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Who's the Employer?

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

"Safe Harbor" Leased Employee Plans After Rev. Proc. 2002-21

(Posted June 21, 2002)

Question 204: IRC 414(n) allows leased employees to be disregarded for various IRC rules if these individuals are covered under a safe harbor plan. How will Rev. Proc. 2002-21 affect these plans?

Answer: There will be no direct effect. But indirectly, Rev. Proc. 2002-21 probably will put an end to such safe harbor plans. That might not be a bad thing.

IRC 414(n)(5) is a grossly misunderstood provision. It says that a recipient of a worker's services need not treat the worker as a leased employee for retirement plan purposes, on these conditions:

Leased employees must constitute no more than 20% of the recipient's non-highly compensated workforce; and
The worker is covered by a safe harbor plan which meets all of the following requirements:
- It is a money purchase pension plan. No other type of plan will qualify, regardless of the amount of contribution.
- The plan provides a nonintegrated employer contribution of 10% or more.
- The plan provides full and immediate vesting.
- Virtually all worksite employees of the leasing organization are covered under the plan.

Safe harbor plans always have been something of a danger because they are misunderstood. People think they can turn their entire staff over to a PEO with a safe harbor plan and not worry about covering them. That's wrong, because the safe harbor rules can be used only if at least 80% of your staff is on your own payroll. Perhaps more important, it is a dangerous assumption because so many employees on the payroll of staffing firms/PEOs are still common law employees of the recipient/client organization for whom they provide services. Accordingly, the leased employee rules (including the safe harbor rules) are irrelevant and the workers have to be treated just like all other common law employees.

Technically, Rev. Proc. 2002-21 does not change the rules relating to leased employees-- just the rules for PEOs. Therefore, it does not change the rules for safe harbor plans. However, it does say that if a PEO maintaining a plan covering Worksite Employees wishes for the plan to be rely on determination letters after 2003, it has to be a multiple employer plan cosponsored by the recipient/client organization. So the recipient, instead of being able to forget about the workers because they are in a safe harbor plan, will instead be cosponsoring the plan.

What affect will the safe harbor rules have after 2003? Well, suppose you have a recipient who satisfies the 20% test and is cosponsoring a safe harbor plan with a PEO. Suppose further that the PEO is the common law employer of the workers on its payroll and that the client is not. (That is a huge assumption!) Suppose further that these workers would otherwise qualify as leased employees. In that case:

Without the safe harbor rules, they will be regarded as employees of the PEO and leased employees (and hence treated as employees) of the recipient. Thus, they will be included in testing the multiple employer plan both by the recipient and by the PEO.
With the safe harbor rules, the recipient no longer has to treat them as leased employees. Thus they are only included in testing the PEO's portion of the multiple employer plan.

With that miniscule a difference, I would expect that safe harbor plans, already fairly rare, will disappear from the landscape altogether. In their place will be plans more carefully targeted to the needs and desires of the companies involved. More importantly, the misunderstandings about these safe harbor plans will go away as well.

Click here for more about the administration of multiple employer plans.
Also, you can review detailed coverage of the Rev. Proc. at my web site. Finally, I should note that I discuss safe harbor plans with detailed examples in chapter 4 of my book, Who's the Employer.

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.