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A Guide to Employee and Aggregation Issues Affecting Qualified Plans

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Concerns, Suggestions

Overall, Rev Proc 2002-21 does a good job of dealing effectively with many of the concerns involving PEO Retirement Plans.  However, there are several open questions and pressing concerns which should still be addressed.

The IRS is aware of this and at one point was considering issuing clarification.  At this point, I doubt that they will.  I have outlined my expectations of the ultimate IRS enforcement policy in a BenefitsLink column.  In short, based on what I can derive from reviewing the Rev. Proc. and its intentions, I believe that the IRS will limit the application of the Rev. Proc. to organizations commonly regarded as staffing firms or PEOs, and that they will not treat true temps as Worksite Employees.  I wish the IRS would state that formally, but I doubt that they will. 

In any event, here are the issues that I believe are still open and my proposed resolution to them:

  1. Define PEO. The Rev. Proc. is a trap for the unwary unless the term PEO is defined. I would define a PEO as an organization which, as its principal business purpose, provides Worksite Employees to COs. Alternatively, you could set a lower threshold and say that an organization is a PEO if it derives more than 30% of its gross receipts from providing Worksite Employees to COs. This will allow the Rev. Proc. to target those entities it is meant to target and exclude hospitals and other organizations which may lease some employees as an incidental accommodation.  Although we lack a formal definition, I doubt that the IRS will enforce the Rev. Proc. against hospitals and similar organizations.
     
  2. Exclude temps. I would exclude temps from the definition of Worksite Employee, since they are likely to be the common law employees of the PEO/staffing firm. Just to be specific, I would say that persons who customarily work less than 4 months/year for any given CO are not Worksite Employees. I would add that a PEO may conclusively presume that such individuals are its employees for retirement plan purposes. Otherwise, there is no way retirement benefits can be provided for such workers under the Rev. Proc.  I believe that the IRS will, as a practical matter, not treat true temps as Worksite Employees.
     
  3. Expand relief for multiple employer plans. Section 4.03 of the Rev. Proc. provides "For the purpose of determining whether a PEO Retirement Plan or Spinoff Retirement Plan satisfies the qualification requirements in 401(a) upon plan termination (as described in section 5.06), Worksite Employees may be treated as if they were employees of the PEO." This is a very important protection, and it should be expanded to cover PEOs who choose a multiple employer plan.
     
  4. Provide a mechanism for determining employee status in multiple employer plans. One of the strengths of the Rev. Proc. is that it accomplishes its work without having to deal on a case-by-case basis with employee status issues. However, if a PEO goes with a multiple employer plan, as many already have and many more will, it still must determine employee status to administer that plan correctly. I would provide a safe harbor under which Worksite Employees (excluding temps as described above) would be conclusively presumed for retirement plan purposes, to be the employee of the CO and not the PEO. I would also provide a safe harbor under which Worksite Employees of nonparticipating COs are conclusively presumed not to be the common law employee of the PEO. Without this protection, there will just be additional problems down the road. This presumption would only apply for purposes of the multiple employer plan. It would apply to all 413(c) plans cosponsored by a PEO and one or more COs.  I believe as a practical matter that a PEO which treats Worksite Employees as common law employees of the CO will not find any opposition from the IRS on this point.  I recommend that multiple employer plans contain a clause to that effect.
     
  5. Clarify nonreliance. The Rev. Proc. provides a crucial incentive for compliance: "After the Compliance Date, a PEO may not rely on a determination letter for a PEO Retirement Plan that benefits Worksite Employees performing services for COs, regardless of when the determination letter was issued." To complete this provision, I would also say that the PEO may also not rely on a favorable notification or opinion letter issued with regard to a prototype or volume submitter plan which it may use. Having said that, I think it would be useful (and perhaps required by law) to provide a mechanism whereby a PEO that believes it is the common law employer of its workers to obtain a ruling not only on plan qualification but also on employment status.
     
  6. Clarify affected PEOs. The Rev. Proc. says, "The definition of a PEO Retirement Plan does not include a plan maintained as a multiple employer plan that has been adopted by a PEO and one or more COs." Literally, this means that the Rev. Proc. only in cases in which no COs cosponsor the plan. But there can be situations in which some, but not all COs cosponsor the plan, and the Worksite Employees of nonparticipating COs are in the plan. I would only exclude multiple employer plans in which all COs of participating Worksite Employees cosponsor the plan. Additionally, I would automatically apply the relief of the Rev. Proc. to PEO plans which, prior to the effective date, terminated their plan or converted it to a multiple employer plan.
     
  7. Remove distribution limitations. I would provide that distributions may be made from the terminating PEO Retirement Plan and the Spinoff Retirement Plan as though the plan termination were described in IRC 401(k)(10), without regard to whether other plans exist.  I doubt that the IRS will enforce the distribution limitations against terminating PEO plans and Spinoff plans complying with the Rev. Proc.
     
  8. Provide relief for COs. Allow COs to administer their plans prior to the Compliance Date as though the Worksite Employees were common law employees of the PEO. In effect, this expands the protection of Section 4.03 to COs.
     
  9. Eliminate the "bad apple" rule. This Rev. Proc. will result in a massive increase in the number of multiple employer plans in existence. With that in mind, it is time to revisit Reg 1.413-2(a)(3)(iv), which says, "The failure by one employer maintaining the plan (or by the plan itself) to satisfy an applicable qualification requirement will result in the disqualification of the section 413(c) plan for all employers maintaining the plan." This provision is a tremendous disincentive, particularly when the employers are connected only because they use the same staffing provider. It makes far more sense to sever the plan and allow for disqualification only of the offending portion. In light of the current EPCRS climate, the easiest way to do that is to provide that sanctions for a multiple employer plan are computed separately for noncompliant employers, and without regard to other employers. That way, the Service can make the change without amending regulations or seeking a statutory change from Congress.

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Last Revised 11/02/02

 


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