Is guidance coming?
Don't hold your breath. At this point, I doubt that we will see much more in the way of official guidance from the IRS on the issues covered in Rev. Proc. 2002-21. There are at least two reasons I say this:
- The employee benefits folks at the IRS have a lot else on their plates at the moment. There is still a ton of guidance which needs to come out about EGTRRA, and I know they are working hard on it.
- From a political and practical standpoint, there is only so far they can go. Remember, this is an issue Congress has been trying to deal with for years and they haven't gotten anywhere. There is a lot of disagreement from folks with a lot of clout. One of the most public hand slappings Congress gave the IRS on a substantive issue in my memory has dealt with the core issue of Rev. Proc. 2002-21: employee status. There is only so far they can go publicly without risking that happening again.
Direction Without Guidance
If we're not going to hear anything more from the IRS, then what should PEOs, their clients, and those who advise them do? After all, there are a lot of open issues that need resolution.
In this column, I'll suggest answers to how those issues should be resolved by PEOs and other affected stakeholders. Of course, this is a summary. I am developing these issues more fully in the upcoming third edition of my book, Who's the Employer.
To understand the comments I am about to make, it is important to understand where the IRS is coming from. Once you see the logical underpinning, the suggestions I am making will make sense.
- The IRS is familiar with and concerned about PEOs. Their interest was manifested most strongly before now with an audit project the Houston IRS office conducted in 1994. They audited 90 leasing companies in 24 states to determine what employment tax and employee plan problems exist. The audit revealed many problems for some of the staffing firms and their clients, including:
- Staffing firms are not the common law employers, especially of owners or officers of recipients;
- Retirement plans of staffing firm violate the exclusive benefit rule;
- Unfunded or underfunded retirement and health plans;
- Unreported employees;
- Non-filing of returns;
- Failure to collect and pay over withholding taxes;
- Failure to collect and deposit employee contributions;
- Failure to report employees for workers' compensation and unemployment insurance; and
- Difficulty of verifying relationship between recipient and leasing organization or leasing organization legal compliance.
In one particularly egregious case, the IRS found that 80% of the 1,500 "employees" of a leasing organization were not covered under their 401(k) plan. Most of the 300 that were covered were highly compensated employees of their respective recipient organizations.
- With that in mind, it is easy to see the target of Rev. Proc. 2002-21. Whether it used the terminology to completely convey this idea or not, the IRS is clearly concerned with what we would commonly refer to as PEOs or staffing firms (as opposed to others who might lease out a few employees). Moreover, its concern is with "permatemps," people under long-term staffing arrangements.
- Although as a political matter the IRS cannot say so, there is no question in my mind that the IRS believes that virtually all permatemps working for these staffing firms are common law employees of the organizations for which they are performing services. The Rev. Proc. only makes sense if you assume that is where the IRS is coming from. Otherwise, its actions are unnecessarily draconian and out of character with the IRS we have seen in the last several years in the employee plans arena. Incidentally, I agree with them on this point, and have repeated my analysis on this issue often and publicly.)
- By contrast, the IRS is not concerned about "true temps," who are the folks who come in to replace your receptionist or secretary when they are ill or on vacation. Why? Because court decisions and IRS guidance already has proclaimed that true temps probably are the common law employees of the temp agencies, and not of the recipient.
- The whole emphasis of the Rev. Proc. is to make the problems of single employer PEO plans go away. By the end of the 2003 plan year, those plans either should be terminated or be converted into multiple employer plans. The Rev. Proc. is trying to smooth the way for that to happen. That being the case, I don't think we should expect the IRS to be throwing technical roadblocks in the way of those who are trying to follow their lead.
- Above all, in understanding the guidance, we must remember that this is the IRS of self-correction, not the IRS of the actuarial audit cases. In other words, this is an IRS that wants employers to accomplish the public policy goals of providing retirement benefits for workers. While the IRS fully intends to enforce the law, it isn't hiding in the corner waiting to jump out and yell "Gotcha!"-- it realizes that most employers are trying to follow the law, and that honest mistakes happen. That's why IRS officials often say that when we don't have guidance, we should follow a reasonable interpretation and that they won't jump down our throats for doing so. That's why the Rev. Proc. lets PEOs put the past behind them, so to speak, and move forward with appropriate multiple employer plans.
Questions and Suggested Answers
With that background in mind, let me review the most important open questions about the Rev. Proc. and give what I feel is a reasonable interpretation of the Rev. Proc. and IRS intentions. I know that in several cases I am going beyond what the Rev. Proc. says. Nonetheless, I believe that what I am about to suggest represents what the IRS was trying to accomplish. I would be very surprised if their subsequent enforcement actions varied significantly from what I suggest here.
- Are true temporary employees Worksite Employees for purposes of the Rev Proc? No. The IRS did not have these employees in mind when it wrote the Rev. Proc. I know that the literal wording of the Rev. Proc. implies that temps are Worksite Employees, but that's not the direction the IRS is headed. Therefore, if a PEO has both true temps and "permatemps," the true temps simply should be regarded as common law employees of the PEO (as they almost undoubtedly are), the same as the PEO's back office employees. I believe the PEO can continue to cover its true temps as its common law employees without great concern of IRS challenge, even if the COs for whom those temps provide services do not cosponsor the PEO's plan. Usually it is easy to tell the difference between a temp on the one hand and a permatemp or employee under a long term arrangement on the other. In a close case, consult with legal counsel.
- What is a PEO for purposes of the Rev. Proc? Notwithstanding my earlier comments on the issue (see Q&A 166), I do not believe the IRS will interpret the Rev. Proc. to mean that anyone who leases employees, including hospitals (Q&A 198) will be regarded as a PEO. That was certainly not what they had in mind. Only firms that lease out Worksite Employees as a major part of their business should consider themselves PEOs subject to the Rev. Proc. (That means that firms handling only true temporary employees are not PEOs and are not subject to the Rev. Proc.) Can you imagine the stink that would be raised if the IRS started going after hospitals that lease out a few employees to nearby clinics and started disregarding their determination letters because they didn't follow this Rev. Proc. dealing with PEOs? Again, if there is a close case, consult with counsel, but I think the IRS will enforce the negative aspects of the Rev. Proc. only against entities most people would agree are primarily in the employee leasing business.
- When a PEO converts to a multiple employer plan, should Worksite Employees be treated as common law employees of the PEO or the CO? The Rev. Proc. does not give any direct guidance on this issue. However, as noted above, the whole idea of the Rev. Proc. is that the IRS believes Worksite Employees are common law employees of the CO. They can't say so publicly, but the Rev. Proc. makes sense only if that is what they are thinking. If a multiple employer plan is administered on that basis, the likelihood that the IRS will challenge it is next to nil. (For that matter, treating the Worksite Employees as common law employees of the CO is correct in most all cases.) If I were drafting a PEO multiple employer plan, I would include a clause specifically to that effect.
- Will a PEO plan making distributions in accordance with the Rev. Proc. be violating the distribution restrictions of IRC 401(k)? No. The IRS didn't think about this as it wrote the Rev. Proc., but I cannot imagine it will raise this issue against someone following the instructions in the Rev. Proc. Remember, both a terminating PEO plan and a terminating Spinoff plan must request determination letters on termination in order to comply with the Rev. Proc. Those letters ought to insulate the sponsor from liability on this issue.
- How confident do you feel about these responses? Based on the reasoning I've outlined and the understandings I have, I feel very confident. In fact, I feel confident enough that I would be willing to write an opinion letter for a client on the basis outlined here.
However, we all know that what I understand, however I might understand it, is far removed from the law and the prophets coming down from Mount Sinai. Moreover (as long as I'm referring to Exodus), there's always the possibility that there may arise "up a new king . . . which knew not Joseph." Or, to put it more plainly, there may be personnel changes at the IRS that bring in people at the top level who would view the world differently, who could use the unfinished language of the Rev. Proc. to do some real damage.
Accordingly, the most conservative approach is to read the Rev. Proc. at its Machiavellian worst, terminate anything that smells like it might be deemed a single employer PEO plan in accordance with the Rev. Proc., and breath a sigh of relief that the bad guys aren't coming to get you today. But I don't believe that a reasonable interpretation of the Rev. Proc. requires such a severe response.
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