Who's the Employer

A Guide to Employee and Aggregation Issues Affecting Qualified Plans

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Rev Proc 2002-21 Background

PEO's routinely claim either to be the common law employer of their Worksite Employees, or to be a coemployer of those workers with the CO. Case after case, however, has found the CO to be the common law employer. This leaves PEO plans open to a claim that they violate the exclusive benefit rule of IRC 401(a) and 401(a)(2), which requires that plans be maintained for the exclusive benefits of the plan sponsor's employees and their beneficiaries. That rule requires qualified plans to be maintained for the exclusive benefit of the sponsor's employees and their beneficiaries.

In response to this concern, some PEO's have chosen not to establish retirement plans. Others have ignored the issue and set up single employer plans. These single employer plans are the focus of the Rev Proc. Others have taken a conservative approach and have set up multiple employer plans with the COs who participate. Essentially, those already sponsoring such multiple employer plans have nothing to worry about - thanks to IRC 413(c)(2) - and they are not affected by the new Rev Proc.

For years, in all my writings and my seminar presentations, I have taught that PEOs are at serious risk on this exclusive benefit rule issue, unless they cosponsor with their COs. In my view, at least 90% of single employer PEO plans are subject to disqualification under this provision. For further discussion of this issue, see Chapter 4 of Who's the Employer, or my summary of this issue in my Benefitslink column.

Obviously, this has been a major concern for the PEO industry. Congress has considered bills for the last several years which would give PEOs a safe harbor of sorts to let them sponsor a plan. Those bills have not gotten out of committee. Tired of waiting for Congress, and realizing the need for guidance for an increasingly important industry, the IRS decided to act to resolve the situation. 

In Rev Proc 2002-21, the IRS does not say that no PEO is the employer of its workers.  Rather, it says that if a single employer PEO plan wants the benefits of a favorable determination letter, it should convert to a multiple employer plan, or terminate in accordance with the Rev Proc. 

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Last Revised 01/31/03


Copyright 2005, S. Derrin Watson.  All rights reserved.