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Leasing & Independent Contractor Do's & Don'ts

Employee Leasing:

There's lots of talk about employee leasing these days...but almost no awareness of the giant hole which can suck unwary employers as well as managed care entities into very serious legal problems. For example, there is rarely mention of the very touchy personnel & employee benefits legal status relating to employee leasing. Most people who decide to use leased employees think they are having their cake (the employees are "theirs") and eating it too (avoiding human resources & employee benefits hassles). Government would never let anything that logical & easy happen! There are laws and more laws! The official IRS definition of "leased employee" is in the Internal Revenue Code, section 414(n)(2)(B), but other agencies seem to use different definitions. There is great confusion in government over the issue of leasing, and it's virtually impossible to get a firm answer consistent for all applicable agencies.

The easiest way to understand leased employees is to view it like a rented car. You can steer the car, but there is never any question over who actually owns the car...no question who decides when to buy & sell it, who decides to fix it, its cost, etc. The lessor is the owner. Vocabulary check: "Lessor" = the firm renting out the worker. "Lessee" = the firm acquiring the worker to be in their office.

Too many people who "lease" employees...especially firms that convert from traditional employer format to leasing...think of the employees as "theirs". Also, for various business reasons, the "leased" employee is given various attributes (business cards, titles, etc.) of being a regular employee of the employer. After all, what business wants it to seem its employees are just "temps".

If a "leased" employee is not absolutely positively clearly an impersonal "leased" item (like the rented furniture), then the business acquiring workers is probably going to be considered an "employer". If the business is considered an "employer" (and IRS or other agencies can decide that retroactively years later), then all kinds of reporting & taxes take effect for the incorrectly-leased period. Also, the lessor's health coverage plan for the various "employers'" workers is then considered a MEWA (Multiple Employer Welfare Arrangement) instead of a single-employer plan for the lessor company. About 30 states have various prohibitions on MEWAs, so the health plan (which often sparked the decision to lease) suddenly becomes illegal in many states. (A true clear leasing arrangement is considered a single-employer plan for the lessor company employees. Thus, the lessor firm plan is covered by ERISA preemption from state benefit laws.

If the line between "employee" status and "leased" is not crystal clear, a lessee firm acquiring workers can find itself hit with "employer" laws such as COBRA, MSP (Medicare, Secondary Payor), FMLA (Family Medical Leave Act), and a whole alphabet of other acronyms. IRS leased employee regulations can even be read to say that leased employees who are covered under the group health plan of the business acquiring (leasing) the workers must provide COBRA. Of course, an IRS decision that leased workers are actually your "employees" also triggers the host of Social Security and tax-withholdings & penalties for the retroactive period.

A new wrinkle (and pitfall) is when medical plans "lease" merely health coverage for your employees. All or some of the other attributes of employment (compensation package, hiring, employee taxes, pension, etc.) remain with the employer. In those cases, the "lessor" of medical coverage is actually, technically, selling a form of insurance (and usually without registration or license to be in the business of insurance). State Insurance Commissioners are starting to take notice with alarm at the booming number of unlicensed unregulated sources of health coverage from such "leased" coverage as well as from provider-owned entities such as Physician Hospital Organizations (which give themselves all kinds of names) who are hospitals or medical entities who sell health coverage directly to employers & individuals. So, expect a crackdown on "illegal insurance".

The reverse of that kind of arrangement is also popping up...in which the business "leases" (acquires) the employees for all purposes...except considers the workers its "employees" for purposes of having a health or pension plan. This strategy is often because the boss would otherwise not be eligible for a plan himself (he doesn't lease himself) or needs employee participation to take advantage of 401(k) or other profit-sharing plans under the IRS discrimination testing rules.

So, whether to lease or hire employees is not as simple & isolated as the decision whether to buy or rent the office car or furniture. Do not be misled by common sense or what merely seems to make business sense! There are dozens (hundreds?) of other laws and regulations to consider vis a vis each situation...and more limitations probably coming. The arrangement must be crystal clear who is the worker's true legal controlling "employer", and that status must be consistent over the worker's total employment arrangement.

Independent Contractors:

Any discussion of leased employees should also trigger in your mind similar cautions about "independent contractors". Those are people who deal with you as outside businesses. Your law firm, CPA firm, and other clearly-established businesses are fine. However, do you have a computer consultant, free-lance writer or other service which has been working for you, often in your office? That person or entity has been filing tax forms and taking tax deductions as a separate business. For example, mileage is not reimbursable for someone driving to their own office...but is deducible for driving to a client's office. Similarly, an employee's workspace at home is not deducible...but an independent contractor can deduct the percent of all expenses of his home used for his "office".

When this is multiplied by all the other tax advantages, the tax revenue losses are huge. So, not surprisingly, IRS takes a very aggressive approach towards disproving independent contractor arrangements. There are certain guidelines considered the litmus test of whether an independent contractor is an "independent" business or a sham. These include how many clients, who controls the working style & work product of the contractor, whether there's a profit & loss risk, etc. etc. In these times of tight federal budgets, expect more and more pressure on this area which is perceived (by IRS) to have lots of abuse.

So, if you're using an independent contractor, ask yourself in the most cynical way possible whether this is a true outside business...or is it actually just like a regular employee. How tough should you be in asking yourself that question? Well, consider that IRS reportedly noticed that an independent contractor was routinely included as an employee at the firm's holiday party for employees.

Moral of the story:

Both leasing & independent contractors are great options to enhance staff capacity. Most are legitimate (and the others are more apt to be ignorant of the laws than evil). The biggest problem, frankly, is the users (employers hiring leased or independent contractor workers). The employers want their cake (the feeling of having & controlling their own workers) and eating it too (avoiding the personnel costs & hassles). Therefore, to be safe, go into any leasing or independent contractor arrangement with an ongoing tough cynical evaluation of your own intentions. If it sounds too good to be true, or it's not something you would proudly proclaim & document for an IRS or other government agent, then rethink it. (One easy test is to imagine the arrangement you're considering as if it were cars or furniture being leased. Does the deal still seem logical? It should. Leasing people & cars is the same in the structure of the law.)