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CASH OR DEFERRED ARRANGEMENTS,
AND EMPLOYEE CONTRIBUTIONS
Mary Oppenheimer and Michael Karlan
Cash or deferred arrangements, also known as "CODAs" or "401(k) plans", are one of a wide variety of plans permitting individuals to make before-tax contributions to retirement plans. In addition to the standard CODA, which is described in detail in this outline, other options available to some or all employers include:
401(k) SIMPLE (Savings Incentive Match Plans for Employees of Small Employers) can be established by employers with no more than 100 employees earning $5000 or more during the preceding year. See Section X(A) below.
IRA SIMPLE arrangements can be established by employers with no more than 100 employees earning $5000 or more during the preceding year. See Section X(B) below.
Section 403(b) salary reduction arrangements can be established by section 501(c)(3) organizations and certain educational institutions. See Section X(C) below.
Section 457 nonqualified deferred compensation arrangements can be established by tax-exempt organizations and state and local governments. See Section X(D) below.
Salary Reduction Simplified Employee Pensions (SARSEPs) could be established by small employers before January 1, 1997. Although new SARSEPs cannot be established, old ones can continue to operate. See Section X(E) below.
Extraordinary growth of elective arrangements, especially 401(k) plans, has been accompanied by concern about complexity of nondiscrimination testing, resulting in a multiplicity of possible nondiscrimination tests.
Growth of elective arrangements is fueled by a number of factors.
Flexibility in who contributes what responds to demographic change.
Disparity in contributions for highly compensated and other employees can be higher than under more traditional arrangements.
Plan contributions can often be limited to salary reduction, requiring no true employer contribution.
Ability to make pre-tax contributions coincides with the desire to reduce current taxation.
Small Business Job Protection Act of 1996 (P.L. 104-188) ("SBJPA") supplemented basic 401(k) testing methods, described in Section III(B) below, with safe harbor methods described in Section III(C).
All cash or deferred arrangements involve an election under which an employee chooses between cash (or some other taxable form of compensation) or an employer contribution to a plan that is qualified or is intended to be qualified. Reg. § 1.401(k)-1(a)(3)(i).
An irrevocable one-time election at the commencement of employment or plan participation is not a cash or deferred election. Reg. § 1.401(k)-1(a)(3)(iv).
The one-time election rule was especially controversial as applied to partnership plans. Prior to TRA '86, these plans often provided one level of contributions for employees, but permitted partners to elect that level or any lower level of contributions on an annual basis. (This design, in turn, reflected pre-1984 requirements for plans benefitting self-employed individuals, if any of these had a more than ten percent interest in capital or profits.) Partnership representatives contended these elections should not be treated as cash or deferred elections, and should therefore not be limited to $7000. For partnership plans, see reg. § 1.401(k)-1(a)(6).
See also Notice 88-127, 1988-2 C.B. 538, and reg. § 1.401(k)-1(a)(6)(ii)(C), which gave partnership plans until the later of March 31, 1989, or the first day of the first plan year beginning after December 31, 1988, either to be amended to become qualified CODAs or to require individuals to make one-time irrevocable elections. The 1994 regulations clarified perceived ambiguities in the 1988 language by requiring the election to be made on or before December 23, 1994.
The election must be made with respect to compensation that is neither currently available nor treated as an after-tax employee contribution. Reg. §§ 1.401(k)-1(a)(2)(ii) and 1.401(k)-1(a)(3)(ii).
Amounts are currently available if they have been paid to the employee or if the employee can currently receive the amount at his/her discretion. Reg. § 1.401(k)-1(a)(3)(iii).
Thus, section 401(k) permits deferral of amounts already earned so long as they are not yet paid or payable.
A cash or deferred election may be changed as often as the plan permits so long as it relates only to compensation that is not currently available.
Maximum deferrals under qualified cash or deferred arrangements
A qualified cash or deferred arrangement is the exclusive method for electively deferring compensation under a qualified plan on a pre-tax basis.
Amounts deferred under a qualified CODA are excluded from the participant's income under section 402(g). Reg. § 1.401(k)-1(a)(4)(iii).
The maximum amount that can be deferred is governed by section 402(g), which limits deferrals under a cash or deferred arrangement to $7000.
This figure is adjusted annually. Section 402(g)(5). For 1989 it was $7313; for 1990 it is $7979; for 1991 it was $8475; for 1992 it was $8728; for 1993 it was $8994; for 1994 and 1995 it was $9240; for 1996 and 1997 it was $9500; for 1998 it is $10000.
The $7000 limit was made a qualification requirement by TAMRA. See section 401(a)(30).
Plans may provide for distribution of deferrals in excess of $7000, provided the distribution is made by April 15 of the subsequent year. Income attributable to the deferral must also be distributed. Section 402(g)(2)(A) and reg. § 1.402(g)-1(e)(2).
Despite the language of the statutory caption, these distributions are not required to be made by plans. Distributions of excess deferrals cannot be made unless permitted by the plan. Reg.§ 1.402(g)-1(e)(4).
However, if distributions are not made by April 15, the excess deferral is included in income both in the year in which contributed and the year in which distributed. See sections 402(a), 402(g)(1), 402(g)(2), and 402(g)(7), and reg. § 1.402(g)-1(a). Section 402(g)(7) provides the participant with no investment in the contract if the excess is not distributed. See also reg. § 1.402(g)-1(e).
If the excess distribution is not timely distributed, it cannot be distributed until occurrence of a distributable event under section 401(k)(2)(B). See reg. § 1.402(g)-1(e)(8)(iii). But see permitted correction under the Standardized VCR Procedure. Rev. Proc. 98-22, 1998-12 I.R.B. 11, App. A.04.
If distributions are made in a timely fashion, the excess deferral is included in income in the year in which deferred. TAMRA altered the tax treatment of income on the excess deferral, which now is includible in income in the year in which distributed. Section 402(g)(2)(C) and reg.§ 1.402(g)-1(e)(8)(i).
NONDISCRIMINATION TESTS FOR QUALIFIED CASH OR DEFERRED ARRANGEMENTS
A qualified cash or deferred arrangement must comply with the coverage requirements of section 410(b)(1). Section 401(k)(3)(A)(i). However, a governmental plan is treated as meeting this requirement. Section 401(k)(3)(G).
Any employee eligible to make a cash or deferred election is treated as an eligible employee for purposes of section 410(b) with respect to a cash or deferred arrangement. Section 410(b)(6)(E).
Employees who are suspended due to a distribution, loan, or election not to participate are considered eligible employees. Reg. § 1.401(k)-1(g)(4)(i) and 1.401(m)-1(f)(4)(i).
NOTE: Under reg. § 1.410(b)-9, a 401(k) plan includes only elective deferrals. It does not include amounts treated as elective deferrals. The consequence is that both the 401(k) plan and any related plan to which other contributions, such as qualified nonelective contributions, are made must separately satisfy section 410(b).
A qualified cash or deferred arrangement must also comply with the special nondiscrimination test of section 401(k)(3). This test involves several steps, and a number of alternative approaches are available. In addition, for post-1998 plan years, safe harbor methods are available. See III.C. below.
The first step is computing the "actual deferral ratio" for each participant. The actual deferral ratio is the amount deferred divided by the participant's plan year compensation. Thus, if a participant earns $40,000 and defers $4,000, the participant's actual deferral ratio is 10 percent. If the participant defers nothing, the participant's actual deferral ratio is zero.
Any safe harbor or alternative definition of compensation contained in the 414(s) regulations may be used in computing the actual deferral ratio. See reg. § 1.401(a)(4)-12 for the definition of plan year compensation.
Elective deferrals may be included or excluded, i.e., gross or net compensation may be used.
If the individual participated in the plan for only part of the plan year, compensation for the partial year can be used. Reg.§ 1.401(k)-1(g)(2)(i).
In the case of highly compensated employees who participate in two or more cash or deferred arrangements maintained by the same or related employers, all the arrangements are treated as a single arrangement. Thus for purposes of testing any of the arrangements, elective deferrals under all of the arrangements are taken into account. Reg.§ 1.401(k)-1(g)(1)(ii)(B)
The next step is computing the average deferral percentage (ADP) for two groups -- highly compensated employees who are participants and nonhighly compensated employees who are participants.
The ADP is the average of the actual deferral ratios of participants in the group.
. Assume a plan has two nonhighly compensated participants who earn $10,000 and $40,000 respectively. The participant earning $10,000 defers nothing, while the participant earning $40,000 defers 10 percent. The ADP for the group is five percent.
For plan years beginning after December 31, 1998, if the plan includes employees who do not meet the minimum age and service requirements of section 410(a)(1)(A), the average deferral percentage for nonhighly compensated employees can be calculated by excluding those employees. See Section 401(k)(3)(F) as amended by SBJPA.
The ADP of highly compensated participants may not exceed:
125 percent of the ADP of nonhighly compensated participants; or
200 percent of the ADP of nonhighly compensated participants, provided that not more than two percentage points separate the two groups. Section 401(k)(3)(C).
In testing for discrimination, the actual deferral ratios may include qualified matching contributions (QMACs) or qualified nonelective employer contributions (QNCs) to a qualified plan if the following conditions are met. Reg. §§ 1.401(k)-1(b)(5) and 1.401(k)-1(g)(13).
The contributions are nonforfeitable when made. Thus, matching contributions or other employer contributions subject to a vesting schedule may not be treated as QMACs or QNCs.
The contributions are subject to the same withdrawal restrictions as elective contributions. In addition, for post-1988 plan years, the contributions may not be withdrawn on account of hardship. Reg. § 1.401(k)-1(d)(2)(ii).
The contributions are subject to other requirements contained in regulations. Thus, for example, QNCs can be used only if the nonelective contributions satisfy the general nondiscrimination rules of section 401(a)(4) both before and after the use of QNCs, and only if the plan under which they are contributed can be aggregated with the CODA under reg. § 1.410(b)-7(d).
Special rules must be applied to define the plan that is subject to testing under section 401(k)(3).
Amounts deferred, and amounts treated as elective deferrals, cannot be taken into account for determining whether another plan meets coverage, nondiscrimination, or other qualification rules, except as permitted under section 401(m). Section 401(k)(4)(C).
Aggregation of ESOPS with cash or deferred arrangements that are not ESOPS is not permitted for discrimination testing. Reg.§§ 1.401(k)-1(b)(3), -1(g)(11)(i) and 1.410(b)-7.
Final regulations require disaggregation of collectively bargained and noncollectively bargained employees. Further disaggregation, on the basis of each collective bargaining unit, is permitted but not required. Reg. § 1.401(k)-1(g)(11)(ii)(B).
Effective for plan years beginning after December 31, 1996, the average deferral percentage for nonhighly compensated employees must be determined on the basis of the preceding plan year (three percent in the case of the first plan year) unless the employer elects, prior to the end of the year before the change is to take effect, to use the current plan year. Although the employer is not required to notify the IRS of the election, the plan document must reflect whether the plan uses the current year testing method or the prior year testing method for a testing year. The election may not be changed from the current year method to the prior year method without consent. Section 401(k)(3)(A) as amended by SBJPA.
The prior year’s ADP for nonhighly compensated employees may be determined as soon as prior year data are available.
The nonhighly compensated employees for the preceding year are determined using the definition of nonhighly compensated employees in effect for that year. Notice 97-2, 1997-2 I.R.B. 22. Thus the changes in the definition of highly compensated employee made by the SBJPA can be disregarded in determining the actual deferral ratio for use in the 1997 plan year.
In addition, the nonhighly compensated employees taken into account in determining the prior year’s ADP are those who were nonhighly compensated employees during the preceding year, without regard to status in the current year. Thus, an individual is treated as nonhighly compensated for the prior year if that individual is no longer nonhighly compensated due to termination of employment or new status as highly compensated during the current year. Notice 97-2.
A special weighting rule applies under the prior year method when there is a significant change in plan coverage during the testing year. In that case, the ADP and ACP for nonhighly compensated employees for the prior year under the plan is the weighted average of the ADPs and ACPs, respectively, for the prior year subgroups. Notice 98-1, 1998-3 I.R.B. 42.
However, if at least 90% of the total number of nonhighly compensated employees from all prior year subgroups are from a single prior year subgroup, then in determining the ADP or ACP for nonhighly compensated employees for the prior year under the plan, the employer may elect to use the ADP and ACP for nonhighly compensated employees for the prior year of the plan under which that single prior year subgroup was eligible. Notice 98-1.
Notice 98-1 provides that an employer using the prior year method may take into account QNCs and QMACs in calculating ADP, and QNCs in calculating ACP, under the same standards as used in current year testing even though the QNCs allocated to the highly compensated employees and nonhighly compensated employees in a single plan year are taken into account in different testing years for ADP and ACP testing.
If prior year testing is used, the ADP for nonhighly compensated employees for the first plan year is 3%, unless the employer elects to use the actual ADP for that plan year. A similar rule applies for ACP testing. Notice 98-1.
For ADP purposes, the "first plan year" is the first year in which the plan provides for elective deferrals. However, a plan does not have a first plan year if it is aggregated with any other plan that was or that included a 401(k) plan in the prior year.For ACP purposes, the "first plan year" is the first plan year in which a plan provides for employee contributions or matching contributions, or both. However, a plan does not have a first plan year if it is aggregated with any other plan that was or included a 401(m) plan in the prior year.
A successor plan is not eligible for the first plan year rule. A plan is a "successor plan" if the employer maintained another section 401(k) plan (or section 401(m) plan, as applicable) in the prior year and 50% or more of the eligible employees for the first plan year were eligible employees under that plan.
If a plan uses this first plan year rule, then the use of the prior year testing method for the next testing year is not treated as a change in testing method. Such a plan would not be subject to the limitations on double counting of contributions for the next testing year.
Notice 98-1 provides that if an employer elects to use the current year testing method for purposes of the ADP test, the employer may switch to prior year testing only in the following circumstances:
A transaction occurs that is described in section 410(b)(6)(C)(i) and reg. § 1.410(b)-2(f), that transaction results in the employer maintaining both a plan using the prior year testing method and a plan using the current year testing method, and the change occurs by the end of the plan year after this transaction; or
The change occurs during the plan's remedial amendment period for the SBJPA changes.
The plan (or all plans, if the plan is the result of the aggregation of two or more plans) used the current year testing method for each of the five preceding plan years or, if less, the number of years the plan has been in existence;
New safe harbor testing rules can be used for plan years beginning after December 31, 1998.
One alternative is matching 100 percent of elective contributions, up to three percent of compensation, and 50 percent of the elective contributions between three and five percent of compensation. Variants which result in contributions equal to the aggregate under the specified formula are possible. Section 401(k)(12)(B).
A second alternative is making three percent nonelective contributions to all nonhighly compensated participants. Section 401(k)(12)(C).
Prohibited discrimination with respect to contributions or benefits is not limited to the amount of the contributions or benefits, but includes, for example, the conditions under which the contributions or benefits are provided or the privileges attached to them under the plan. Reg. § 1.401(k)-1(a)(4)(iv).
The right to make each rate of elective contributions is specifically listed as a "right or feature" in reg. § 1.401(a)(4)-4(e)(3)(iii)(D). Each level of elective contributions must therefore be currently available and effectively available to a group of employees that satisfies section 410(b). Reg. § 1.401(a)(4)-4(a).
The rate of elective contributions is determined using the plan's definition of compensation out of which elective contributions are made even if that definition of compensation does not satisfy section 414(s). However, if the same rate is provided to different groups of employees using different definitions of compensation (or different formulas or other requirements) there will be multiple rates for purposes of testing other rights and features. Reg.§ 1.401(a)(4)-4(b)(1).
METHODS FOR CORRECTING DISCRIMINATION
For post-1986 plan years, discrimination under a cash or deferred arrangement may be corrected using one or more of the following three methods.
The plan may correct discrimination by distributing the aggregate amount of excess contributions and income thereon to highly compensated employees. Section 401(k)(8)(A).
Excess contributions are amounts deferred in excess of maximum permitted. The excess contribution for each highly compensated participant is determined through a levelling process under which the highest deferral ratio is reduced to the next highest level, etc., until the permitted level for highly compensated employees is reached. Reg. § 1.401(k)-1(f)(2).
For plan years beginning before January 1, 1997, the amount of each highly compensated employee’s excess contributions, and income thereon, was distributed to that highly compensated employee in order to correct discrimination. This resulted in less highly compensated highly compensated employees receiving larger distributions than more highly compensated highly compensated employees. (This is because a given elective contribution, e.g. $8000, is a higher percentage of the compensation of an individual earning $80,000 than of an individual earning a greater amount.)
The SBJPA amended section 401(k)(8)(C) to provide that distributions of excess contributions for any plan year are made to highly compensated employees on the basis of the amount of contributions by or on their behalf. This does not affect the total amount of excess contributions to be distributed, but merely reallocates the distributions among the highly compensated employees.
As a result of the SBJPA amendment, determining the amount to be distributed to each highly compensated employee requires using a four step process described in Notice 97-2.
Calculate the excess contribution for each highly compensated employee as described in reg. § 1.401(k)-1(f)(2).
Determine the sum of the excess contributions.
Reduce the elective contributions of the highly compensated employee with the highest dollar amount by the amount required to bring that employee’s elective contributions down to those of the highly compensated employee with the next highest dollar amount. Distribute this amount. However, if a smaller reduction, when added to prior distributions, would equal the total excess contributions, distribute the smaller amount.
If the total amount distributed is less than the total excess contributions, repeat the step above until the required amount has been distributed.
Note that under the new method, it is not necessary that the ADP test be satisfied after excess contributions have been distributed using the above method. For details, see example in Notice 97-2.
Excess contributions are deemed to be the first contributions made during the plan year. Conference Report on TRA '86, p. II-388.
The amount distributed must be reduced by excess deferrals previously distributed with respect to the taxable year of the employee ending with or within the plan year. Reg. § 1.401(k)-1(f)(5)(i)(B).
Time of inclusion of amounts distributed within two and one-half months after the close of the plan year depends on the aggregate amount of excess and excess aggregate contributions (excluding income) distributed to the individual under a plan. Section 4979(f)(2).
If the amount is less than $100, the excess contributions and earnings are includible in income in the year distributed.
If the amount is $100 or more, the excess contributions and earnings are includible in income in the year in which the excess contributions were made. Thus, an amended Form 1099R must be provided by the employer and an amended income tax return may be needed.
Amounts distributed more than two and one-half months after the close of the plan year are includible in income in the taxable year in which distributed. However, the employer is liable for a ten percent excise tax on the amount of these excess contributions. Section 4979(a).
Distribution must include income allocable to excess contributions.
Plan can use its normal method for allocating income to accounts if that method satisfies section 401(a)(4), and is used for all participants and all corrective distributions for the plan year.
As an alternative, income allocable to excess contributions is that portion of the income on the participant's account balance for the year that bears the same ratio to total income as the excess contributions bear to the opening account balance. Reg. § 1.401(k)-1(f)(4)(ii)(C).
If plan so provides, income that must be distributed includes income for the "gap period" between the end of the plan year and the date of distribution. Reg. § 1.401(k)-1(f)(4)(ii). A safe harbor method for calculating gap period income is contained in reg.§ 1.401(k)-1(f)(4)(ii)(D).
Any distribution of less than the entire amount of excess contributions plus income attributable to the contributions is treated as a pro-rata distribution of excess contributions and income. Reg. § 1.401(k)-1(f)(1)(iv). Thus, assume that an excess contribution of $1,000 is distributed, but not the related income of $100. $909 would be treated as a distribution of excess contributions, and $91 as a distribution of income.
For examples and transition rules, see Notice 88-33, 1988-1 C.B. 513.
In accordance with regulations, the plan may recharacterize excess contributions as employee contributions. Section 401(k)(8)(A)(ii).
Regulations permit recharacterization for all years plan has been in existence. However, the plan must permit employee contributions. Reg.§ 1.401(k)-1(f)(3)(iii)(B). In addition, recharacterization must be completed within 75 days after the close of the plan year. For this purpose, recharacterization occurs on the day on which notice is provided to the last affected highly compensated employee. Reg. § 1.401(k)-1(f)(3)(iii)(A).
Recharacterized amounts are treated as employer contributions for all purposes except sections 72, 401(a)(4), and the discrimination rules of section 401(k). Reg. § 1.401(k)-1(f)(3)(ii). Employee contributions resulting from recharacterization are, of course, tested for discrimination under section 401(m).
The employer may make additional QNCs or QMACs to increase ADP of nonhighly compensated employees.
Prior to TRA '86, this was the sole method of correction permitted under IRS regulations.
This method avoids excise tax under section 4979, even if contributions are made more than 2 1/2 months after the close of the plan year.
If correction does not occur within 12 months after the close of the plan year, administrative correction is available. For example, the Standardized VCR Procedure (SVP) contains the following method. Rev. Proc. 98-22, 1998-12 I.R.B. 11.
Corrective contributions must be made on behalf of all eligible NHCEs and these contributions must be either the same flat dollar amount or the same percentage of compensation. QNCs contributed to satisfy the ADP test do not have to be matched.
The plan must satisfy the ACP test, and it must count as eligible employees for the ACP test any employees who would have been eligible for a matching contribution had they made elective deferrals.
A plan may not be treated as two separate plans, one covering employees that would otherwise be excludable and the other covering all remaining employees in order to reduce the number of employees eligible to receive QNCs. Similarly, the plan may not be restructured into component plans in order to reduce the number of employees eligible to receive QNCs.
For reporting rules applicable to corrective distributions, see Notice 87-77, 1987-2 C.B. 385, Notice 88-33, 1988-1 C.B. 513, and Notice 89-32, 1989-1 C.B. 671.
DISTRIBUTION REQUIREMENTS FOR QUALIFIED CASH OR DEFERRED ARRANGEMENTS
Amounts deferred may generally not be distributed prior to death, disability, separation from service, hardship, or attainment of age 59 1/2. Section 401(k)(2)(B). In general, the distribution rules also apply to qualified nonelective and qualified matching contributions, and to earnings attributable to elective deferrals, qualified nonelective, and qualified matching contributions.
One of the most controversial issues concerning cash or deferred arrangements has been the definition of "hardship".
Final regulations define a hardship distribution as one that meets two tests.
It is made on account of an immediate and heavy financial need of the employee. Reg. § 1.401(k)-1(d)(2)(i).
It is necessary to satisfy the need and cannot be satisfied from other resources that are reasonably available to the employee. Reg. § 1.401(k)-1(d)(2)(iii).
In general, what constitutes an immediate and heavy financial need is to be determined on the basis of facts and circumstances. The fact that an expenditure is voluntary or foreseeable does not, however, mean it is not a hardship. Reg. § 1.401(k)-1(d)(2)(iii)(A).
The following may be deemed to be immediate and heavy financial needs under a plan. Reg. § 1.401(k)-1(d)(2)(iv)(A). Of course, other items may also be immediate and heavy financial needs, but that must be determined by the plan administrator or other fiduciary.
Medical expenses previously incurred or necessary for obtaining medical care deductible under section 213(d) for the participant, spouse, or dependents.
Purchase of principal residence (excluding mortgage payments) for participant.
Payment of post-secondary tuition, related educational fees, and room and board for next 12 months for participant, spouse, children, or dependents.
Prevent eviction/foreclosure on participant's principal residence.
A distribution may be deemed necessary to satisfy an immediate and heavy financial need if the following requirements are met. Reg. § 1.401(k)-1(d)(2)(iv)(B). This too is a safe harbor: the plan may instead make determinations based on facts and circumstances.
The distribution does not exceed the amount of the immediate and heavy financial need. The distribution may be "grossed up" to take into account taxes that will be incurred as a result of the distribution.
The employee has obtained all other non-hardship distributions and nontaxable loans currently available under all plans maintained by the employer.
The plan, and all other plans maintained by the employer, provide for a twelve month suspension of elective and employee contributions.
The plan, and all other plans maintained by the employer, limit the participant's elective contributions for the succeeding taxable year to the difference between the section 402(g) limit for the year and the amount deferred in the previous taxable year. Thus, if an employee deferred $2000 in 1988, and took a hardship distribution during that year, the maximum deferral in 1989 would be $5313 ($7313 - $2000).
The Code provides that only elective deferrals can be distributed on account of hardship. Section 401(k)(2)(B)(i)(IV). See also Conference Report at II-389.
Because of administrative problems faced by plan administrators that had not maintained sufficient records to distinguish elective deferrals, other elective contributions, and income thereon, reg. § 1.401(k)-1(d)(2)(ii) permits distribution of amounts treated as elective contribution and of income allocable to elective deferrals and other amounts treated as elective contributions. These amounts must have been credited to participants' accounts on or before December 31, 1988, or -- if later -- the end of the last plan year ending before July 1, 1989.
In a general information letter, the Service has indicated that, in the event of subsequent loss, the dollar amount determined as of December 31, 1988, less subsequent hardship distributions, may be distributed in the event of hardship.
Special rules permit distributions upon plan termination without establishment of a successor plan. Section 401(k)(10) and reg.§ 1.401(k)-1(d)(3).
A successor plan is a defined contribution plan, other than an ESOP, that is maintained by the same employer at the time of plan termination or within twelve months thereafter. An exception is provided if less than 2 percent of the participants in the terminated plan are or were eligible under the other defined contribution plan within 12 months before or after the plan termination date. Reg. § 1.401(k)-1(d)(3).
The amount distributed must be a lump sum distribution within the meaning of section 402(e)(4), except that it may be made on account of termination, does not require a minimum period of service, and is not subject to the one-time election rule of section 402(e)(4)(B). Section 401(k)(10)(B) and reg. 1.401(k)-1(d)(5).
In addition, distributions may be made in the event of certain sales of subsidiaries and assets. Section 401(k)(10).
A sale of 85 percent of the assets used in a trade or business is deemed to be a sale of substantially all the assets used in the trade or business. Reg. §1.401(k)-1(d)(4)(iv).
These distributions are permitted only with respect to employees who continue employment with the subsidiary or with the purchaser of the assets. Section 401(k)(10)(A)(ii) and (iii) and reg.§ 1.401(k)-1(d)(4)(ii).
These distributions are permitted only if the transferor corporation continues to maintain the plan. Section 401(k)(10)(C). A similar concern is reflected in the requirement that the plan from which distributions are made cannot be maintained by the transferee employer. See, e.g., reg. § 1.401(k)-1(d)(4).
The distribution must be a lump sum distribution, subject to the same exceptions as upon plan termination. Section 401(k)(10)(B) and reg. § 1.401(k)-1(d)(5).
A loan is not treated as a distribution, even if it is secured by the employee's accrued benefit attributable to elective contributions or is includible in the employee's income under section 72(p). However, if a default on a loan causes a reduction of an employee's accrued benefit derived from elective contributions, the reduction is treated as a distribution. Reg. § 1.401(k)-1(d)(6)(ii). Hence, if the reduction occurs prior to an event permitting distribution, the CODA will cease to be qualified.
Final DOL regulations indicate that a loan is considered adequately secured despite such a delay so long as it is reasonably anticipated that there will be no loss to the plan of principal or interest. DOL reg. §2550.408b-1, 54 FR 30526 (July 20, 1989). Earmarked loans should meet this requirement.
Note also that DOL regulations permit up to 50 percent of the present value of a participant's vested account balance to be used as security for a loan. DOL reg. §2550.408b-1(f)(2).
OTHER REQUIREMENTS FOR QUALIFIED CASH OR DEFERRED ARRANGEMENTS1. The amounts cannot be nonforfeitable solely because of age and service. See reg. § 1.401(k)-1(c)(1)(i).
The cash or deferred arrangement must be part of a profit-sharing or stock bonus plan, a pre-ERISA money purchase pension plan that contained a deferral feature, or a rural cooperative plan. Section 401(k)(1).
For plan years beginning before January 1, 1997, section 401(k)(4)(B) barred tax-exempt organizations (other than rural cooperatives) and state and local governments from establishing 401(k) plans. (Plans established by tax-exempt organizations before July 2, 1986, and by state or local governments before May 6, 1986, were grandfathered.)
This led to serious problems for tax-exempt organizations other than 501(c)(3) and certain educational organizations, inasmuch as there was no vehicle permitting deferrals by employees who were not in a "select group of highly compensated and management employees".
In addition, the status of plans established by Indian tribes was unclear.
For plan years beginning after December 31, 1996, tax-exempt organizations and Indian tribes may establish 401(k) plans.
For post-1998 plan years, no more than one year of service and attainment of age 21 can be required as a condition of plan participation. Section 401(k)(3)(F).
Amounts deferred must be nonforfeitable when contributed. Section 401(k)(2)(C).
Thus an amount that is nonforfeitable by reason of a vesting schedule may not be taken into account under section 401(k).
Other employer benefits, other than matching contributions, cannot be contingent upon the employee's election to make or not make elective contributions. Section 401(k)(4).
Thus, neither welfare benefits (such as health benefits) nor participation in another plan of deferred compensation (including 457 plans or 403(b) annuities) can be limited to employees who defer a specified amount. For an extensive list of contingent benefits, see reg. § 1.401(k)-1(e)(6)(ii).
In addition, a plan that permits only employees who defer a specified amount to make after-tax employee contributions, or which permits after-tax employee contributions only in the case of recharacterization, will violate section 401(k)(4).
The following items will not violate the contingent benefit rule. Reg. § 1.401(k)-1(e)(6).
Any benefit provided under a cafeteria plan.
Participation in a nonqualified deferred compensation plan, unless the participant's failure to make elective contributions under the cash or deferred arrangement increases deferrals under the nonqualified arrangement.
Benefits under defined benefit or excess benefit plans that are dependent upon the participant making, or not making, elective contributions under a cash or deferred arrangement.
SPECIAL DISCRIMINATION RULES FOR PLANS WITH EMPLOYEE OR MATCHING CONTRIBUTIONS
For post-1986 plan years, the amount of before-tax employee contributions and employer contributions that match either employee contributions or elective deferrals must meet the nondiscrimination tests of section 401(m). Elective deferrals recharacterized as employee contributions must be included in this calculation.
Section 401(m) does not apply to employee contributions to a defined benefit plan. See reg. § 1.401(m)-1(f)(6).
For plan years beginning after 1988, section 401(m) applies to employee and matching contributions under a section 403(b) plan, except in the case of an annuity purchased by a church within the meaning of section 3121(w)(3)(B). Section 403(b)(12)(A)(i).
Section 401(m) parallels section 401(k). Thus, it first requires computing, for each participant, a contribution ratio equal to the sum of the employee's employee and matching contributions divided by the employee's compensation. The average contribution percentages (ACPs) for the groups of highly compensated and nonhighly compensated employees are then calculated and compared, using the 125 percent and 200 percent/two percentage point tests. As with the average deferral percentage, effective for plan years beginning after December 31, 1996, the average contribution percentage for nonhighly compensated employees must be determined on the basis of the preceding plan year (three percent in the case of the first plan year) unless the employer elects to use the current plan year. The election may not be changed without consent. See Section 401(m)(2)(A) and Notice 97-2, 1997-2 I.R.B. 22. Safe harbor methods are available for plan years beginning after December 31, 1998. Section 401(m)(11)(A).
Elective deferrals and QNCs may be taken into account in computing contribution ratios under certain conditions, which generally parallel those under which QNCs and QMACs may be used in 401(k) testing. Reg. § 1.401(m)-1(b)(5). These amounts may not also be used in testing for discrimination under section 401(k).
Section 401(m)(9)(A) provides that regulations may prevent the multiple use of the 200 percent/two percentage point limitation with respect to any highly compensated employee.
The regulations are effective for post-1988 plan years. See reg. § 1.401(m)-2(d)(1).
There is no multiple use unless at least one plan exceeds the 125 percent limit. Reg. § 1.401(m)-2(b)(1)(i)(C) and (D).
In addition, there are also special rules to eliminate inappropriate results for plans with extremely low deferral rates. Reg. §1.401(m)-2(b)(3).
Cash or deferred arrangements with matching contributions may run afoul of the multiple use restriction. For example, assume that elective deferrals are six percent of highly compensated employees and four percent of nonhighly compensated employees. If there is a fifty percent match, the contribution percentages will be three and two percent respectively. Regulations require reduction of either elective deferrals or matching contributions or both in this case. See reg. § 1.401(m)-2(c).
Excess aggregate contributions (those exceeding permitted amount) may be corrected by distributing or (if forfeitable) forfeiting the amounts by the close of the following plan year. Section 401(m)(6)(A). The SBJPA changed the method of calculating how these amounts are distributed. See Section IV(A)(1) above.
Income and excise tax consequences are identical to those described with respect to section 401(k).
Note that recharacterized elective deferrals may be required to be distributed in order to correct excess aggregate contributions.
The correction mechanism cannot discriminate in favor of highly compensated employees. Thus, for example, employee contributions may not be distributed while matching contributions remain in the plan. A pro rata distribution of matching and employee contributions will be considered nondiscriminatory. Reg. § 1.401(m)-1(e)(4).
A plan subject to section 401(m) must also meet the nondiscriminatory availability requirements of section 401(a)(4). Note that the right to each rate of employee contributions, the right to an allocation of each rate of matching contributions, and the formulas and requirements for matching contributions are all rights and features listed in reg. § 1.401(a)(4)-4(e)(3)(iii)(E) and (F) and 1.401(m)-1(a)(2). Thus a plan may fail to meet the nondiscrimination requirements of section 401(a)(4) if, for example, the rate of matching contributions favors highly compensated employees, either expressly under the plan formula or because highly compensated employees receive matches on excess deferrals, excess contributions, or excess aggregate contributions.
. A highly compensated employee has elective contributions of two percent and matching contributions of two percent. Half of the elective contributions must be distributed to satisfy section 401(k)(3). The highly compensated employee thus has a two hundred percent match. This is a discriminatory rate.
. Section 411(a)(3)(G) and reg. § 1.401(k)-1(f)(5)(iii) permit forfeiture of matching contributions that relate to excess contributions, excess deferrals, and excess aggregate contributions. This is true even if the matching contribution is vested.
. Neither the Code nor regulations permit matching contributions to be distributed to correct the discriminatory rate.
RELATIONSHIP BETWEEN PLAN QUALIFICATION AND SATISFACTION OF SECTIONS 401(K) AND (M)
A defined benefit plan or post-ERISA money purchase pension plan that includes a cash or deferred arrangement cannot be qualified. Reg. §1.401(k)-1(a)(1).
A plan (other than a defined benefit plan or post-ERISA money purchase pension plan) that includes a qualified CODA satisfies section 401(a)(4) with respect to the amount of contributions or benefits under the qualified CODA. Reg. § 1.401(a)(4)-1(b)(2)(ii)(B). Of course, a plan is a qualified CODA only if it satisfies the special nondiscrimination rule of section 401(k)(3) described at III above.
A plan (other than a defined benefit plan or post-ERISA money purchase pension plan) that includes a nonqualified CODA, including a CODA that is nonqualified only because it fails to meet the special nondiscrimination test of section 401(k)(3) satisfies section 401(a)(4) with respect to the amount of contributions or benefits only if the contributions satisfy the general nondiscrimination test of reg § 1. 401(a)(4)-1(b)(2)(ii)(A) or (B). Cross-testing is permitted, as is imputing disparity. See reg. § 1.401(a)(4)-1(b)(2)(ii)(B).
A plan that consists of contributions subject to section 401(m) satisfies section 401(a)(4) only if the plan satisfies the nondiscrimination rules described in VII above.
RELATIONSHIP BETWEEN SECTIONS 401(K) AND 415
For purposes of section 415, in plan years beginning after December 31, 1997, compensation includes elective deferrals and similar amounts under cafeteria plans and eligible section 457 plans.
For plan years beginning before January 1, 1998, section 415 compensation does not include elective deferrals. Reg. § 1.415-2(d)(3). Plan administrators often forgot this when processing deferral elections. Thus, for example, an employee earning $28,000 may have been incorrectly permitted to defer $7000. The participant's section 415 compensation was then $21,000, and the participant had deferred 33 1/3 percent of compensation.
Reg. § 1.415-6(b)(6)(iv) was amended in 1991 to permit correction of excess annual additions by distributing elective deferrals to the extent that this would reduce the excess annual additions.
Elective deferrals distributed under this provision are includible in income when distributed. Rev. Proc. 92-93, 1992-2 C.B. 505.
Reporting requirements for these distributions are also contained in Rev. Proc. 92-93.
OTHER ELECTIVE ARRANGEMENTS
401(k) SIMPLE arrangements
401(k) SIMPLE arrangements, like the SIMPLE IRA described below, are intended to increase retirement savings by providing a simple vehicle for use by small employers. The new vehicle is effective for plan years beginning after December 31, 1996. Note that section 401(k)(11)(D) cross-references section 408(p) for most definitions
401(k) SIMPLEs are restricted to employers with no more than 100 employees earning $5000 or more during the preceding year. See section 408(p)(2)(C)(i)(I).
The 401(k) SIMPLE is intended to be the exclusive plan benefitting its participants. Section 401(k)(11)(C) provides that it must be the only plan to which contributions were made or benefits were accrued for services during the year on behalf of employees eligible to participate.
Salary reduction contributions are limited to $6000, indexed for cost-of-living adjustments. Section 401(k)(11)(B)(i)(I).
Special nondiscrimination rules must be used.
The employer must make either 3 percent matching contributions or a 2 percent nonelective contribution to each eligible participant who has at least $5000 in compensation for the year. Sections 401(k)(11)(B)(i)(II) and 401(k)(11)(B)(ii).
The plan is treated as meeting top-heavy requirements if it allows only contributions required under paragraph 401(k)(11). Section 401(k)(11)(D)(ii).
This arrangement, however, will remain subject to the other rules governing qualified plans.
This top-heavy exception applies to 401(k) SIMPLE plans only, and not to other CODAs.
The plan year for the 401(k) SIMPLE must be the calendar year.
All other qualification requirements apply.
A model amendment for employers that wish to adopt a 401(k) SIMPLE arrangement is contained in Rev. Proc. 97-9, 1997-2 I.R.B. 55. Use of the model is not, of course, required.
As with 401(k) SIMPLE arrangements, SIMPLE plans are intended to increase retirement savings by providing a simple vehicle for use by small employers.
Basic structure involves employer establishment of plan, which is funded by contributions to special IRAs (SIMPLE IRAs) established for all eligible employees.
If employer does not wish to make contributions to SIMPLE IRAs established by employees at multiple financial institutions, employer can establish SIMPLE IRAs for all employees with designated financial institutions. Section 408(p)(7).
Eligible employers are those with no more than 100 employees earning $5000 or more during preceding year. Section 408(p)(2)(C)(i)(I).
Two year grace period in which plan of growing employer may continue to be maintained. Section 408(p)(2)(C)(i)(II).
If there is failure to meet requirement result of acquisition, disposition, or similar transaction, rules similar to those of section 410(b)(6)(C)(i) apply. Section 408(p)(2)(C)(i)(II).
Employer cannot maintain any other plan under which employees receive contributions or accrue benefits for the year. Section 408(p)(2)(D). There are two exceptions:
An employer may maintain a collectively bargained plan covering only collectively bargained employees who are excluded from the SIMPLE plan. Section 408(p)(2)(D)(i).
An employer may maintain another plan if the failure to meet the one-plan requirement is the result of an acquisition, disposition, or a similar transaction, and the employer complies with rules similar to those of section 410(b)(6)(C). Section 408(p)(2)(D)(iii).
Eligible employees are those who received at least $5000 in compensation during two preceding years and are reasonably expected to earn that amount in current year. Section 408(p)(4). Model documents (see below) permit inclusion of employees with less compensation.
Salary reduction contributions by eligible employees, expressed as percent of compensation, with maximum of $6000 for year. Section 408(p)(2)(A). Cost-of-living adjustments apply to $6000 limit. Section 408(p)(2)(E).
Dollar-for-dollar match by employer, up to three percent of compensation. Section 408(p)(2)(A)(iii).
Percentage match, can be reduced, but not below one percent of compensation, for two out of every five years. Section 408(p)(2)(C)(ii).
In lieu of match, employer may make two percent contribution to all eligible employees . Section 408(p)(2)(B)(i).
Can limit recipients to those with at least $5000 in compensation, even if larger group is eligible to make salary reduction contributions.
Compensation limited to section 401(a)(17) amount. Section 408(p)(2)(B)(ii).
Match on behalf of a self-employed individual is not treated as an elective employer contribution. Section 408(p)(9).
Other contributions must be made by the due date of the employer’s tax return for the year in which the calendar year ends. Section 408(p)(5)(A)(ii).
Section 408(p)(5)(A)(i) requires salary reduction contributions to be made by 30 days after last day of month with respect to which contributions are made. To comply with Department of Labor plan asset regulations, contributions must be made as soon as reasonably segregable, but in no event later than the end of the 30-day period. The 15-day rule in 29 CFR 2510.3-102(b) does not apply. (See model form and instructions.)
Notification requirements and election periods
Employees must have 60-day election period before beginning of year and at beginning of participation in which to elect salary reduction. Section 408(p)(5)(C).
Announcement 96-112, 1996-45 I.R.B. 7, provides special rule for 1997 year, under which 60-day election period before beginning of year was not required to begin before January 1, 1997, for plans effective on that date.
Model forms (I-96-46) permit election period upon eligibility for participation to begin at any time from 60 days before eligibility for participation up to the date on which eligibility occurs.
Employees must be able to terminate election at any time. Section 408(p)(5)(B).
Notification of right to make contributions, and of employer contribution formula (other than dollar-for-dollar match up to three percent) must be provided immediately before the election period. Section 408(l)(2)(C). Employees must receive summary plan description as part of notification.
Reporting and fiduciary requirements under Title I of ERISA.
Participant is treated as exercising control over assets upon affirmative investment decision, rollover to another plan, or one year after account is established.
Form 5500 reporting requirements do not apply.
Distributions reported on Form 1099-R.
Financial institution provides Form 5498.
Annual statement of account activity must be provided to participant within 31 days after calendar year. Section 408(i).
Tax treatment of SIMPLE IRAs.
Rules applicable to IRAs generally apply with respect to rollovers, treatments, and distributions. However, if rolled over or transferred to a regular IRA within first two years of participation, distribution is includible in gross income. Section 408(d)(3)(G).
If distributions are made from SIMPLE IRA within first two years of participation, section 72(t) tax is increased to 25 percent. Section 72(t)(6).
IRS has provided two model documents (Form 5305-SIMPLE) for establishing SIMPLE IRA plans, one of which is designed for use with a "designated financial institution". Two model SIMPLE IRAs (Forms 5305-S and 5305-SA) are available for use with trust or custodial accounts.
For a detailed discussion of rules applicable to SIMPLE IRAs, see Notice 98-4, 1998-2 I.R.B. 25. For procedures for obtaining opinion letters on SIMPLE IRAs and a model amendment to be used in establishing prototype SIMPLE IRAs, see Rev. Proc. 97-29, 1997-24 I.R.B. 9.
Available to 501(c)(3) organizations, schools, and home health service agencies.
Amount that can be deferred is $9500 (unindexed), with higher catch-up amounts under certain circumstances. This is coordinated with 401(k) deferrals by section 402(g).
No discrimination tests apply to deferrals. However, for post-1988 years, sections 401(a)(4) (and thus section 401(m)), 401(a)(5), 401(a)(17), 401(a)(26), and 410(b) will apply to contributions other than elective deferrals. Section 403(b)(12).
These are plans maintained by state and local governments and tax-exempt organizations. Note that due to section 457(b)(6) funding restrictions and Title I funding rules, a tax-exempt organization can only maintain this type of plan if it is a "top hat" plan.
Deferrals are limited to $7500 (or one-third of taxable compensation, if less) with a catch up. The amount is coordinated with section 402(g) deferrals by section 457(c)(2). For tax years beginning after 1996, the $7500 figure is adjusted annually for inflation. Section 457(e)(15). For 1997, it was $7500. For 1998, it is $8000.
No nondiscrimination rules apply.
Beginning August 20, 1996, all amounts of compensation deferred under a section 457(b) plan maintained by a state or local government (or its agency or instrumentality), and all the plan's assets and income, must be held in trust for the exclusive benefit of participants and their beneficiaries. Section 457(g)(1).
However, if a plan is in existence on August 20, 1996, the trust does not have to be established before January 1, 1999.
This requirement does not affect section 457 plans of tax-exempt organizations. Section 457(b)(6).
SEPS are in essence "superIRAs" designed to appeal to small employers. See section 408(k).
In general, SEPS are subject to the tightest nondiscrimination rules of any plans. See section 408(k)(2) and (3).
TRA '86 introduced elective SEPS which are subject to looser nondiscrimination rules patterned after section 401(k). Section 408(k)(6). New SARSEPs cannot be established after December 31, 1996.
Elective deferrals under SEPS are limited to $7000 (adjusted), and are coordinated with those under 401(k) plans and 403(b) annuities.
Historical Background of Cash or Deferred Arrangements
Progenitors were plans that allowed employees to defer a portion of their year-end bonus. The size of this universe was limited because relatively few employers provide bonuses to rank and file employees.
These plans raised issues of constructive receipt. However, Rev. Ruls. 63-180 and 68-89 resolved this issue by saying that there was no constructive receipt if an irrevocable election to defer was made by the end of the year before the bonus was paid. Note that this is a year later than would be required under the IRS nonqualified deferred compensation ruling position.
Questions of discrimination in coverage and contributions were resolved in Rev. Rul. 56-497, which approved a plan in which over 50% of the participants were in the bottom 2/3 of participants and disapproved a plan in which less than 50% were in that group.
Regulations proposed in 1972 would have barred cash or deferred arrangements that involved salary reduction. This position was highly controversial. In Section 2006 of ERISA, Congress barred issuance of final regulations before a specified date and provided that, in the interim, plans existing on June 27, 1974, were to be dealt with in accordance with the cited rulings.
In 1978, Congress enacted section 401(k), effective for tax years beginning after 1979. Shortly thereafter, the 1972 proposed regulations were withdrawn.
Although some plans were established in 1980 and 1981, the pace of change was slowed by uncertainty about whether loans and salary reduction contributions would be allowed.
Proposed regulations issued in November 1981 permitted both loans and salary reduction, and the avalanche of plan adoptions and plan conversions began.
Section 401(k) has been modified by subsequent legislation, most notably by the Tax Reform Act of 1986 (TRA '86), which lowered the maximum dollar amount that could be deferred and also tightened nondiscrimination rules.
The 1981 proposed regulations were finalized on August 8, 1988. Additional regulations under sections 401(k) and (m) reflecting the changes made by TRA '86 were proposed on the same date. These regulations were further modified in additional regulations proposed May 14, 1990 (55 FR 19947), Notice 88-127, 1988-2 C.B. 538, Rev. Proc. 89-65, 1989-2 C.B. 786, and regulations published on September 14, 1990 (55 FR 37888). A new set of final regulations, incorporating both the various proposals and notices and the previous final regulations, was published on August 15, 1991 (56 FR 40507). Proposed regulations modifying requirements to disaggregate on the basis of collective bargaining units were published on January 4, 1993 (58 FR 43). Final regulations published on December 23, 1994 (59 FR 66165) adopted the 1993 proposed regulations, added cross-references to final regulations under sections 401(a)(4) and 410(b), and clarified several other issues. (These 1995 regulations are often referred to as "the concordance".)
DIFFERENCES IN TREATMENT OF
UNDER SELECTED STATE AND FEDERAL STATUTES
Kurt L.P. Lawson and Michael J. Karlan
Employees and employers face substantially different treatment from independent
contractors and their clients under a wide range of laws, including federal and state employment
tax, income tax and labor laws. This outline describes some major differences in treatment
between employees and employers on the one hand and independent contractors and their clients
on the other, and the factors used to distinguish between them, under selected state and federal
These differences are important because they help define the legal rights and obligations
of workers and their clients or employers. However, they assume particular importance in the
case of workers whose employment status is unclear. The parties have more leeway to decide
whether to treat such workers as employees or independent contractors, and these differences
are (or should be) taken into account in making that decision. Also, the employment status of
such workers is more likely to be changed or challenged after the fact, making compliance with
applicable legal requirements more difficult.
II. FEDERAL TAX LAW
B. Differences in Treatment
Social Security and Medicare. Compensation paid to employees is subject to Social
Security and Medicare taxes, if at all, under the Federal Insurance Contributions Act ("FICA").
By contrast, compensation paid to independent contractors generally is subject to Social Security
and Medicare taxes, if at all, under the Self-Employment Contributions Act ("SECA").
Since 1990, the combined tax rates on employees and their employers on the one hand
and independent contractors and their clients on the other have been virtually identical under
both FICA and SECA. Before 1983, the tax rates on independent contractors were substantially lower, even though they were generally eligible for the same Social Security and Medicare benefits as employees. Legislation in 1983 mostly eliminated the rate differential effective in 1984, and made other conforming changes that became folly effective in 1990.
Some differences still remain, however. In some cases they can be substantial. While
the gross tax base generally is the same under FICA and SECA, items that reduce FICA wages
generally do not reduce SECA income unless these items are deductible on Schedule C for
income tax purposes. In particular, contributions to a qualified pension plan or an accident and
health plan generally are not includible in FICA wages, but are included in SECA income.
Contributions to certain nonqualified plans might also receive more favorable treatment under
FICA. Finally, FICA wages of an employee-shareholder of a corporation are limited to
amounts distributed to him or her as compensation, whereas the SECA income of a general
partner generally includes his or her entire distributive share of partnership income.
On the other hand, trade or business expenses may be deducted from compensation
before SECA compensation is calculated, but cannot be so deducted for FICA purposes, and
higher FICA taxes may be imposed on the employer when an employee changes jobs in mid-
year. Finally, unlike employees, independent contractors who are eligible for Social Security
benefits sometimes can avoid application of the Social Security earnings test through the use of
Unemployment Insurance. The first $7,000 of wages paid to an employee generally are
subject to tax under the Federal Unemployment Tax Act ("FUTA"). Under the integrated
federal/state system, part of the tax is ordinarily paid to the state of employment, while part is
paid to the federal governrnent; the combined rate is 6.2 percent through 2007. The federal
portion of the tax is paid quarterly. Independent contractors are not subject to FUTA tax, but
likewise generally are not eligible to receive any unemployment benefits.
Collection Mechanisms. Income taxes on employees are collected mainly through the
withholding system, whereas income taxes on independent contractors are collected mainly through the estimated tax system. Both systems are backed up by information reporting requirements imposed on service-recipients.
Employers are required to withhold a portion of their employees' wages as they are paid
and remit it to the federal government as payment of the employees' income taxes. Withholding
rates are specified in tables and procedures published by the Internal Revenue Service ("IRS"),
and are calculated to colect approximately the same amount of tax as the employees ultimately
will owe with respect to the wages if they work all year at the same wage level. Clients of an
independent contractor generally are not subject to a withholding requirement unless the
independent contractor is subject to backup withholding.
Unless certain exceptions apply, both employees and independent contractors must pay
their estimated income tax liabilities for the current year in quarterly installments throughout the
year. The installments are due on April 15, June 15, and September 15 of the current year, and
January 15 of the following year. The amount of each installment generally is one quarter of
the lesser of the taxpayer's income tax liability for the prior year, or 90 percent of his or her
liability for the current year. Because of withholding, however, employees generally do not
have to make any estimated tax payments. This is because withholding generally requires earlier
payments than would be necessary under the estimated tax system, and these amounts are
credited towards employees' estimated tax obligations. Thus, employees generally are required
to make estimated tax payments only if they have substantial non-wage income.
Employers generally must report all wages paid to an employee annually on Form W-2.
Similarly, clients generally must report all compensation paid to an independent contractor
annually on Form 1099-MISC; no Form 1099-MISC generally is required, however, for
payments to a corporation, payments that are not made by a business, or payments to a service-
provider that aggregate less than $600 in a calendar year.
Forms W-2 must be sent to the employee and to the Social Security Administration. The
Social Security Administration subsequently sends information from the forms to the IRS. In
addition, the employee is required to attach Forms W-2 that he or she receives to his or her
income tax return. Using this information, the IRS can determine whether wages have been
under-reported. While Forms 1099 must be sent to the independent contractor and the IRS,
there is no requirement that they be attached to the individual's income tax return.
Trade or Business Expense Deductions. Under current law, independent contractors face
fewer restrictions on their ability to deduct trade or business expenses than do employees. In
particular, employees (but not independent contractors) generally may not deduct their trade or
business expenses unless they itemize their deductions on their federal income tax returns, and
even then only to the extent that these deductions exceed two percent of the employee's adjusted
gross income from all sources. Also, employees must satisfy additional requirements before
they may deduct their automobile, home office and certain other expenses.
Independent contractors' trade or business expenses generally are deductible "above-the-
line," i.e., as a direct reduction in their business income reported on Schedule C. Employees'
trade or business expenses, by contrast, generally are deductible only "below-the-line," i.e., as
itemized expenses. Especially for lower-income employees, use of the standard deduction is
often more favorable than itemization of expenses; such individuals effectively get no tax benefit
from their trade or business expenses. In addition, since 1986, employees' trade or business
expenses generally have been deductible only to the extent that these expenses (plus any other
miscellaneous itemized deductions) exceed two percent of the employee's adjusted gross income
The two-percent floor generally does not apply to an employee's trade or business
expenses to the extent that these expenses are reimbursed by his or her employer: in such a case,
generally no deduction is necessary, because the reimbursement is not included in the employee's
taxable income in the first place. Only reimbursement arrangements that require the employee
to account to the employer for any expenditures are eligible for this treatment, however. This
prevents employees from excluding from income an amount greater than that which they could
have deducted. Client reimbursements always are included in an independent contractor's
gross income, and the expenses for which these reimbursements are made must be deducted.
Inadequate accounting by the independent contractor to the client is therefore generally irrelevant
Unlike independent contractors, employees may not deduct interest expenses incurred in
their trade or business of being an employee: such interest is considered a personal expense.
Entertainment expenses generally may not be deducted unless they satisfy the business
purpose requirements of section 274(a). The rules applicable to employees and their employers
on the one hand and independent contractors and their clients on the other are about the same
for this purpose. Special exemptions are provided, however, for food or beverages furnished
on an employer's business premises primarily for its own employees, and for recreational or
social activities primarily for their benefit. Independent contractors may, however, benefit
from both as long as they are not provided primarily for the contractors' benefit.
Travel and entertainment expenses, business gifts, and expenses associated with "listed
property" (including automobiles, computers, cellular telephones and property used for
entertainment) also may not be deducted unless the taxpayer has adequate records or other
evidence to substantiate their amount and business purpose, within the meaning of section
274(d). Again, the rules applicable to employees and their employers on the one hand and
independent contractors and their clients on the other are about the same. Employers may use
certain simplified substantiation methods that are unavailable to clients of independent
contractors, however. In particular, they may rely on records maintained by their employees
with respect to the use of listed property, and they can avoid any substantiation requirements
with respect to the use of vehicles by adopting a policy statement prohibiting personal use and
meeting certain other requirements. These methods might be denied to clients of independent
contractors because clients generally do not provide them with the property necessary to perform
their jobs, and, in any event, cannot supervise the independent contractors' use of the property
Business meal expenses generally may not be deducted unless the taxpayer or one of its
employees is present. Independent contractors may be treated as employees for this purpose
only if they render "significant services" to the taxpayer.
Home office expenses and rental and depreciation expenses associated with listed property
(as described above) might be subject to special deduction limits unless these expenses meet
certain business use requirements. These limits were tightened substantially in the Tax
Reform Act of 1986 ("TRA '86"). The limits for employees and independent contractors
generally are the same except that, in the case of home office expenses, the employee's business
use also must be "for the convenience of the employer," and, in the case of listed property
such as home computers, such use must be "for the convenience of the employer and required
as a condition of employment." These standards are difficult for many employees to meet.
For purposes of the alternative minimum tax, miscellaneous itemized deductions are an
adjustment item. Trade or business expenses are a miscellaneous itemized deduction for
employees. Accordingly, for purposes of the alternative minimum tax, trade or business
expenses are not deductible for employees but are deductible for independent contractors.
Employee Benefits. Independent contractors generally are not taken into account under
the employee benefit provisions of the Internal Revenue Code ("Code"). On the one hand, this
means that independent contractors' clients generally are not required to include them in any
pension or welfare benefit plans they provide for their employees in order to avoid discrimination in favor of highly compensated employees and otherwise maintain the plans' tax-qualified status, and the independent contractors have correspondingly greater freedom to structure their own benefit arrangements. On the other hand, this means that independent contractors generally are not allowed to participate in such plans even if they want to do so and their clients agree, and some of the benefit arrangements that independent contractors establish for themselves as sole proprietors or partners might not be tax-favored.
The Code provides tax-favored treatment for a wide range of common employee benefits,
including pension plans, group-term life insurance plans and accident and health plans. In many
cases, such treatment is not available for benefits provided to highly compensated workers unless
the employer also provides comparable benefits to a minimum number of its nonhighly compensated workers. Generally, only an employer's common law employees (and independent
contractors treated as employees under the Code) are taken into account for this purpose. In
addition, these same provisions generally prohibit an employer from offering tax-favored benefits
to its independent contractors. A list of tax-favored benefits, and the conditions under which
they may be offered to employees and independent contractors, are shown in Table A.
An independent contractor who is unable to participate in his or her client's plans
generally can establish his or her own benefit arrangements in his or her capacity as a sole
proprietor (or as a partner, if he or she is in business with other individuals). As indicated in
Table A, some of the more substantial types of employee benefits might be available on a tax-
favored basis.
B. Determination of Employment Status
The status of a worker as an employee or independent contractor for federal tax purposes
is, with few exceptions, determined under the common law test for determining whether a
master-servant (employment) relationship exists.
Background. The common law test focuses exclusively on the employer's control or right
to control how an employee does his job. It first assumed importance under the employment
tax provisions of the Code. The original Social Security Act simply defined an "employee" as
including "can officer of a corporation." Treasury regulations issued in 1936 used the
common law test to determine employee status. The lower courts, however, applied a variety
of different tests, some relying less than others on common law precedents. In 1947, the
Supreme Court issued a pair of opinions that attempted to clarify the governing tests. In
these opinions, the Court applied an "economic reality" test under which "employees are those
who as a matter of economic reality are dependent on the business to which they render
services." Obviously, the economic reality test, which focused on dependency, had the
potential to treat many more workers as employees than the common law test, which focused
The IRS (and the Social Security Administration) proposed amendments to their
regulations to incorporate the Court's new economic reality test, but these never took effect:
Congress reacted immediately by passing (over President Truman's veto) the so-called Gearhart
Resolution, endorsing the use of the common law test.
Current Rules. Current Treasury regulations provide that an individual generally is an
employee if, under the common law test, the relationship between the individual and the person
for whom he or she performs services is the legal relationship of employer and employee. Such
a relationship generally exists if the person for whom the services are performed:
has the right to control and direct the individual who performs the services, not
only as to the result to be accomplished by the work but also as to the details and
means by which that result is accomplished. That is, an employee is subject to
the will and control of the employer not only as to what shall be done but [also]
how it shall be done.
Over the years, the IRS has identified 20 important factors for determining when the common
law test is satisfied. These factors are listed in Table B. Recently, the IRS has begun
emphasizing that these factors are not the only ones that may be taken into account, or even the best way to approach the classification issue. The IRS has not departed from the basic common
law test, which focuses on control. However, the IRS instructs its agents to take all of the facts
and circumstances into account in determining whether sufficient control exists, and to organize
them according to whether they relate to behavioral control, financial control or the relationship
Statutory Employees. Congress and the courts have overridden the common law test in
some situations. Some individuals are treated as independent contractors for tax purposes
regardless of the circumstances. These include certain door-to-door salesmen and real estate
agents. Clergy generally are treated as independent contractors for employment tax purposes
regardless of the circumstances. Conversely, some individuals are treated as employees for
employment tax purposes regardless of the circumstances. These include certain full-time life
insurance salesmen, agent-drivers and commission-drivers engaged in the distribution of specific
kinds of products, homeworkers and traveling or city salesmen.
Section 530. Section 530 of the Revenue Act of 1978 provides statutory relief from
reclassification for certain employers involved in employment tax controversies with the IRS.
Generally speaking, section 530 prohibits the IRS from challenging an employer's treatment of
an employee as an independent contractor for employment tax purposes if the employer has a
reasonable basis for such treatment and certain other requirements are met. It also generally
prohibits the IRS from issuing regulations or publishing revenue rulings addressing the status of
workers as employees or independent contractors for employment tax purposes. Section 1706
of the Tax Reform Act of 1986 excludes taxpayers that broker the services of technical services
workers from coverage under section 530.
Relevance of Incorporation. An employee generally cannot change his or her status to
that of an independent contractor via incorporation. The common law test focuses on the
relationship between the individual performing the services and the service-recipient; if an
employment relationship exists, it generally is irrelevant whether payments are made directly or
through a corporation controlled by the individual.
An independent contractor also generally cannot change his or her status to that of an
employee of his or her client via incorporation; he or she may, however, be treated as an
employee of his or her own personal service corporation for certain purposes, and derive certain
tax benefits as a result. The effect depends in part on whether the personal service corporation
elects to be taxed as a Subchapter S corporation under section 1362 of the Code. If it does not,
the individual will generally be treated as an employee of the corporation for income and
employment tax purposes, and can thus take advantage, inter alia, of various employee
benefit provisions of the Code. The individual will, moreover, not be subject to the two-percent
floor on itemized deductions or other limits on employee trade or business expense deductions
to the extent he or she causes such expenses to be deducted at the corporate level.
If the personal service corporation does elect to be taxed as an S corporation, the
individual generally also will be treated as an employee of the corporation for income and
employment tax purposes, with one significant exception: assuming his or her ownership
interest exceeds two percent, he or she will be treated as a partner for purposes of the employee
fringe benefit provisions of the Code. The treatment of trade or business expenses is roughly
the same as for a C corporation.
Relevance of Contract. Language in a contract is not dispositive in determining whether
a worker is an employee or independent contractor for federal tax purposes. Nevertheless,
a contract might be relevant in making that determination to the extent it provides evidence of
the parties' intent, the extent to which the service-recipient can control and direct the worker,
and other factors taken into account in making that determination. A contract also can be
used to clarify the effect of a worker's status as an employee or independent contractor. For
example, a contract with a worker generally can provide that the worker, despite being classified
as an employee, may not participate in any of employee benefit plans maintained by the
employer for its employees.
C. Identification of Employer
Multi-Party Arrangements. Sometimes more than one entity controls at least some aspects
of the employment relationship. For example, a leasing company might have the right to
determine the amount of wages and benefits that leased employees will receive, and to hire or
fire the employees, while the service-recipient might have the right to supervise their work on
a daily basis. In such a situation it might not be clear which entity is the employee's common
The exact identity of the common law employer generally is irrelevant for employment
tax purposes, since the entity that controls the payment of wages to the employee can be treated
as the employer for employment tax purposes even if it controls no other aspect of the
employment relationship. However, the exact identity of the common law employer might
be important for income tax purposes. For example, only the common law employer of an
employee may provide him or her with benefits that are limited to employees, and entities that
are not common law employers are not subject to any nondiscrimination or other obligations
imposed on common law employers with respect to their employees.
Typically, the IRS tries to decide whether an entity involved in a multi-party employment
situation is an employer or a particular worker by determining whether that entity has enough
control over the worker for the worker to be considered its employee under the 20-factor or
other test. This analysis has obvious limitations, however, where no single party has enough
control clearly to satisfy that test.
Under the common law, two or more entities may be treated as an employee's "joint
employer" if they share control over the employee. The IRS has recognized that, because
the rule is based on the common law, it applies for employment tax purposes. Since the
common law also applies for purposes of the employee benefit provisions of the Code, the rule
presumably applies in that context, as well. However, in practice the IRS has not been inclined
to apply it in either context.
The Code contains a few special rules for dealing with multi-p any arrangements. For
example, section 414(n) provides that a leased employee who has worked for a service-recipient
on a substantially foil-time basis for at least a year may be allowed to participate in the service
recipient's employee benefit plans as a common law employee and must be considered an
employee in determining whether those plans discriminate in favor of highly compensated
employees, but only if the service-recipient exercises "primary direction or control" over the
employee. Section 3506 provides that a sitter-referral agency will not be treated as the
employer of the sitter.
Affiliated Entities. Sometimes an employer is affiliated with other entities. If so, it
might not be clear whether the affiliate is part of the employer, with the same rights and
responsibilities towards employees of the employer as the employer itself, or instead is a
separate entity. Entities that are legally separate, such as separate corporations, are not
aggregated for employment tax purposes regardless of their degree of affiliation. However, if
a group of related entities pays wages through a single member of the group-the "common
paymaster"-that member may be treated as the employer of all of the entities' employees for
employment tax purposes. Affiliated entities are aggregated for certain income tax purposes.
Of particular importance, corporations that are part of a "controlled group" of corporations,
entities under "common control" and "affiliated service groups" are treated as parts of the same
employer for certain employee benefit purposes.
III. OTHER LAWS
1. Federal Labor Laws
Most federal labor laws apply only or primarily to employees.
ADA (Title I). Title I of the Americans with Disabilities Act ("ADA") generally
prohibits an employer with 15 or more employees from discriminating on the basis of disability
with respect to the terms, conditions and privileges of employment, including the provision of
employee benefits. Independent contractors are not covered by this prohibition. However,
in appropriate circumstances they might be covered by prohibitions found in other titles of ADA.
ADEA. The Age Discrimination in Employment Act ("ADEA") generally prohibits an
employer with 20 or more employees from discriminating on the basis of age with respect to the
terms, conditions and privileges of employment, including the provision of employee benefits.
Independent contractors are not covered by this prohibition.
COBRA. The Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA")
amended the Code and ERISA generally to require a group health plan maintained by an
employer with 20 or more employees to give covered employees and their beneficiaries the right
to continue coverage under the plan after their coverage has ceased, if coverage ceases on
account of certain qualifying events. This requirement applies to employees and independent
contractors, provided that plan covers at least some common law employees.
ERISA (Title I). Employee pension and welfare benefit plans are subject to various
coverage, funding, fiduciary, reporting, and other requirements under Title I of ERISA. Title
I does not apply to plans benefitting only nonemployees, and many of the specific requirements
of Title I extend only to employee-participants. It is not clear at this time to what extent Title
I applies to a plan benefitting independent contractors if the plan also covers at least some
common law employees.
Because plan coverage typically is limited to employees, an employer's unilateral
reclassification of an employee as an independent contractor, or discharge followed by rehire as
an independent contractor (e.g., outsourcing), can under some circumstances be viewed as a
violation of Section 510 of ERISA, which prohibits any person from discharging or discriminating against a participant "for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan" or ERISA.
FMLA. The Family and Medical Leave Act ("FMLA") generally requires an employer
with 50 or more employees to allow employees to take up to 12 weeks of unpaid leave (with the
right to reinstatement) for certain family and/or medical purposes. Independent contractors need
not be allowed to take such leave.
Medicare (secondary payor rules). The Social Security Act generally provides that
Medicare is the secondary payor of benefits provided to an individual by a group health plan of
an employer that has at least 20 employees by virtue of the individual's current employment
status. Thus, this rule generally does not apply to coverage provided to an independent
WARN Act. The Worker Adjustment and Retraining Notification (" WARN ") Act requires
an employer that employs 100 or more employees to notify employees affected by a plant closing
or their union representatives at least 60 days before the closing occurs. Independent contractors
are not required to receive such notice.
Other Labor Laws. Independent contractors generally are not covered by the National
Labor Relations Act ("NLRA"), and therefore generally may not engage in collective bargaining
or similar protected activities. They also receive no protection under the nondiscrimination
requirements of the Equal Pay Act ("EPA") or Title VII of the Civil Rights Act of 1964,
the safety requirements of the Occupational Safety and Health Act ("OSHA") or the minimum
wage and overtime requirements of the Fair Labor Standards Act ("FLSA"). Independent
contractors who leave to perform military service are not entitled to reemployment or seniority
("USERRA"). Furthermore, employers are not subject to penalties under the Immigration
Reform and Control Act ("IRCA") with respect to the receipt of services from independent
Unlike the income and employment tax provisions of the Code, no laws comparable to
the laws described above apply to independent contractors. For example, while independent
contractors are not subject to FICA taxes, they are subject to roughly the same level of SECA
taxes. By contrast, if a worker is classified as an independent contractor under a federal law
prohibiting a particular form of discrimination, he generally has no protection from that form
of discrimination under federal law.
2. Federal Patent and Copyright Laws
An employer generally is considered the author of any work prepared during the course
of an employee's employment for purposes of the federal copyright laws; no such presumption
exists with respect to work prepared by independent contractors. By contrast, generally no
legal distinction is drawn between employees and independent contractors under the federal
patent laws. In practice, however, independent contractors might find it somewhat easier to
secure patent protection for on-the-job creations than employees, since this issue often turns on
a court's analysis of the implicit bargain struck between the parties.
3. State Labor Laws
Many state laws also impose different requirements on employers and employees on the
one hand and independent contractors and their clients on the other. In particular, employers
generally are required to contribute a portion of the wages paid to each of their employees to
state workers' compensation and unemployment funds. Clients of independent contractors
generally are not required to do so, and, as a consequence, independent contractors generally
are not eligible for benefits under these systems. Employee wages also might be protected under
state wage payment laws, while payments to independent contractors are not. To the extent
that employers' right to discharge employees at will has been limited, the limits apply solely to
In Nationwide Mutual Ins. Co. v. Darden, the Supreme Court held that, when a statute
uses the term "employee" without defining it, Congress is presumed to have intended to apply
the common law test. Many of the federal labor laws discussed above do not contain useful
definitions of the term "employee." Thus, employment status under those laws-include Title
I of ADA, ADEA, COBRA, Title I of ERISA, the Medicare secondary payor rules,
NLRA, USERRA and Title V11-is determined using the common law test.
That has not always been true. Before Darden, agencies and courts were more inclined
to apply a version of the economic reality test adopted by the Supreme Court in 1947 and
subsequently rejected by Congress in the Gearhart Resolution. Moreover, in applying that test
for purposes of a particular law, they tended to focus on whether the worker was a potential
victim of the "wrong" being "righted" by that law, This resulted in a test that was result-driven
and even more complex and subjective than the common law test.
The economic reality test continues to apply where it is required or authorized by statute,
including FMLA, EPA and FLSA. Many state workers' compensation and unemployment
insurance statutes also apply (or are interpreted by the courts or the agencies responsible for
interpreting them to apply) definitions that are more expansive than the common law.
Even in contexts where it applies, the common law test is taking a while to sink in. For
example, the IRS Training Materials issued last spring list financial control as a factor to be
taken into account in determining whether a worker is an employee. However, they carefully
The question to be asked is whether the recipient has the right to direct and
control business-related means and details of the worker's performance. The
question is not whether the worker is economically dependent on or independent
of the business for which the services are performed. This analysis has been
rejected by Congress and the Supreme Court as a basis for determining worker
classification. . . . As a result, a worker's economic status is inappropriate for
use in analyzing worker status.
By contrast, the EEOC Enforcement Guidance on Contingent Workers issued last fall lists a
service-recipient's control over how a worker performs his job as only one of many factors to
be taken into account in making that determination.
a worker is an employee or independent contractor for labor law purposes. Nevertheless, a
contract might be relevant in making that determination to the extent it provides evidence of the
parties' intent, the extent to which the service-recipient can control and direct the worker, and
other factors taken into account in making that determination.
A contract also can be used to clarify the effect of a worker's status as an employee or
independent contractor. For example, ERISA generally limits participation in an employee
benefit plan to employees. However, it does not require an employee benefit plan to cover all
employees of an employer. Thus, a contract with a worker generally can provide that the
worker, despite being classified as an employee, may not participate in any of the employee
benefit plans maintained by the employer for its employees. A worker generally also can
waive his right to recover under a particular labor law if the waiver is knowing and voluntary
and is not prospective.
Relevance of Tax Treatment. The employment status of a worker for tax purposes is
relevant in determining his status for labor law purposes, at least to the extent that his status is
based on the common law test, which applies in both contexts. To the extent that his employment status for tax purposes is based on section 530 or some other tax-specific rule, it has little,
if any, relevance.
Most federal labor laws apply only to employers and only with respect to their own
employees. There are some exceptions. However, they generally are limited in scope.
Multi-Party Arrangements and Affiliated Entities. The same problem of identifying the
employer that arises under the Code arises under most federal labor laws. To resolve this
problem, agencies and courts use some of the same rules that apply for purposes of the Code,
although they derive them from different sources.
Most but not all of the aggregation rules that apply for purposes of the employee benefit
provisions of the Code also apply for purposes of COBRA, Titles I and IV of ERISA, and the
Medicare secondary payor rules. Other labor laws contain no specific aggregation rules.
Instead, agencies and courts interpreting those laws use the common law "single employer" rule.
That rule treats two or more entities as a single employer if they are closely integrated based on
all of the facts and circumstances.
As noted above, under the common law two or more entities may be treated as an
employee's "joint employer" if they share control over the employee. Although this rule applies
for federal tax purposes, it has been used very little in that context. By contrast, agencies and
courts interpreting federal labor laws frequently use the rule in multi-party situations to treat the
leasing company or broker and its client as employers of an employee, and therefore accountable
for any violations of those laws involving the employee, whether or not they are directly
responsible for the violations.
Finally, the EEOC and some courts aggressively interpret some labor laws to apply to
employers with respect to individuals employed by other entities, if they employ the requisite
number of employees to be considered "employers" under those laws and exercise control over
one or more aspects of the employees' employment. The EEOC refers to this interpretation
as the "third party interference" doctrine, and uses it and the joint employer rule to conclude
that, in most circumstances, a leasing company or broker is accountable for violations of federal
labor laws perpetrated by its clients, and vice versa.
TAX-FAVORED BENEFITS AVAILABLE TO EMPLOYEES
To Employee Contractor To independent
Benefits in Employer's Plan in Client's Plan Contractor in Own Plan
Employee achievement awardsa Available
Group-term life insuranceb Available
Accident and health insurancecAvailable Limited exclusion only Limited deduction only
Tuition remissiond Available
Meals and lodginge Available
Group legal servicesfAvailable Available
Cafeteria plansg Available
Educational assistancehAvailable Available
Dependent care assistanceiAvailable Available
No-additional-cost fringejAvailable Available
Qualified employee discountskAvailable Available
Working condition fringeslAvailable Available Available
m Available Available AvailableQualified transportation fringesn Available
On-premises athletic facilitiesoAvailable Available
New-product testingpAvailable Available
Qualified pensions and annuitiesqAvailable Available
Tax-sheltered annuitiesr Available
Qualified, incentive stock options Available
Employee stock purchase plans Available
VEBAs Available
a. Code §§ 74(c), 274(j)(3)(B).
b. Code § 79(d); Treas. Reg. § 1.79-0(b).
c. Code §§ 105(g), 106, l62(/)(1); Treas. Reg. § 1.105-1(a). Coverage and discrirnination requirements might apply
if the plan is self-funded. Code § 105(h). Coverage of an independent contractor under his or her client's plan is
possible if the coverage is treated as a working condition fringe to the extent of the deduction under section 162(1).
d. Code § 117(d)(2)(A).
e. § 119.
f. § 120(c)(1), (c)(2), (d)(1).
g. § 125(b)(1), (d)(1)(A); Prop. Treas. Reg. § 1.125-1, Q&A-4.
h. § 127(b)(2), (c)(2); Treas. Reg. § 1.127-2(h)(1)(iii).
i. § 129(d)(2), (d)(3), (d)(8), (e)(3).
j. § 132(b), (j)(i); Tress. Reg. § 1.132-1(b)(1).
k. § 132(c), (j)(1), Treas Reg § 1.132-1(b)(l).
l. § 132(d); Treas. Reg. § 1.132-1E)(2).
m. § 132(e); Treas, Reg § 1.132-1(b)(4). Certain nondiscrirnination rules apply to eating facilities, however.
n. § 132(f).
o. Code § 132(j)(4); Treas. Reg. § l.l32-1(b)(1), (3).
p. Treas. Reg. §§ 1.132-1(b)2) (flush language), 1.132-5(n).
q. Code §§ 401(a)(4), 401(c). 410(b); Treas. Reg. §§ 1.72-17(a), 1.4O1-10(b).
r. Code § 4O3(b); Treas. Reg. § 1.4O3(b)-1(a)(1).
s. Code §§ 421-22; Treas. Reg. § 1.421-7(h).
t. Code § 423; Treas. Reg. § 1.423-2(e)(2).
u. Code § 501(c)(9); Treas. Reg. § 1.501(c)(9)-2(b).