Start up 401k wants to include sub contractors

I have not run into this previously, but I have a potential start up 401k that would be pretty routine in many ways, but the owner wants to include most sub-contractors in the plan.  He started his career as a sub-contractor and feels strongly that he wants to offer a 401k to them as well.

He is considering a safe harbor 401k match plan.  But how would that work in regard to withholding pay for individuals who are not on payroll but are paid without any tax withholding?    Would the SubCs indicate that only a portion of their income be paid to them while $X.XX goes into the 401k?  Can they employer provide the match on a payroll basis if they are included?  This seems like it could get messy......

Thanks

No idea... maybe the subs can be employed by the owner for the time that they work for the owner?  So "part-time" or "on-call" employees that are allowed to participate in the owner's 401k plan?

In order to be a qualified plan, the plan must be maintained for the exclusive benefit of the employees of the employer and their beneficiaries. A contractor, by definition, is not an employee, and they can not participate in a plan maintained by the employer.

Might your inquirer consider a multiple-employer plan under which a contractor might be a participating employer?

Have the securities law issues been resolved for multiple employer 401(k) plans (not that anyone seemed to care much, ever)?

Unlike a single-employer plan, a multiple-employer plan might get no Securities Act of 1933 § 3(a)(2) exemption.

Years ago, I lost an engagement because I mentioned a securities-law issue. Although I said that responding to the issue was not a condition to my availability and explained that enforcement was unlikely, the organizer disliked being told even that there was any issue.

There’s a meaningful difference between an “open” multiple-employer plan with unrelated employers and a “closed” MEP involving business relationships.

For a multiple-employer plan about which the employers have business ties, the staff of the US Securities and Exchange Commission have delivered no-action letters.

16 hours ago, Peter Gulia said:

Might your inquirer consider a multiple-employer plan under which a contractor might be a participating employer?

It seems to me that this is asking for trouble. The employer above apparently wants to do something akin to payroll withholding for the contractors. For example, if contractor M elects a 5% contribution, and for a given week the employer pays them $1,000 in non-employee compensation, the employer wants to instead pay them $950 and contribute $50 to the plan, plus maybe another $40 as a match - seems simple, right? Even if M did join the employer's MEP as a participating employer, this would still not be correct, since $1,000 is not M's plan compensation - if M is unincorporated, then it is just the starting point for calculating M's net earned income; if M is incorporated then their comp is their W-2 which may have no relation to the $1,000 at all.

It gets even messier when you consider that the contractors probably have other work besides this particular employer. Assuming the contractor is operating as a sole prop, is all of their income from all of their other work now subject to the contribution election and match? I would think it would have to be, unless you could write up a very specific definition of comp to somehow exclude it. Who is going to make sure it is calculated correctly? Do the contractors know they will have to submit their schedules C? And what if they end up having a net loss (and consequently $0 comp and $0 415 limit) after the employer made contributions on their behalf? The administration on this would be cumbersome to put it mildly.

And what if the contractor hires employees?

I applaud the employer's desire to offer retirement savings via payroll deduction to his people - studies have shown this is one of the most effective ways for workers to save for retirement. It really does say a lot about this employer that he wants to provide this benefit. Unfortunately the current tax law is not set up to help him do it easily.

Your client needs to decide whether these individuals are employees or contractors, review the factors under federal and applicable state law, and make sure that the business arrangement is structured in a way that reflects the factors favoring the classification chosen. If they would otherwise be considered contractors except that they are being treated as employees for purposes of eligibility to participate in an employee benefit plan, then a state regulator or class action lawsuit might pop through the door and challenge their treatment as contractors for other labor law purposes. 

As others have mentioned, there are options to cover non-employees through a MEP. Or you might be able to come up with a structure whereby they are treated as leased employees, co-employees, etc. But it can get very complicated very quickly when your client is trying to have their cake and eat it too on an issue like this. You have several interacting legal regimes from different jurisdictions that you need to sort through to make sure there is no issue. 

Hard pressed to think of a worse idea. The generous sentiment is nice but think of a better way of doing it outside the Plan.

If you're taking a vote, I agree with Larry B.  The substantive question, of course, is are these so-called subs really employees (in the single employer plan context).  Any clear law on the rules that apply the context of a qualified plan?  I do not know.  Ask an ERISA attorney.  By the way, how does said contractor treat his so-called subs for income tax withholding and social security tax purposes, and this is just for starters?

Just to draw a distinction, these would not be leased employees, as those would have to actually be employed through a leasing agency.  With a leasing agency or leasing company, they are independent contractors and the issues discussed above make this a bad idea to try to include them in the employer's 401k plan.