Proposed Regs to Prevent Use of Affiliated Service Groups, Employee, and Other Arrangements to Avoid Employee Benefit Requirements.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document provides proposed regulations prescribing rules for determining: (1) when a management organization and the organization for which the management organization performs management services constitute an affiliated service group; (2) when leased employees are treated as employees of the lessee organization for purposes of certain employee benefit provisions; and (3) when arrangements involving separate organizations, employee leasing, or other arrangements will be ignored in order to prevent the avoidance of certain employee benefit requirements. Changes to the applicable tax law were made by the Tax Equity and Fiscal Responsibility Act of 1982, the Tax Reform Act of 1984, and the Tax Reform Act of 1986. The regulations provide the public with guidance needed to comply with those Acts and would affect employers that maintain, and participants in, qualified plans.

DATES: Written comments and requests for a public hearing must be delivered or mailed by October 26, 1987. The regulations provided by this document are proposed to be generally effective for tax years beginning after December 31, 1983.

ADDRESS: Send comments and requests for a public hearing to: Commissioner of Internal Revenue, Attention: CC:LR:T (EE-111-82), Washington, D.C. 20224.

FOR FURTHER INFORMATION CONTACT: Michael Garvey of the Employee Plans and Exempt Organizations Division, Office of Chief Counsel, Internal Revenue Service, Constitution Avenue, N.W., Washington, D.C. 20224, Attention: CC:LR:T, (202) 566-3903, not a toll-free call.

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document contains proposed amendments to the Income Tax Regulations (26 CFR Part 1) under sections 414(m)(5), 414(n), and 414(o) of the Internal Revenue Code. These amendments are proposed to conform the regulations to sections 246 and 248 of the Tax Equity and Fiscal Responsibility Act of 1982 (26 USC 414(m)(5), 414(n)), section 526 of the Tax Reform Act of 1984 (26 USC 414(n)(2), 414(o)), and section 1146 of the Tax Reform Act of 1986 (26 USC 414(n), 414(o)). Other sections of the Tax Reform Act of 1986 that relate to section 414(n) are not reflected in this document.

ORGANIZATIONS PERFORMING MANAGEMENT FUNCTIONS

Section 414(m)(5) of the Code expands the definition of an affiliated service group that is to be treated as a single employer under section 414(m) for purposes of certain employee benefit requirements. Pursuant to section 414(m)(5), an affiliated service group includes a management organization and a recipient organization (i.e., the organization (and related organizations) for which the management organization performs management functions). An organization is a management organization if the principal business of the organization is the performing of, on a regular and continuing basis, management functions for a recipient organization.

EMPLOYEE LEASING

Section 414(n) provides that, under certain circumstances, an individual ("leased employee") who performs services for a person ("recipient") through another person ("leasing organization") shall be treated as the employee of the recipient for purposes of certain employee benefit requirements. If the services being provided by an individual to a recipient are pursuant to an agreement between the recipient and the leasing organization, and the individual performs such services for the recipient on a substantially full-time basis for a period of at least one year, and the services are of a type historically performed by employees, then the individual is a leased employee and, therefore, shall be treated as an employee of the recipient.

Section 414(n)(5) provides, however, that if the leasing organization maintains a safe-harbor plan with respect to a leased employee, such individual will generally not be treated as an employee of the recipient. Section 414(n)(5), as originally enacted, required that a safe-harbor plan must be a qualified money purchase pension plan with provision for nonintegrated employer contributions of at least 7-1/2 percent, immediate participation, and full and immediate vesting.

The Tax Reform Act of 1986 amended several provisions relating to sections 414(n) and 414(o). These amendments include the following:

(1) The definition of a safe-harbor plan under section 414(n)(5) has been amended to require a contribution rate of 10 percent and to require that the plan must cover all employees of the leasing organization (other than employees who perform substantially all of their services for the leasing organization (and not for recipients) and employees whose compensation from the leasing organization is less than $1,000 during the plan year and during each of the 3 prior plan years).

(2) Under section 414(n)(5), a leased employee will be treated as an employee of the recipient, regardless of the existence of a safe-harbor plan, if more than 20 percent of the recipient's nonhighly compensated workforce are leased employees (as specially defined for this purpose).

(3) A recordkeeping exception from the section 414(n) employee leasing provisions is provided under section 414(o) in the case of an employer that has no section 416(g) top-heavy plans and that uses the services of nonemployees only for an insignificant percentage of the employer's total workload.

(4) The scope of the section 414(n) employee leasing provisions has been expanded to include a number of non-pension employee benefit requirements (listed under section 414(n)(3)), including group-term life insurance, accident and health plans, qualified group legal services, cafeteria plans, etc. In addition, the employee leasing provisions will apply to these non-pension employee benefit requirements regardless of the existence of a safe-harbor plan.

Except for the amendments relating to the non-pension employee benefit requirements, the proposed regulations reflect the Tax Reform Act of 1986 amendments described above. Guidance relating to the non- pension employee benefit requirements, and other relevant amendments made by the Tax Reform Act of 1986, will be forthcoming.

AVOIDANCE OF CERTAIN EMPLOYEE BENEFITS REQUIREMENTS

Section 414(o) provides that the Secretary shall prescribe such regulations as may be necessary to prevent the avoidance of any employee benefit requirement listed in sections 414(m)(4) or 414(n)(3) through the use of separate organizations, employee leasing, or other arrangements. Specifically, the Secretary has the authority to provide rules in addition to the rules contained in sections 414(m) and 414(n).

Pursuant to section 414(o), the proposed regulations provide rules relating to several arrangements that may result in the avoidance of the listed employee benefit requirements. These arrangements include the leasing of certain owners, the leasing of certain managers, the creation of successive organizations in time, expense sharing arrangements, plans maintained by certain corporate directors, and plans covering certain five-percent owners.

EFFECTIVE DATES

The amendments made to section 414 by the Tax Equity and Fiscal Responsibility Act of 1982 are effective for tax years of a recipient or of a member of an affiliated service group that begin after December 31, 1983.

The amendments made to section 414 by the Tax Reform Act of 1984 are effective as of July 18, 1984. The regulations promulgated under section 414(o), however, are variously effective for (1) plan years beginning more than six months after this document is published in the Federal Register, (2) plan years beginning more than sixty days after this document is published in the Federal Register as a Treasury decision, and (3) plan years beginning during or after the first tax year of a recipient beginning after December 31, 1983. (To the extent that the regulations under section 414(o) aggregate plans for purposes of section 415 that were not previously aggregated, the rules of section 1.415-10 apply.)

The amendments made to section 414 by the Tax Reform Act of 1986 are generally effective with respect to services performed after December 31, 1986. The recordkeeping exception from section 414(n), provided under section 414(o), and certain clarifying amendments under section 414(n) are effective as if originally enacted as part of the section 414 amendments made by the Tax Equity and Fiscal Responsibility Act of 1982. The section 414(n)(3) amendments relating to the non-pension employee benefit requirements are generally effective when section 89 applies to such non-pension employee benefits (see section 1151(k) of the Tax Reform Act of 1986).

SPECIAL ANALYSIS

The Commissioner of Internal Revenue has determined this rule is not a major rule as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. Although this document is a notice of proposed rulemaking that solicits public comment, the Internal Revenue Service has concluded that the regulations proposed are interpretative and that the notice and public procedure requirements of 5 USC 553(b) do not apply. Accordingly, these proposed regulations do not constitute regulations subject to the Regulatory Flexibility Act (5 USC chapter 6).

COMMENTS AND REQUESTS FOR A PUBLIC HEARING

Before adopting these proposed regulations, consideration will be given to any written comments that are submitted (preferably eight copies) to the Commissioner of Internal Revenue. All comments will be available for public inspection and copying. A public hearing will be held upon written request to the Commissioner by any person who has submitted written comments. If a public hearing is held, notice of the time and place will be published in the Federal Register.

DRAFTING INFORMATION

The principal author of these proposed regulations is Philip R. Bosco of the Employee Plans and Exempt Organizations Division of the Office of Chief Counsel, Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and Treasury participated in developing the regulations, both on matters of substance and style.

LISTS OF SUBJECTS IN 26 CFR 1.401-1 - 1.425-1

Employee benefit plans, pensions.

PROPOSED AMENDMENTS TO THE REGULATIONS

The Income Tax Regulations (26 CFR Part 1) are proposed to be amended as follows:

Paragraph 1. The authority citation for Part 1 is amended by adding the following citation:

Authority: 26 USC 7805. * * * Section 1.414(n)-1 also issued under 26 USC 414(n). Section 1.414(o)-1 also issued under 26 USC 414(o).

Par. 2. The following new sections are added immediately following section 1.414(m)-4 and read as follows:

[Editor's Note: Proposed Regulations sections 1.414(m)-5, 1.414(m)-6, 1.414(n)-1, 1.414(n)-2, 1.414(n)-3, 1.414(n)-4, 1.414(o)-1(c) through (j), and 1.414(o)-1(k)(1), 1.414(o)-1(k)(3), and 1.414(o)-1(k)(4) have been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(m)-5 Organizations performing management functions.

[Editor's Note: Proposed reg. section 1.414(m)-5 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(m)-6 Application of section 414(o) to section 414(m).

[Editor's Note: Proposed Regulations section 1.414(m)-6 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(n)-1 Employee leasing.

[Editor's Note: Proposed reg. section 1.414(n)-1 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(n)-2 Qualified plan coverage of leased employees.

[Editor's Note: Proposed Regulations section 1.414(n)-2 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(n)-3 Employee benefit requirements, recordkeeping, and effective dates.

[Editor's Note: Proposed reg. section 1.414(n)-3 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(n)-4 Application of section 414(o) to section 414(n).

[Editor's Note: Proposed Regulations section 1.414(n)-4 has been withdrawn by CO-053-92 on April 27, 1993.]

Section 1.414(o)-1 Avoidance of employee benefit requirements through the use of separate organizations, employee leasing, or other arrangements.

[Editor's Note: Proposed Regulations sections 1.414(o)-1(c) through (j), and 1.414(o)-1(k)(1), 1.414(o)-1(k)(3), and 1.414(o)-1(k)(4) below have been withdrawn by CO-053-92 on April 27, 1993.]

(a) IN GENERAL. (1) Pursuant to section 414(o), this section provides rules, in addition to the rules contained in sections 414(m) and 414(n) and the regulations there-under, to prevent the avoidance of any employee benefit requirement listed in either section 1.414(m)-3 or section 1.414(n)-3, through the use of separate organizations, employee leasing, or other arrangements.

(2) For the definition of the terms "person" and "leased employee", see section 1.414(n)-1(b). For the definition of the term "organization", see section 1.414(m)-5(a)(2). For the definition of the terms " management functions" and "management activities or services", see section 1.414(m)-5(c).

(3) For purposes of this section, the term "plan" means a stock bonus, pension, or profit-sharing plan qualified under section 481 (a) or a simplified employee pension under section 408(k).

(4) For purposes of this section, the term "employee" includes a "self-employed individual" as defined in section 481(c)(1).

(5) For purposes of this section, the term "maintained", when used in the context of a plan maintained by any person, means "maintained at any time".

(6) For purposes of this section, services performed for a person other than as an employee of such person means services performed directly or indirectly for such person.

(b) SERVICES PERFORMED BY LEASED OWNERS -- (1) IN GENERAL. (i) If an individual is a leased owner with respect to a recipient, then for purposes of determining whether any qualified plan actually maintained by the recipient and whether any qualified plan maintained by a leasing organization in which the leased owner is a participant (or in which the leased owner has or had an accrued benefit) satisfies the employee benefit requirements of section 1.414(n)-3(a) (except for paragraph (a)(6) of that section) for a plan year, the leased owner's interest in the leasing organization's qualified plan attributable to services performed by the leased owner for the recipient is to be treated as provided under a separate qualified plan maintained by the recipient covering only the leased owner and the leased owner is to be treated as an employee of the recipient. If a separate qualified plan is treated as maintained by the recipient with respect to a leased owner and such leased owner also participates in a qualified plan actually maintained by the recipient, the leased owner's interest in the leasing organization's qualified plan attributable to the leased owner's performance of services for the recipient that is treated as provided to the leased owner under a separate qualified plan of the recipient is to be treated as provided to the leased owner under the qualified plan actually maintained by the recipient for purposes of determining whether such qualified plan satisfies the applicable employee benefit requirements. If either the separate qualified plan for the leased owner that is treated as maintained by the recipient or any qualified plan that is actually maintained by the recipient fails to satisfy any of the applicable employee benefit requirements, then except as provided in paragraphs (b)(1)(ii) and (b)(1)(iii) of this section, the following qualified plans shall be treated as not satisfying such requirements: any qualified plan actually maintained by the recipient in which the leased owner is a participant (or has or had an accrued benefit) and any qualified plan that is actually maintained by a leasing organization in which the leased owner has an interest that is attributable to the leased owner's performance of services for the recipient.

(ii) The Commissioner will not apply paragraph (b)(1)(i) of this section so as to disqualify a plan actually maintained by a recipient unless the Commissioner determines that, taking into account all the facts and circumstances, the disqualification of a leasing organization's plan would be ineffective as a means of securing compliance with the applicable employee benefit requirements. For example, it may be appropriate to disqualify the recipient's plan where a leasing organization's plan was terminated or substantial assets were removed therefrom in a year for which the statute of limitations has run with respect to the employer, employee, or trust.

(iii) If pursuant to paragraph (b)(1)(i) of this section, more than one leasing organization plan is subject to disqualification and at least one of the plans would not be disqualified if another plan or plans were disqualified first, all affected plan sponsors may, by agreement, elect the plan or plans subject to disqualification, provided that such election is not inconsistent with the purposes of this paragraph (b), such a where the plan or plans elected were terminated or substantial assets were removed therefrom in a year for which the statute of limitations has run with respect to the employer, employee, or trust. In the absence of such an election, the Commissioner, taking into account all the facts and circumstances, shall have the discretion to determine which plan or plans shall be disqualified.

(2) LEASED OWNER (i) For purposes of this paragraph (b), an individual is a "leased owner" with respect to a recipient if during the plan year of a plan maintained by a leasing organization the individual (A) performs any services for a recipient other than as an employee of the recipient and (B) is, at the time such services are performed, a five-percent owner of the recipient. The fact that an individual may also perform services as an employee of the recipient does not affect his status as a leased owner. If an individual becomes a leased owner with respect to a recipient, such individual is from that point on always to be considered a leased owner with respect to the recipient, notwithstanding anything in this paragraph (b) to the contrary, even if subsequently all services performed by the individual for the recipient are performed as an employee of the recipient.

(ii) Except as provided in paragraph (b)(2)(iii) of this section, and notwithstanding the first sentence of paragraph (b)(2)(i) of this section to the contrary, an individual is not a leased owner with respect to a recipient for purposes of a plan year of a plan maintained by a leasing organization if, during each calendar year containing at least one day of such plan year, less than 25 percent of his total hours actually worked for substantial compensation are for all recipients with respect to which he is a leased owner (but for the application of this paragraph (b)(2)(ii)) and less than 25 percent of his total compensation is derived from performing services for all such recipients. For purposes of this paragraph (b)(2)(ii), performing services for the recipient includes services performed as an employee of the recipient and in any other capacity. For purposes of this paragraph (b)(2)(ii), the term "compensation" means (A) With respect to services performed as a common-law employee, compensation reportable on Form W-2, and (B) with respect to services performed other than as a common-law employee, earned income as defined in section 401(c)(2). See section 414(s) for the definition of "compensation" for years beginning after December 31, 1986.

(iii) Paragraph (b)(2)(ii) of this section does not apply to an individual who (A) is a leased owner with respect to a recipient pursuant to the application of the first sentence of paragraph (b)(2)(i) of this section, and (B) performs professional services (as defined in section 1.414(m)-1 (c)) for the recipient, whether or not as an employee of the recipient, during the plan year of the plan maintained by the leasing organization, of the same type as the professional services performed by the recipient for third parties.

(3) RECIPIENT. For purposes of this paragraph (b) the term "recipient" has the same meaning as in paragraphs (b)(2) and (b)(6) of section 1.414(n)-1, except that "leased owner" is substituted for "leased employee".

(4) LEASING ORGANIZATION. For purposes of this paragraph (b), the term "leasing organization" has the same meaning as in section 1.414(n)-1(b)(1), except that "leased owner" is substituted for "leased employee" and that "or provided" is added after "provides".

(5) FIVE-PERCENT OWNER. For purposes of this paragraph (b), an individual is a five-percent owner of a recipient if such individual is a 5-percent owner (as defined in section 416(i)) of any person included in the recipient.

(6) CONTRIBUTIONS, BENEFIT, ETC., PROVIDED TO A LEASED OWNER. For purposes of this paragraph (b), a leased owner's interest in a leasing organization (as defined in section 1.414(n)-2(b)(1)(i)) and in a leasing organization's qualified plan (as defined in section 1.414(n)-2(b)(1)(i)), to the extent attributable to services for the recipient by the leased owner, is, for purposes of the applicable employee benefit requirements, treated as provided by the recipient or under a plan of the recipient. For rules relating to the application of this requirement, see paragraph (b)(2) of section 1.414(n)-2.

(7) EFFECT ON EMPLOYEE RULES. To the extent that a leased owner performs services for a recipient other than in the capacity of an employee, a leased owner is not an employee of the recipient and may not be actually covered by a plan of the recipient. Such leased owner may, however, qualify as a leased employee under section 414(n) and the regulations thereunder.

[Editor's Note: Proposed Regulations sections 1.414(o)-1(k)(1), 1.414(o)-1(k)(3), and 1.414(o)-1(k)(4) have been withdrawn by CO-053-92 on April 27, 1993.]

(k) EFFECTIVE DATES.

(2) The provisions of paragraph (b) of this section are effective for tax years of recipients beginning after December 31, 1983. Therefore, the provisions of paragraph (b) apply to plan years beginning during and after the first tax year of a recipient beginning after December 31, 1983. For purposes of applying paragraph (b) to plan years beginning during and after the first tax year of a recipient beginning after December 31, 1983, contributions, forfeitures and benefits provided during any plan year beginning prior to the first tax year of a recipient beginning after December 31, 1983, shall be taken into account if they would have been taken into account had paragraph (b) been effective for such prior plan year.