q&A from 2004 on this point. Here is a link the the Q&A document, see Q&A-26. http://www.abanet.org/jceb/2004/qa04irs.pdf

The Q&A reads as follows:

26. §409(l) - Definition of Employer Securities

Approximately ten percent of an ESOP company's workforce consists of leased employees, who are on the payroll of a leasing organization, but who work on a full-time basis for the ESOP company under its discretion and control. May these employees be included as participants in the ESOP, and receive allocations of ESOP company stock? Or would that violate the "employer securities" provisions of §409(l) with respect to these employees?

Propsed response: Although the statutory language can be read to exclude these employees, it is not consistent with the general purpose of Congress in permitting and encouraging ESOPs. The situation would be exacerbated if their exclusion were to cause a §410(b) coverage failure.

IRS response: The IRS disagrees with the proposed answer. The answer assumes the workers are not common-law employees of the sponsor, but are leased employees. The employees must be employed by the controlled group in order to participate in the ESOP. Notice 84-11 does not list 409(l) as treating leased employees as employees of the sponsor for this purpose.