Employee now considered "contract labor"

[MarZDoates]

I have a situation where a 401(k) Plan participant will no longer be "on the company's payroll" and will be working as "contract labor".

For plan puposes, would this be considered a severance from employment?

[ETA Consulting LLC]

Yes. When you pay someone on a 1099 as an independent contractor, you are "saying" that you've made a determination that they are "not your employee". Whether or not that determination is correct goes beyond merely paying them on a 1099 instead of a W-2, but a bona fide contractor is not your common law employee.

Good Luck!

[MarZDoates]

Whether or not that determination is correct goes beyond merely paying them on a 1099 instead of a W-2, but a bona fide contractor is not your common law employee.

Good Luck!

Agreed! Thanks.

[Peanut Butter Man]

I have to disagree. What about the preamble to the Final 401(k) Regs, which says that a change in employment status is not a "severance from employment". The IRS said:

"Because an individual who is a leased employee (as defined in section 414(n) is treated as an employee of the recipient of the individual's services for purposes of section 410(b) (unless the safe harbor plan requirements described in section 414(n)(5) are met), the individual does not incur a severance from employment as a result of becoming a leased employee."

Even though the Preamble specifically says "leased employee", I think the IRS would apply the same standard to a contract employee because the standard in Treas. Reg. 1.401(k)-1(d)(2) is whether your contract employee ceased employment, and from what OP says, the employer is still receiving the benefit of their services..

(Just attended Erisafile's webinar about severance from employment and this is in the materials).

[PensionPro]

A common law employee becoming a leased employee is a change of employment status. A common law employee becoming an independent contractor is a termination of employment, not a change of employment status. Provided the classifications are accurate, a leased employee and an independent contractor are treated very differently. An independent contractor is a "vendor" with presumably multiple clients. A properly classified independent contractor is never an employee by law. I am curious if there was something new on this topic in the webinar.

[MoJo]

Yes. When you pay someone on a 1099 as an independent contractor, you are "saying" that you've made a determination that they are "not your employee". Whether or not that determination is correct goes beyond merely paying them on a 1099 instead of a W-2, but a bona fide contractor is not your common law employee.

Good Luck!

"Multiple "Likes" to this. This exact "mistake" cost Microsoft a ton of money.....

[masteff]

A common law employee becoming a leased employee is a change of employment status. A common law employee becoming an independent contractor is a termination of employment, not a change of employment status. Provided the classifications are accurate, a leased employee and an independent contractor are treated very differently. An independent contractor is a "vendor" with presumably multiple clients. A properly classified independent contractor is never an employee by law. I am curious if there was something new on this topic in the webinar.

I agree w/ your analysis and will add... Having been down this road (had EEs move to both classifications), an essential and critical element of a 414(n) "leased employee" is the 3rd party "leasing organization" who is payrolling the worker. (Note: I did error on the side of being conservative and found a few nonstandard 3rd parties as counting; in rare situations, employees of contractors (but not the owner of a vendor firm) can become leased employees if the element of "primary direction or control" was met.)