USA Today recently ran an article describing how many
companies are using alternative work arrangements to meet staffing
needs during the economic recovery. Such arrangements may include use
of leased employees, independent contractors or part-time/seasonal
workers, all of which are commonly referred to as contingent workers.
One of several reasons often cited is the savings in
benefit-related costs; however, it takes careful planning to ensure
benefit plans properly reflect those intentions. The analysis
generally requires employers to answer three key questions:
Which workers are legally considered to be my employees?
What does my plan document say about employees?
Will my plan be considered discriminatory if I exclude certain
Who Are Your Employees?
You may be thinking, "Of course I know who my employees are!"
However, the answer can be much more complex than it seems and has
tripped-up many well-intentioned companies. In fact, employers as
large as Microsoft, Coca-Cola and Time Warner have found themselves in
litigation over this very issue.
To avoid the complexities, some employers simply include all
workers in their benefit plans, but this option also has its
drawbacks. The federal laws governing retirement plans mandate that
plans be maintained and operated for the exclusive benefit and in the
best interest of employees. By covering workers that are not
employees, a plan sponsor violates this foundational rule.
Perhaps the easiest way to examine the situation is through a
series of examples, so let's consider the following basic fact
Spencer is a college student who is home for
break and looking for work. Shady Oaks Golf Club is looking for
temporary help but does not need to bring on full-time employees.
Spencer speaks to Aaron, the hiring manager at Shady Oaks, and they
discuss several arrangements.
Aaron tells Spencer that he can come on board as an independent
contractor. He will work as a groundskeeper and is to report to work
daily from 7:30 a.m. to 5:00 p.m. and will use the club's equipment.
His hourly compensation will be reported on Form 1099, no taxes will
be withheld and he will not be eligible for benefits. Both agree to
these terms in writing. Is Spencer an independent contractor or an
Unfortunately, it's not as simple as pointing to Aaron and
Spencer's agreement or the fact that Spencer will receive a 1099
instead of a W-2. The IRS has provided guidelines for employers to use
in its so-called "Twenty Factor Test" which focuses on whether a
company, Shady Oaks in this case, has the right to control the worker.
Several of the factors include whether the company has the right to:
Set the work schedule;
Establish the work location;
Pay by the time worked rather than by the job or on commission;
Furnish equipment for the worker's use; and
Require work-related training.
Based on these criteria, it is likely that Spencer is legally an
employee of Shady Oaks even though he is being treated as a
contractor. Apart from liability for the payroll taxes it didn't
withhold from Spencer's compensation, Shady Oaks may also be required
to provide retroactive benefits to Spencer due to the
Employees Not Working Full-Time
Aaron hires Spencer as a W-2 employee but specifies that he will
not receive benefits, because he is not working on a full-time basis.
This situation is much more straightforward in that Spencer and
Aaron both consider Spencer to be an employee of Shady Oaks. The issue
is whether or not he is somehow less of an employee such that he can
be excluded from company benefits.
In 2006, the IRS issued a Quality Assurance Bulletin to address
this issue. It indicates that employees who work other than full-time
schedules are still employees and that the plan documents, not
employment agreements, must be consulted to determine eligibility for
benefits. Examples of classifications that are often mishandled
Part-Time Employees: those who work less than a standard 40-hour
Temporary Employees: those who are employed for a limited period
delineated by specific dates or the duration of a project;
Seasonal Employees: those who work during a specific season such
as retail workers during the holidays or snow-plow operators in
Per Diem Employees: those who do not have a set work schedule
but are called in as needed.
The list also includes those whose normal work schedule is less
than a certain number of hours, e.g. someone who is normally scheduled
to work less than 20 hours per week.
Based on the Quality Assurance Bulletin, Spencer is a regular
employee whose eligibility for Shady Oaks' retirement plan must be
determined by the plan document regardless of the side agreement he
made with Aaron.
What Does the Plan Document Say About
Plan documents are generally written to include all employees
unless a certain classification is specifically excluded. Common
exclusions are independent contractors, union members and non-resident
aliens. However, documents can be tailored to a company's needs by
excluding others such as students, interns, groundskeepers, etc.
Proper worker classification is key to knowing if the plan excludes
certain individuals. In the 1990s, a group of workers classified as
independent contractors sued Microsoft, claiming they were entitled to
benefits. Microsoft defended itself by pointing out that the plan
document specifically excluded independent contractors. While the
court agreed that the exclusion was in place, it ruled that the
workers in question were not actually contractors but common law
employees; therefore, they did not fall under the documented
exclusion. Microsoft was ordered to pay nearly $100 million in back
While this is a high profile case involving a large company, the
IRS is aware of the issue of misclassification and looks for it when
auditing plans of all sizes.
Precise Document Language
Classification issues can sometimes be addressed by precise wording
in the plan document. The Microsoft case prompted many document
amendments to exclude workers classified as independent contractors on
the payroll records of the company. This more precise exclusion takes
the determination out of the realm of the common law definition of
employee and ties it to how the particular plan sponsor classifies
Another example of a classification that may require precision is
that of student. If a plan excludes students, is the intention to
exclude all students or just college students? What about a senior
executive who decides to go back and earn an MBA? That person is a
college student. Should he or she now be excluded from the plan?
Careful planning and precise wording at the beginning can eliminate
much of the frustration and liability that can arise later due to
Election to Waive Benefits
Employers will sometimes indicate that a particular individual
waived benefits. In the above examples, Spencer agreed in writing to
forego benefits. Again, the plan document must be consulted. Many
retirement plans simply do not allow a participant to waive benefits.
In that situation, Spencer's waiver cannot be applied to the
retirement plan whether he wants the benefits or not. For plans that
do allow waivers, regulations prescribe the process. Specifically, the
waiver must be in writing, must indicate that it is irrevocable and
must be signed before the employee becomes eligible. For a plan that
provides immediate eligibility, that means the waiver must be signed
before the employee's first day on the job.
What Does the Plan Document Say About
Once it is determined which classifications are covered by the
plan, it is necessary to understand the age and service requirements
an employee must satisfy to join. The law generally limits the maximum
age requirement to 21 and the maximum service requirement to one year
(defined as completion of 1,000 hours in a 12-month period) but plans
are free to implement more generous rules.
This is where the part-time/seasonal/temporary classifications come
into play. As noted above, these individuals must be treated as any
other employees. That means if a plan permits employees to join after
completion of 30 days of service, seasonal employees who remain
employed for more than 30 days become eligible. Similarly, an employee
who works 20 hours a week for a year becomes eligible for a plan that
imposes the maximum wait of 1,000 hours in a 12-month period (20 hours
per week x 52 weeks = 1,040 hours).
Furthermore, regulations require that service be combined for
employees who are terminated and rehired within certain timeframes. If
Spencer works for Shady Oaks during winter break, spring break and
summer vacation all in the same year, his service during all three of
those stints is combined to determine if he has worked the requisite
The easy solution may seem to be to simply exclude these groups.
However, the Quality Assurance Bulletin indicates that doing so will,
in most cases, violate the maximum statutory eligibility requirements,
in that it indirectly keeps someone out of the plan based on the
amount of time they work even though that time may be greater than the
one year maximum. It may be possible, however, to exclude these
individuals by some other means. For example, if all of Shady Oaks'
seasonal employees are groundskeepers like Spencer, they could write
their plan document to exclude groundskeepers (type of work) rather
than seasonal employees (length of service).
What About Nondiscrimination Issues?
There is one final step to determine if the plan can exclude
contingent workers and that is ensuring that the exclusions do not
violate the nondiscrimination requirements. The primary test involved
is the ratio percentage test. While a full description of the test is
beyond the scope of this article, it generally dictates that a plan
cannot exclude any more than 30% of its Non-Highly Compensated
Employees, i.e. non-owners and those who earn less than $110,000 per
year. In other words, if the sum of all the excluded employees is less
than 30% of the total number of NHCEs, the plan satisfies the ratio
percentage test and the exclusions are permitted.
The use of contingent workers carries many benefit-related issues.
It is possible, in many cases, to exclude them from retirement
benefits, but all three components discussed above (proper
classification, precise document language and a passing
nondiscrimination test) are required. Given the complexities involved,
it is very important for employers facing this challenge to work with
knowledgeable experts who can provide guidance every step of the way.
The information contained in this newsletter is
intended to provide general information on matters of interest in the
area of qualified retirement plans and is distributed with the
understanding that the publisher and distributor are not rendering
legal, tax or other professional advice. You should not act or rely on
any information in this newsletter without first seeking the advice of
a qualified tax advisor such as an attorney or CPA.