The idea behind worker leasing is that the leased workers are supposed to be the leasing firm’s employees, not yours. In the ideal worker leasing arrangement, the leasing firm is responsible for supervising and controlling the worker’s job performance, paying the leased workers’ salaries and paying and withholding federal and state payroll taxes, paying for unemployment compensation, providing workers’ compensation coverage and any employee benefits. Ideally, all you do is pay the leasing firm a fee.
A Look at Other Alternative Work Arrangements
Besides leasing employees, there are many other alternative work arrangements that don’t require full-time year-round work in a hiring firm’s workplace. They include:
- hiring part-time workers
- hiring short-term workers
- having workers work at home and communicate with the office via phone and computer—also known as telecommuting, and
- using seasonal workers.
Some hiring firms believe that workers involved in such work arrangements can never be their employees. This is not the case. The fact that workers work part time, short term or at home has relatively little impact on their status. If you have the right to control such workers on the job, they will be your employees.
Whenever you’re on the top rung of a three-sided relationship like this, you have much less chance of being audited. As long as the leasing firm pays all applicable taxes, there is little likelihood that you’ll have any problems with the IRS.
Problems With Retirement Plans
If your company leases workers full time for work that used to be performed by employees, the IRS may view the leased workers as company employees for retirement and profit-sharing plan purposes.
The leased workers would be counted in determining whether the nondiscrimination and minimum participation rules governing tax-qualified retirement plans are satisfied. This is important because a minimum number of employees must be included in a retirement plan for it to be tax-qualified—that is, for company contributions to the plan to be deductible by the company and nontaxable to the recipients until retirement.
If any of your plans are found not to comply with the requirements for tax-qualified status, then all previous tax deductions for benefits or contributions to the plan can be thrown out. Your business can lose the deductions, and the benefit recipients will have to pay taxes on the benefits.
There are ways to avoid this problem. But this is a very complex area of the law, so it’s best to discuss this issue with a retirement plan administrator, or to seek advice from a retirement plan consultant or an attorney or CPA specializing in this field.
a. The problem of joint employment
Unfortunately, things don’t always work out as described above. If you control a leased worker’s performance on the job, you can be considered the worker’s employer along with the leasing company. This is called joint employment. If you’re a joint employer of a leased employee, you lose all the benefits of employee leasing. You have the same duties and liabilities as if you were the worker’s sole employer.
EXAMPLE: The Merrill Lynch securities firm leased the services of Amarnare through an employment agency. Amarnare’s pay and benefits were paid by the agency, not Merrill Lynch. Amarnare was fired after two weeks on the job and then sued Merrill Lynch, but not the employment agency, for unlawful discrimination claiming that she was fired because of her sex and race. Merrill Lynch claimed it was not liable because it was not Amarnare’s employer, the employment agency was.
The court disagreed. It held that Merrill Lynch was Amarnare’s joint employer, along with the employment agency, because it completely controlled Amarnare on the job. Merrill Lynch controlled Amarnare’s work assignments, working hours and manner of performance; directly supervised her; and had the right to discharge her and request a replacement if it found her work unsatisfactory. (Amarnare v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 611 F.Supp. 344 (S.D. N.Y. 1984).)
If you’re found to be a joint employer of a leased worker, you’ll not only be liable for labor and anti-discrimination law violations, but can have a legal duty to provide the worker with unemployment insurance and workers’ compensation. If the leasing company fails to provide them, you’ll have to and will be subject to penalties for the leasing company’s failure to do so in the first place.
b. Avoiding joint employer status
To avoid being a joint employer of a leased worker, you must give up all control over the worker. The leasing firm, not you, must control the leased worker’s performance on the job.
Carefully follow these guidelines.
- Don’t ever deal or negotiate with a leased worker about such matters as time, place and type of work, working conditions or the quality and price of the services to be provided by the worker. The leasing company should handle all these negotiations for you—that is, you tell the leasing company what you want and it tells the worker.
- The leasing company should have the sole right to determine whether to assign or reassign workers to perform needed tasks.
- The leasing company should set the rate of pay for the leased workers.
- The leasing company should pay the leased workers from its own account.
- The leasing company, not you, should have the right to hire or fire the leased workers; if the company fails to provide you with high quality workers, don’t fire them. Instead, hire a new leasing company.
- The leasing company should have the authority to assign or reassign a worker to other clients or customers if you feel the worker is not acceptable.
It’s also very helpful if the leasing company provides its own supervisor or on-site administrator to manage and supervise the leased workers. This will significantly reduce your control over the workers and reduce the chances that you’ll be a joint employer.
If you’re unable or unwilling to relinquish all control over leased workers, you can still go ahead with a leasing arrangement. But be aware that you may be considered to be the leased workers’ joint employer. As such, you’ll need to make certain that the leasing firm is paying all required payroll taxes, providing workers’ compensation insurance and not engaging in behavior that could get you sued, such as discriminating against workers on the basis of race or age.
c. Problems with workers’ compensation insurance
Another problem area with which you need to be concerned when you lease workers is workers’ compensation insurance. The employee leasing company, not you, is supposed to provide the leased workers with workers’ compensation coverage.
In the past, some shady hiring firms saved money on workers’ compensation insurance premiums by having equally shady leasing firms hire their employees and lease them back to them. The leasing firm would purchase workers’ compensation insurance for the employees at a lower rate than the hiring firm because it was newly in business and few or no workers’ compensation claims had been filed against it. Workers’ compensation premiums are based in part on how many claims are filed against a company. This factor is called the experience modifier. Companies that have many claims filed by employees pay more than companies that don’t. These leasing companies continually changed their names and formed new business entities. Each new entity would have a clean workers’ compensation record and so would pay a lower workers’ compensation premium.
This scam is no longer possible in most states. Most now require employee leasing companies to use the same experience modifier as their client firms use for similar workers. To make sure that a leasing company is paying the proper workers’ compensation premium, ask to see a copy of its workers’ compensation policy showing the classifications and experience modifier used. If these are different from those in your own policy, question the leasing company closely.
Also, make sure your agreement with the leasing company requires it to notify you in writing if its workers’ compensation insurance is canceled for any reason. You may end up having to pay premiums for leased employees if the leasing firm’s insurance is canceled.