What Difference Does It Make If I Hire a Former “Leased” Employee?

By Nick White

A large client of ours (the “Company”) regularly employs temporary workers (“temps”) provided by several professional leasing agencies. Over the past several years, the Company has made job offers to a number of these temps and, thus, many of them have become regular employees of the Company.

Recently, the Company conducted an internal audit of its 401(k) plan (the “Plan”) and discovered that, with respect to calculating participation and vesting, the conversion of the temps to regular employees had not been handled properly. That is, under the Internal Revenue Code, a tax-qualified retirement plan is required to credit employees with any periods of service they previously performed for the plan sponsor as a leased employee. Contrary to this rule, when a temp converted to a regular employee, the Company counted their service for purposes of Plan eligibility and vesting only from the date they were hired as a regular employee. The failure to follow the qualified plan rules subjected the Plan to disqualification by the IRS, which could result in severe, adverse tax consequences.

We were consulted on how to correct this problem and, thus, avoid the severe consequences of an IRS audit. Essentially, the IRS requires in this situation that the plan sponsor give the affected employees the benefits (adjusted for earnings) and vesting credit they would have received if they had been timely credited with their prior service as leased employees. In this regard, we faced two significant challenges. The first was to figure out how to deal with the fact that the Company did not maintain accurate work records for temps. And the second was to see if we could reduce the potentially enormous administrative cost of calculating the correction — and, in particular, the amount of the “missed” earnings.

Initially, we approached these matters through a series of meetings with senior IRS officials. We proposed to the IRS, among other things, that the Company be permitted to use (i) certain assumptions to deal with the fact that the Employer did not maintain records reflecting hours worked by temps and (ii) a “weighted average” approach to simplify the corrective earnings calculation, which would dramatically reduce the administrative costs in this regard. Ultimately, these discussions proved extremely helpful, because we were able to obtain approval of our proposals. In addition, by demonstrating to the IRS the immediacy with which the Company had addressed the problem and the efforts it had made to ensure the benefits of all affected employees, we were able to negotiate a penalty equal to the absolute minimum amount permitted under IRS procedures.

We believe this case is important to you because it highlights an issue often overlooked by plan sponsors, but which is clearly on the radar screen of the IRS. At the same time, this case demonstrates the advantages of knowing how to address plan problems when they occur, and pursuing them proactively and aggressively.

© 2003 Reish Luftman Reicher & Cohen. All rights reserved. The ERISA Report for Plan Sponsors is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.

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