Special Issue: Spotlight on PEOs
 

1. The “New Law” authored by NAPEO and introduced in Congress for several years is never going to pass. Under that proposed law, PEO firms would have been permitted to treat their leased employees (or “co-employees”) as employees of the PEO firm for benefit plan purposes.
2. Single employer retirement plans will not satisfy IRS.
3. Health and welfare plans may still be MEWAs, even in states that have enacted PEO laws.
4. Workers compensation and health plans are still a good “tax-shelter”. Many PEOs have saved significant taxes due to losses under their workers compensation and health plans.
   In this special issue of Benefit Strategies Report we will discuss benefit issues facing PEO firms today, and recommend some responses.

WHO IS THE EMPLOYER?
Since the issuance of the court’s opinion in Professional & Executive Leasing v. Commissioner, 862 F2d 751 (9th Cir, 1988), PEOs have been on notice that they might not be the employer for purposes of providing employee benefits. Now that IRS has completed their 5-year Houston-based study of PEO benefit plans, and no new legislation is on the horizon to permit PEOs to provide qualified retirement plan benefits, the IRS’s position is clear: PEOs never were the “true” employer and they never will be. The only exception would be in a case where the PEO firm met all of the common-law employer tests, and sought and obtained from the Department of Labor a ruling that the PEO is the employer.

NEW RETIREMENT PLAN REQUIREMENTS
IRS issued Revenue Procedure 2002-21 to clarify the status of most PEO retirement plans (they are illegal!) and to offer PEOs a way out if they act quickly. Under that Procedure, IRS has made it obvious that single-employer retirement plans are not acceptable, since in IRS’ view the employees are really employees of the recipient or client employer. Since IRC §401(a)(2) requires that retirement plans are for the “exclusive benefit” of employees, the only type of plan that an employer may maintain is a multiple-employer plan that conforms with IRC §413(c). Plans existing under that section are considered to be an aggregation of single employer plans inside a combined trust fund. Contributions and forfeitures from one employer may never be allocated to the account of other employers in the group. Top-heavy and ADP/ACP testing are done separately for each employer.The new rules apply to all PEO plans in existence on 5/13/2002 and are effective as of the last day of the plan year beginning after 12/31/2001. For calendar year plans, that means that they have until 12/31/2002 to get their plan cleaned up. [Note: the rules apply to new plans at inception.]Under the procedure the IRS has mandated a “Decision Date” of May 2, 2003, for cleaning up old plans. More than a “decision” is required by that date: An implementation of that decision must have been completed by then. It is more of a “drop dead” date for existing plans.
We expect a lot of unpleasant surprises for PEOs and their clients when the client companies are notified of their requirement to make significant Top-Heavy contributions to their plans for 2002.
> We recommend doing advance testing now to forewarn clients of potential liability.

THE PEO HEALTH PLAN SOLUTION
How does a PEO offer a competitively priced health plan as part of its package of services without attracting undesirable risks? We recently interviewed the owner of a PEO firm in California who has operated its self-funded health plan at a profit for the past three years. Their solution: underwrite the risks before accepting them as PEO clients, and have enough “guts” to turn down business.
In most states, health insurance companies are at a competitive disadvantage with respect to offering health plans:
o They are required to participate in state uninsurable pools;
o They are limited to the “small group reform” discounts and surcharges;
o They are required to accept all groups who apply.
On the other hand PEO firms are not required to participate in state uninsurable pools and they are not required to accept all groups who apply. A PEO that wants to offer a health plan while remaining fiscally healthy itself would be wise to consider those facts and consult with expert in risk assessment and health planning. BCA would love to show you the way to solve the health care crunch.

PEOs & MEWAs
In most of the 17 or so states that have employee leasing laws, it appears that PEOs may provide self-funded or partially self-funded health plans to their co-employees. However, that is not as clear as previously believed. In a recent case the Utah Insurance Department closed down a PEO firm who had elected to self-insure its workers compensation plan. The fact that the PEO firm or its owners had violated other legal requirements may or may not have mattered, since, under Utah law the Department of Commerce is charged with licensing and supervising PEO firms (and the Department of Labor, who reported the problems to the Insurance Department, is charged with enforcing employment laws).

HEALTH REIMBURSEMENT ACCOUNTS: THE NEW PEO BENEFIT PLAN?
When is a health plan not a health plan? When the employer and the PEO have no risk! And a health reimbursement arrangement (“HRA”), recently approved by IRS under Notice 2002-45 and Revenue Ruling 2002-41, provides a way for employers and PEOs to provide health coverage risk-free.
The employer would provide an inexpensive high-deductible health insurance plan coupled with employer-provided HRA “spending accounts”. The HRAs work very much like Flex accounts under IRC §125, except that, since the accounts are employer-funded, amounts not spent at the end of the year can roll over to the next year, thus providing employees with an incentive to minimize utilization. No use it or lose it required!

OTHER HINTS:
There are other precautions we recommend to PEOs to ensure the qualified status of their retirement plan:
> Invoice and account for retirement plan contributions separately, so as to distinguish the financial information to be used for verification of contributions and for testing by individual employers.
> Now is a good time to review contract forms that are used with clients to make sure that the PEO has recourse against the client firm for potential liability for required retirement plan contributions (such as top-heavy minimum contributions, non-elective contributions to the 401(k) plan, etc.) The contracts need to assess the fact that the PEO may not retain the non-vested accounts in the event a client employer terminates its relationship with the PEO.
> Apply for a letter of determination as soon as possible.
> It is a “prohibited transaction” for the PEO firm, an owner or related party (or entity), or a family member of or joint venturer with the owner to receive commissions with respect to investments under the PEO’s retirement plan. However, the Department of Labor has issued several prohibited transaction “class” or other exemptions. We recommend a “compliance audit” to make sure that your plan is in compliance with the prohibited transaction rules, as penalties for violation are quite severe.