recently ran an article describing how many companies are using
alternative work arrangements to meet staffing needs during the
economic recovery. Such arrangements may include use of leased
employees, independent contractors or part-time/seasonal workers,
all of which are commonly referred to as contingent workers.
One of several reasons often cited is the savings in
benefit-related costs; however, it takes careful planning to ensure
benefit plans properly reflect those intentions. The analysis
generally requires employers to answer three key questions:
- Which workers are legally considered to be my employees?
- What does my plan document say about employees?
- Will my plan be considered discriminatory if I exclude
Who Are Your Employees?
You may be thinking, "Of course I know who my employees are!"
However, the answer can be much more complex than it seems and has
tripped-up many well-intentioned companies. In fact, employers as
large as Microsoft, Coca-Cola and Time Warner have found themselves
in litigation over this very issue.
To avoid the complexities, some employers simply include all
workers in their benefit plans, but this option also has its
drawbacks. The federal laws governing retirement plans mandate that
plans be maintained and operated for the exclusive benefit and in
the best interest of employees. By covering workers that are not
employees, a plan sponsor violates this foundational rule.
Perhaps the easiest way to examine the situation is through a
series of examples, so let's consider the following basic fact
Spencer is a college student who is home for break and looking
for work. Shady Oaks Golf Club is looking for temporary help but
does not need to bring on full-time employees. Spencer speaks to
Aaron, the hiring manager at Shady Oaks, and they discuss several
Aaron tells Spencer that he can come on board as an independent
contractor. He will work as a groundskeeper and is to report to work
daily from 7:30 a.m. to 5:00 p.m. and will use the club's equipment.
His hourly compensation will be reported on Form 1099, no taxes will
be withheld and he will not be eligible for benefits. Both agree to
these terms in writing. Is Spencer an independent contractor or an
Unfortunately, it's not as simple as pointing to Aaron and
Spencer's agreement or the fact that Spencer will receive a 1099
instead of a W-2. The IRS has provided guidelines for employers to
use in its so-called "Twenty Factor Test" which focuses on whether a
company, Shady Oaks in this case, has the right to control the
worker. Several of the factors include whether the company has the
- Set the work schedule;
- Establish the work location;
- Pay by the time worked rather than by the job or on
- Furnish equipment for the worker's use; and
- Require work-related training.
Based on these criteria, it is likely that Spencer is legally an
employee of Shady Oaks even though he is being treated as a
contractor. Apart from liability for the payroll taxes it didn't
withhold from Spencer's compensation, Shady Oaks may also be
required to provide retroactive benefits to Spencer due to the
Employees Not Working Full-Time
Aaron hires Spencer as a W-2 employee but specifies that he will
not receive benefits, because he is not working on a full-time
This situation is much more straightforward in that Spencer and
Aaron both consider Spencer to be an employee of Shady Oaks. The
issue is whether or not he is somehow less of an employee such that
he can be excluded from company benefits.
In 2006, the IRS issued a Quality Assurance Bulletin to address
this issue. It indicates that employees who work other than
full-time schedules are still employees and that the plan documents,
not employment agreements, must be consulted to determine
eligibility for benefits. Examples of classifications that are often
- Part-Time Employees: those who work less than a standard
40-hour work week;
- Temporary Employees: those who are employed for a limited
period delineated by specific dates or the duration of a
- Seasonal Employees: those who work during a specific season
such as retail workers during the holidays or snow-plow
operators in winter; and
- Per Diem Employees: those who do not have a set work
schedule but are called in as needed.
The list also includes those whose normal work schedule is less
than a certain number of hours, e.g. someone who is normally
scheduled to work less than 20 hours per week.
Based on the Quality Assurance Bulletin, Spencer is a regular
employee whose eligibility for Shady Oaks' retirement plan must be
determined by the plan document regardless of the side agreement he
made with Aaron.
What Does the Plan Document Say About
Plan documents are generally written to include all employees
unless a certain classification is specifically excluded. Common
exclusions are independent contractors, union members and
non-resident aliens. However, documents can be tailored to a
company's needs by excluding others such as students, interns,
Proper worker classification is key to knowing if the plan
excludes certain individuals. In the 1990s, a group of workers
classified as independent contractors sued Microsoft, claiming they
were entitled to benefits. Microsoft defended itself by pointing out
that the plan document specifically excluded independent
contractors. While the court agreed that the exclusion was in place,
it ruled that the workers in question were not actually contractors
but common law employees; therefore, they did not fall under the
documented exclusion. Microsoft was ordered to pay nearly $100
million in back benefits.
While this is a high profile case involving a large company, the
IRS is aware of the issue of misclassification and looks for it when
auditing plans of all sizes.
Precise Document Language
Classification issues can sometimes be addressed by precise
wording in the plan document. The Microsoft case prompted many
document amendments to exclude workers classified as independent
contractors on the payroll records of the company. This more precise
exclusion takes the determination out of the realm of the common law
definition of employee and ties it to how the particular plan
sponsor classifies workers.
Another example of a classification that may require precision is
that of student. If a plan excludes students, is the intention to
exclude all students or just college students? What about a senior
executive who decides to go back and earn an MBA? That person is a
college student. Should he or she now be excluded from the plan?
Careful planning and precise wording at the beginning can eliminate
much of the frustration and liability that can arise later due to
Election to Waive Benefits
Employers will sometimes indicate that a particular individual
waived benefits. In the above examples, Spencer agreed in writing to
forego benefits. Again, the plan document must be consulted. Many
retirement plans simply do not allow a participant to waive
benefits. In that situation, Spencer's waiver cannot be applied to
the retirement plan whether he wants the benefits or not. For plans
that do allow waivers, regulations prescribe the process.
Specifically, the waiver must be in writing, must indicate that it
is irrevocable and must be signed before the employee becomes
eligible. For a plan that provides immediate eligibility, that means
the waiver must be signed before the employee's first day on the
What Does the Plan Document Say About
Once it is determined which classifications are covered by the
plan, it is necessary to understand the age and service requirements
an employee must satisfy to join. The law generally limits the
maximum age requirement to 21 and the maximum service requirement to
one year (defined as completion of 1,000 hours in a 12-month period)
but plans are free to implement more generous rules.
This is where the part-time/seasonal/temporary classifications
come into play. As noted above, these individuals must be treated as
any other employees. That means if a plan permits employees to join
after completion of 30 days of service, seasonal employees who
remain employed for more than 30 days become eligible. Similarly, an
employee who works 20 hours a week for a year becomes eligible for a
plan that imposes the maximum wait of 1,000 hours in a 12-month
period (20 hours per week x 52 weeks = 1,040 hours).
Furthermore, regulations require that service be combined for
employees who are terminated and rehired within certain timeframes.
If Spencer works for Shady Oaks during winter break, spring break
and summer vacation all in the same year, his service during all
three of those stints is combined to determine if he has worked the
requisite 1,000 hours.
The easy solution may seem to be to simply exclude these groups.
However, the Quality Assurance Bulletin indicates that doing so
will, in most cases, violate the maximum statutory eligibility
requirements, in that it indirectly keeps someone out of the plan
based on the amount of time they work even though that time may be
greater than the one year maximum. It may be possible, however, to
exclude these individuals by some other means. For example, if all
of Shady Oaks' seasonal employees are groundskeepers like Spencer,
they could write their plan document to exclude groundskeepers (type
of work) rather than seasonal employees (length of service).
What About Nondiscrimination Issues?
There is one final step to determine if the plan can exclude
contingent workers and that is ensuring that the exclusions do not
violate the nondiscrimination requirements. The primary test
involved is the ratio percentage test. While a full description of
the test is beyond the scope of this article, it generally dictates
that a plan cannot exclude any more than 30% of its Non-Highly
Compensated Employees, i.e. non-owners and those who earn less than
$110,000 per year. In other words, if the sum of all the excluded
employees is less than 30% of the total number of NHCEs, the plan
satisfies the ratio percentage test and the exclusions are
The use of contingent workers carries many benefit-related
issues. It is possible, in many cases, to exclude them from
retirement benefits, but all three components discussed above
(proper classification, precise document language and a passing
nondiscrimination test) are required. Given the complexities
involved, it is very important for employers facing this challenge
to work with knowledgeable experts who can provide guidance every
step of the way.