FindLaw | Find a Lawyer. Find Answers.

(The Voice, An Industry Bulletin, California Association of Temporary Services, No. 4, 1996)

Our previous article suggested that the IRS may be stepping up its enforcement activity involving staffing industry retirement plans. We know now that they have in fact begun a nationwide audit program specifically targeting these plans, as well as certain income and employment tax issues. Dorothy Lee, the acting team leader of the IRS Employee Leasing Market Segment Group, spoke January 20, 1996, at the American Bar Association Section of Taxation meeting in New Orleans.

According to Ms. Lee, the IRS is undertaking a nationwide study of income tax, employment tax and employee benefits tax issues in connection with the staffing industry. A preliminary study in the Houston area concluded the industry had low rates of timely-filed income tax and employment tax returns, and low rates of timely paid balances due. The national study, intended to confirm those preliminary conclusions as well as focus on other issues, has targeted 92 cases in 28 states. These audits will most directly affect employee leasing companies, but temporary services companies are likely to be affected as well by the results if not also by actual audits. The 92 cases were sent to the field offices in October, 1995, with the hope that the audits would be completed by the end of 1996. Many of the audit targets have probably not yet been notified by the IRS.

In addition to the task force audits, there are also ongoing audits of leasing companies, temporary service companies and the clients of both. These ongoing audits will not be affected by the task force. Ms. Lee did, however, confirm that the clients were not the direct targets of the task force. Ms. Lee indicated that the national effort was focusing on two major issues: (i) who is the employer for employment taxes; and (ii) who is the employer for benefit plan purposes. As we suggested in our prior article, to answer those questions, the IRS will apply the traditional twenty factor test described in Revenue Ruling 87-41, but will attribute heavy weight to the ability to direct and control the services.

The problem is that the relationship between a staffing company, its client company and the worker is rarely that simple. As pointed out by other panelists from the private sector, the relationship between the three parties is frequently so complex that the best conclusion is that the worker is the employee of both the staffing company and its client. The other panelists pointed out that this "co-employer" analysis has been successfully used in other contexts and should apply here as well.

According to Ms. Lee, however, the IRS believes that existing laws prevent it from concluding that both the staffing company and its client are employers. Rather, they feel compelled to treat the worker as an employee of one or the other. As Ms. Lee said, the "co-employer" concept does not exist in the Internal Revenue Code. It would require a legislative solution before the Service would be able to apply that analysis when reviewing pension plans covering these workers. She did indicate that one of the primary goals of the task force would be to push for a legislative solution to the problem.

Ms. Lee stated that a primary concern of the IRS is its ability to collect income and employment taxes. As noted above, the Service believes that the industry is characterized by a low level of compliance. Because those taxes can only be collected from the "employer," the Service is currently reluctant to accept any approach that does preserve its ability to pursue the client, if necessary to collect the employment taxes. Under current laws, Ms. Lee feels, that can only happen if the client is the employer.

The other primary issue involved the employee benefit plans maintained by the leasing companies. As discussed in our prior article, the IRS believes that retirement plans maintained by some leasing companies do not satisfy some of the rules governing qualified plans. The task force will specifically focus on the issues we identified in our previous article, and will also investigate welfare plan issues. There is also some possibility of a separate group to study problems arising out of cafeteria plans.

In the near term, there may be some defensive tactics that can be used by leasing companies and temporary service companies. Because the IRS believes that there is widespread non-compliance with the tax withholding and reporting rules, any late return or late payment will certainly be a red flag. Establishing a track record of timely filing and timely payment and being able to demonstrate compliance with full and complete records will minimize the exposure to a costly audit. Failing to pay employment taxes on time has always been one of the worst things a business could do. This task force is an extra reason to be concerned about compliance.

The author advises that the legal update above is intended as general educational information only must not be relied upon as legal advice. Legal issues should be presented to legal counsel for an opinion considering changes in law, risk analysis, and the unique facts and circumstances of your organization. This advisory must be included in any duplication or other provision of the above update.