Continued Participation by Employees "Leased" to New For-Profit Subsidiary

[401 Chaos]

Am hoping someone may have some prior experience with this or may be able to recommend guidance on point.

Employer is a tax-exempt charitable entity that sponsors 457 plans. The entity is in the process of establishing a new, wholly-owned LLC that is neither charitable or tax-exempt and is intended to function as a for-profit entity. (Eventually, a significant percentage of the the LLC will be owned by others (including those providing services to the LLC) but the charity will continue to own / control 80%+ of the LLC foreseeable future.)

Given its status / classification, it would seem that the LLC is not eligible to generally establish a 457 plan on its own nor participate in the existing 457 plans of the charitable parent, etc. The LLC could presumably establish its own deferred compensation plan subject to 409A but not 457 and may consider doing that in the future. For now, however, it is taking time to get the LLC off the ground and its own infrastructure in place, etc. During this start-up / transition period, the charity intends to "lease" its existing employees (some of whom participate in the 457 plans) to the LLC in order to have them focus solely on LLC-related activities. The Plan is for a number of these individuals to eventually be terminated by the charity and hired directly by the LLC and become LLC employees but that is likely a few months away.

Question is whether the individuals can continue to participate in the 457 plans (and 403(b) too I think) during this interim period where they technically remain employees of the charity but are being formally leased to the LLC and focusing just on LLC work. As a technical matter, the charity will remain their employer for general payroll, tax, reporting purposes and be in control of their work but their services will all essentially be for the benefit of this new for-profit subsidiary.

Welcome any thoughts or advice anyone may have on this issue.

[Carol V. Calhoun]

I can't really see how participation in the 457 plans would be an issue. Outside of a governmental context, section 457(b) is a limitation, not an enhancement, of what could otherwise be provided in the way of deferred compensation. If the IRS recharacterized the employees as being employed by the for-profit, then as to them, the plan would merely be a nonqualified deferred compensation plan. Since both a 457 plan and a nonqualified deferred compensation plan must be limited to a select group of highly compensated and management employees in order to avoid ERISA issues, I cannot see how the recharacterization would be a problem (assuming that the requirements of 409A are met, since a 457(b) plan but not other kinds of deferred comp plans are exempt from 409A).

I'd be more concerned about their participation in the 403(b) plan. If the IRS were to take the position that the employees in question were common law employees of the LLC, their participation in the 403(b) could be an issue. And participation in a 403(b) by individuals employed by an ineligible employer is a hot-button audit issue.

[401 Chaos]

Carol,

Thanks very much. This is very helpful. I like your thinking and the individuals in the 457 plans are certainly welcoming getting away from those restrictions as part of the eventual move. This may be more of a plan design / administration issue than a regulatory issue but the 457 plan is currently drafted very narrowly to limit participation to just the select employees of the charitable entity. It does not specifically define that to include subsidiaries or members of their controlled group although I suppose arguably coverage may extend to those. In any event, there is concern that the leasing may invalidate the individuals' ability to continue participating in the 457 plans and/or that they arguably should be viewed as having separated from service with the charity before the leasing arrangement ends. (The employment lawyers want to view the interim relationship as "co-employment" by both the LLC and the charity.) If the IRS were to recharacterize the employees as being common law employees of the for-profit LLC, do you think that they could just carry on under the 457 Plan without having the 457 Plan specifically address the issue--e.g., I guess they could just abide by the general 457 plan terms and the 457 regulations as before until they officially terminate employment with the charity and get out from under the charity and the plan altogether since the 457 rules are a further limitation.

They are worried about the 403(b) issues as well and I was going to post separately on that issue. Ultimately it seems the question is how far one might go with a leasing arrangement before being viewed as a common law employee of the lessee / service recipient. I suppose that is a facts and circumstances test but it seems they would be wise to err on the very conservative side there. Do you think having them acknowledge that they are "co-employees" of both the LLC and the charity may help on the 403(b) front or perhaps that does more harm than good?

Thanks!

[Carol V. Calhoun]

As to the 457(b) plan: How tough would it be to add something to the 457(b) plan to say something like, "This plan covers individuals treated by [Employer] as leased to [XYZ subsidiary], regardless of whether such individuals are later determined to be common law employees of [XYZ subsidiary]"? That would seem to be the cleanest approach. However, unlike in the 401(a) context, 457(b) doesn't have a specific requirement that a plan be operated in accordance with its terms. At most, this would be a contractual requirement. And I can't see that employees would object to receiving more benefits than the plan arguably provided.

As to the 403(b) plan: I think including the employees is going to be risky, no matter how you do it. And designating them as "co-employees" would likely make the situation worse, not better.