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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

Rev Proc 2002-21; Relief for the Compliant

(Posted April 25, 2002)

Question 162: What's the effect of Rev. Proc. 2002-21 on staffing firms?

Answer: For years I have been saying that plans sponsored by staffing firms, sometimes called Professional Employer Organizations (PEOs), are subject to disqualification for violating the exclusive benefit rule. In fact, from what I have seen, almost no staffing firm qualifies as the common law employer of the workers leased to recipient clients. As such, any "qualified" plan sponsored by such a firm will violate the exclusive benefit rule unless it is a multiple employer plan cosponsored by its participating clients. For a full background of why this is such a serious issue, see Chapter 4 of my book Who's the Employer.

Rev. Proc. 2002-21 goes right along with this analysis. But it also provides an "out" for PEOs if they follow a detailed set of procedures. If they don't, and they aren't in a multiple employer plan arrangement, the following happens:

The PEO has absolutely no relief from the IRS finding that its plan is disqualified for violating the exclusive benefit rule. In other words, the PEO had better be prepared to prove it is the common law employer of all of its workers, which will be a very tough task.
The PEO cannot rely on any determination letter from the IRS after the 2003 plan year (even if the determination letter is dated after 2003).

Effectively, then, although the procedures the IRS outlines are "voluntary," the procedures basically are mandatory unless the PEO wants to "roll the dice" at the high stakes table.

By contrast, if the PEO follows the instructions in the Revenue Procedure, then the PEO's plan will be treated as though there were no exclusive benefit issue relating to the workers it leases to recipent customers. This relief benefits not only the PEO but also all those who receive distributions or transfers from the PEO's plan, including plans of the clients and employees who receive terminating distributions.

To get this relief, the PEO must choose either to go with a multiple employer plan or to terminate its plan. Either way, it must make its choice within 120 days after the start of the 2003 plan year (May 2, 2003 for a calendar year plan). The PEO also must give notice to Client Organizations (COs) who have employees participating in the plan by that date. If the PEO chooses to go with a multiple employer plan instead, it must be adopted by that date.

In the notice to the COs, the PEO must give each CO the following choices:

The CO can join as an adopting employer of the PEO's multiple employer plan (assuming the PEO has chosen that option). To do this, the CO must inform the PEO and must adopt the plan as a cosponsor. The notice from the PEO must specify dates by which this must be accomplished, not later than the end of the 2003 plan year. The multiple employer plan must be effective as of the 2004 plan year.
The CO can instruct the PEO to transfer the assets relating to the CO's workers to a plan the CO sponsors. To do this, the CO must inform the PEO and must provide the PEO with documentation that the CO's plan has a GUST determination or notification letter or has applied for one. Again, the notice from the PEO must specify dates by which this must be accomplished. The actual transfer of assets must be completed by the end of the PEO's 2003 plan year.
The CO can instruct the PEO to spin off the assets relating to the CO's workers. If a CO does not make one of the two choices described above or does not comply with their requirements by the dates in the PEO notice, the CO is deemed to have made this choice. The PEO is to set up a new plan for the assets of employees of such a CO and transfer all assets relating to the CO before the end of the 2003 plan year. Moreover, the CO is to terminate this spinoff plan by that deadline. The spinoff plan must distribute the assets to the employees ASAP.

Although normally a determination letter is not a requirement, the spinoff plan must file for a determination letter on termination. So must the PEO's existing plan if the PEO is terminating the plan. The multiple employer plan must file for a new letter if the PEO decides to go that route.

This is a quick overview of the Revenue Procedure. The main thing it offers is certainty and an end to a controversy that has raged for years, and the IRS is to be commended for taking an approach to resolve the problem which allows PEO plans to comply with the law. However there are open issues, uncertainities, and additional requirements. I discuss these more fully in an article (click here) in the Who's the Employer Reading Room.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.