Leased Employee? Affiliated Service Group? Unrelated?

[Phillip]

A CPA firm has several non-equity (CPA) partners each of whom are paid from their own P.A.  Neither do these CPAs, nor their own P.A.s, own any of the CPA firm and the CPA firm has no ownership in the non-equity partner's P.A.s  Because there is no common ownership, I don't see this as an affiliated service group.  But I am having trouble with classifying them leased employees.

Regarding a Leased Employee and the control test, the EOB states "On the other hand, professionals who regularly make use of their own judgment and discretion on matters of importance in the performance of their services and are guided by professional, legal or industry standards, generally do not satisfy this test."

Question: Are these CPAs who are employed by their P.A.s considered leased employees?  part of an affiliated service group?  Or are they their own separate employer tested as if an unrelated employer? 

[C. B. Zeller]

There are a lot of issues to consider in making an ASG determination. Who is the common law employer of the non-equity partners? How the report their income is not necessarily determinative for this purpose. If the CPA firm has primary direction or control over their work, then they may be considered common law employees of the firm even if the firm does not give them a W-2.

If they are common law employees of the firm, then there is likely an ASG even though there is no common ownership, because the ASG rules require that the A-org or HCEs of the A-org must have ownership in the FSO (or, if treating the firm as the FSO and using the B-org rules, that the B-org be at least 10% owned by the FSO or HCEs of the FSO) - assuming of course that the individuals in question have compensation high enough to be considered HCEs, which it sounds like a "non-equity partner" probably would.

Edit: HCE ownership does not apply for A-orgs

[ESOP Guy]

Not my area of expertise at all but I was thinking under the Affiliated Service groups you needed common ownership for A and B types but NOT for the Management type. 

 

I am close to 100% of my knowledge here.

See starting page 67 in this pdf by the IRS. 

https://www.irs.gov/pub/irs-tege/2013cpe_related_employers.pdf

[C. B. Zeller]

For B-org groups the proposed reg 1.414(m)-2(c)(1)(iii) says that the B-org must be owned at least 10% by members of the "designated group" which includes HCEs, officers, and common owners.

I need to double check on the A-org specifics. I am reading contradictory information in two different sources. I'll update this post when I figure it out.

[Luke Bailey]

On ‎9‎/‎20‎/‎2019 at 9:08 AM, ESOP Guy said:

Not my area of expertise at all but I was thinking under the Affiliated Service groups you needed common ownership for A and B types but NOT for the Management type. 

 

I am close to 100% of my knowledge here.

See starting page 67 in this pdf by the IRS. 

https://www.irs.gov/pub/irs-tege/2013cpe_related_employers.pdf

There has to be some ownership. This sort of situation would have been covered under 414(m) and (s) (to form an ASG) under the management group and shared employee provisions of the proposed regs, but the proposed regs were withdrawn 10 or 20 years ago. Those proposed regs classified professional services provided to or in conjunction with another entity of the same type as that entity provided to customers as "management." But since they were withdrawn, you are left with plain language definition of "management," and what you describe is probably not management. Probably the real answer is that in an ideal world (for tax purists, anyway) the PA's could be disregarded (effective, pierced for tax purposes) and then the individual CPAs could be classified as employees of the accounting firm, but those issues are a forbidding legal wilderness, at least for now, for the IRS, and I doubt they would ever try to go there.

[Phillip]

I thank everyone for their responses.  Yes, ASG A and B types both require at least some common ownership.  Type A requires "Any degree" of ownership.  Type B requires at least 10% ownership of the B-organization by an HCE in the FSO or A-Organization.  However, these non-equity partners receive no W-2 wages directly from the CPA firm.  So they are not HCE's of the FSO along with no common ownership.

Per EOB (downloaded by me on 1/17/2014), regarding Management Groups -

A management group consists of a recipient organization and a management organization. To be an affiliated service group, the management organization's principal business must be the performance of management functions, on a regular and continuing basis, for the recipient organization. IRC §414(m)(5).

2. Management functions. The law does not provide a definition of management functions. The term should be interpreted under common business practices. Activities that involve daily business operations, hiring or firing personnel, business planning, setting employee compensation, and supervisory roles would be examples of management functions.
 

3. Principal business must be performance of management functions. The law does not provide any objective test in determining whether the management organization's principal business is performing management functions for the recipient organization. In normal usage, "principal" means the main function, suggesting a majority (more than 50%) of the organization's business.

I am thinking now these non-equity partners CPA's are a part of a management group.  They do plan out audit engagements and/or meet with clients to do their tax work and they also supervise employees of the CPA firm who do audit or tax work.  The term "principal business" is a bit troubling.  These CPA's probably review the work of other CPA's more than they actually perform the work.  They probably are doing most of the same work as a partner, except for hiring and firing and setting wages.
 

[Luke Bailey]

Phillip, my guess is that most practitioners would require some sort of supervisory function to be considered management. These CPAs seem to be involved in the CPA firm's day to day business activities. For example, if they worked for the CPA firm as senior employees or members, then assuming the firm is of any size and has some degree of centralized management, you would probably not view these individuals as part of the firm's "management." But certainly, if the firm is small and is run by all the members, and these individuals are treated as members in making business decisions, they could be "management." Anyway, this is probably something on which reasonable minds could differ. Again, the withdrawn proposed regs just flat out converted line services of professionals into "management" to get around the issue and prevent this sort of structure as a way around the 414(m) rules. One could infer from that a view at Treasury that the proposed regs had overreached, perhaps specifically on that point. Of course, what really got them withdrawn was lobbying, however.

[Phillip]

Luke,  all of these non-equity partner CPA's have formerly been senior employees of the CPA firm.  When they became non-equity partners, they became employees of their own P.A.  Their roles largely stayed the same.  There are approximately 125 employees scattered largely across 5 states.  There are 15 equity partners and 5 non-equity partners.  Common sense would say they should be included with the CPA firm, because they were before they ceased being employees of the CPA firm.  However, rules are rules, so common sense doesn't necessarily apply.  I like what you said "Anyway, this is probably something on which reasonable minds could differ."  We have been including them as part of the CPA firm and I guess we will continue to do so.

[Luke Bailey]

Phillip, sounds reasonable. Of course, I don't have any real facts and am speaking hypothetically of the legal principles and regulatory history that is in play in your question.

[C. B. Zeller]

I've updated my previous post (and will be sending an email to the authors of the study guide for the CPC Related Groups module).

If they are determined not to be common law employees of the firm, but rather to be common law employees of their own LLCs who are working under the primary direction or control of the firm, then it is possible that a leased employee situation exists.

While not exactly on point, Derrin Watson does address the question of whether one could simultaneously be an independent contractor and a leased employee in ch.5 of Who's the Employer. This situation is a little different since the entities in question are single-member LLCs and not sole proprietorships.

Quote

Q 5:11 Can an independent contractor be both a leased employee and a leasing organization?

Some practitioners wonder whether an independent contractor, who does not receive a paycheck or a W-2 from anyone, might simultaneously be a leased employee and the leasing organization. Must a leased employee work for a third party leasing organization? If not, many independent contractors could simultaneously be leased employees and the leasing organization.

The withdrawn proposed regulations first raised this issue. [Q 5:1] There, the IRS explicitly said that an independent contractor could be both the leased employee and the leasing organization. Consider the following example:

Example 5.11.1 Ned is an experienced freelance computer programmer. He has worked for many companies over the years. Sometimes he will work for several companies at the same time. Sometimes, he will concentrate his efforts on a single job. He has substantial unreimbursed business expenses, including the costs of his advertising in trade publications.

Alan needs a major rewrite of his inventory system, and hires Ned to do so. Under their contract, Ned pays Alan a fixed fee for rewriting the system. This project consumes all of Ned’s working time for 18 months. Ned frequently consults with Alan about Alan’s needs and preferences, and follows Alan’s directions on the form and features of the program. Assume that under the principles outlined in Chapter 3, Ned would be treated as an independent contractor and not an employee of Alan.

The question here is whether Ned would be a leased employee of Alan. We already established he is not Alan’s common-law employee. After he has been working on the program for a year, he will have completed the “substantially full-time” requirement. Ned is subject to Alan’s direction and control to a degree. The proposed regulations said that under these circumstances, Ned would be both the leasing organization and the leased employee. Alan would need to treat Ned like an employee for most purposes under Alan’s retirement plan.

Although not nearly as explicit as the proposed regulations on the point, Notice 84-11 and Code §414(n)(2)(A) both seem to take the opposite approach. They imply that the leasing organization and the leased employee must be separate entities. Q&A 5 of Notice 84-11 says, in pertinent part,

 

A leased employee is any person who performs services for a recipient if . . . such services are provided pursuant to an agreement between the recipient and any other person (the ‘leasing organization’)” [Emphasis added]

 

Presumably “any other person” means any person other than the recipient and the leased employee.

This viewpoint was strengthened by the Conference Committee reports to SBJPA of 1996, which indicate that most “outside professionals who maintain their own businesses (e.g., attorneys, accountants, actuaries, doctors, computer programmers, systems analysts, and engineers) generally would not be considered to be subject to” the primary direction and control of the recipient, and hence would not be leased employees of the recipient. [Q 5:30] In other words, if a company does not have enough control to make an outside professional contractor its common-law employee, it probably does not have enough control to be a recipient under Code §414(n)(2)(C).

Where does this leave the question? At the moment, an employer would have a strong basis under the controlling authority, Notice 84-11, and the SBJPA Committee Reports for treating independent contractors such as Ned as though they are not leased employees.

 

[Phillip]

C. B., thank you very much for presenting Derrin's explanation and your comments.  Being a both a leased employee and an independent contractor has spurred additional thoughts and is quite helpful.  You wrote "Edit: HCE ownership does not apply for A-orgs".  I did not understand this comment as the EOB states "The A-organization must have an ownership interest in the FSO."  I saw no exception for HCE's.  A law firm is used in the first example and says "Each corporation has a one-third partnership interest in the law firm".  Thus the ownership interest is emphasized. 

I have ruled out them being in an A-Org or B-Org as there is no common ownership  For a few years, I have been thinking each these CPA non-equity partners are leased employees from their own P.A.  The only thing that has me doubting leased employee status is this from my original post:

"Regarding a Leased Employee and the control test, the EOB states "On the other hand, professionals who regularly make use of their own judgment and discretion on matters of importance in the performance of their services and are guided by professional, legal or industry standards, generally do not satisfy this test."

However, in my 3rd post I wrote "When they became non-equity partners, they became employees of their own P.A.  Their roles largely stayed the same."  I wrote, per EOB, they "are guided by professional, legal or industry standards, [means they ] generally do not satisfy this test" [of being a leased employee].  Since they are performing basically the same role as when they were a "common-law employee" when employed by the CPA firm, I don't see how being "guided by professional, legal or industry standards" now suddenly disqualifies them from being a leased employee.  I think they are either "leased employees" or part of an ASG "management group".  I am leaning toward thinking they are each a "leased employee".

[C. B. Zeller]

Apologies if I created any confusion. The source I was referencing said that an ASG can exist if there is an ownership interest in the FSO by an A-org or HCEs of an A-org, and upon further review I do not believe that is correct. For a B-org group however, the B-org needs to be 10% owned by the FSO or HCEs of the FSO or its A-orgs. So there might be a B-org group if the CPAs are common law employees of the firm, since then their pay would be counted for HCE determination purposes.