Question 42: ABC, Inc. "leases" all of its employees, from the president on down, from XYZ Staffing. ABC sponsors a profit sharing plan ("PS Plan") for all non-union workers employed at ABC (though these individuals are on XYZ Staffing's payroll). ABC has contributed 15% of pay for the last 3 years into the PS Plan. XYZ Staffing sponsors a single 401(k) plan ("401(k) Plan") that covers all of its employees who are "leased" to its clients (the "recipients" of the leasing services). Some of ABC's employees participate in and contribute to XYZ Staffing's 401(k) Plan. XYZ Staffing also contributes to a union-sponsored retirement plan on behalf of XYZ Staffing's workers who are part of a collective bargaining unit.

It seems to me that, absent the PEO arrangment, the total PS Plan and 401(k) Plan contributions made on behalf of employees working at ABC would violate IRC 404 deduction limit. One or both organizations seem to be taking deductions for contributions that exceed 15% of the wages earned by workers at ABC.

To complicate matters, the client is firing the staffing organization and hiring a new one. Are all (soon to be ex-)employees of XYZ Staffing able to take a distribution from the XYZ Staffing 401(k) Plan or do the same-desk/successor employer rules apply?
Answer: You have put your finger on several important problems with this arrangement. The first problem is summarized nicely by the quotation marks you put around "leases."

We return to the question, "Who is the common law employer?"
If it is XYZ Staffing, then both firms can cover the workers and they are true leased employees. If it is ABC, and XYZ Staffing is litle more than a glorified payroll service, then XYZ Staffing cannot cover the workers XYZ treats them as true common law employees.
Given the facts that (1) all the rank and file is leased; (2) even the president is leased, who surely isn't taking direction from XYZ Staffing; and (3) ABC has the power to move all the employees to a new firm, it certainly appears that ABC is the employer.

If ABC is the employer, then:
XYZ Staffing's plan should be disqualified for violating the exclusive benefit rule.

Nothing at all requires ABC to take XYZ Staffing into account.

XYZ Staffing's plan is fine just as it is.
If XYZ Staffing is the employer, then:
XYZ Staffing's plan is fine.

Nothing at all requires XYZ Staffing to take ABC's plan into account.

For purposes of ABC's plan, it is deemed to have made all contributions that XYZ Staffing made. This is for all purposes listed in 414(n)(3) and IRS Notice 84-11. Interestingly, Section 414(n)(3) does not list IRC 404 as one of the provisions to which the leased employee rules were to be applied. That deficit is corrected in Notice 84-11. Hence, in determining the 404 limits for ABC, it is as though it was the sponsor of both plans.

Of course, the same reasoning applies to IRC 415 provisions, which ABC must also apply on an aggregate basis (while XYZ Staffing looks only to its own plan).
Which of those sets of choices do you like best? (Can you say "None of the above"?)

These issues are discussed in more detail in Chapter 4 of my book, Who's the Employer?.

Incidentally, yes, the same desk rule would clearly apply here, in a very literal fashion.

As a side note, there may be some help on the horizon. HR 3490, introduced two months ago in Congress, would clarify the relationships between PEOs (staffing organizations, or "professional employer organizations") and their clients, and answer many of the problems PEO relationships pose. It is too early to say whether that law would pass or what its final shape will be, but it's encouraging to see efforts to resolve this thorny set of issues.

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.