The next item up for bids in our series on the Department of Labor’s new regulations on multiple employer plans is on professional employer organizations, more commonly referred to by their acronym: PEOs. These organizations have an interesting history when it comes to retirement plans.
For many years, PEOs offered retirement plans to the worksite employees of their employer clients; however, these were structured as single employer plans similar to any other situation where a business might have a 401(k) plan for its employees. In the early 2000s, the IRS issued a Revenue Procedure, noting that the only way a PEO could offer a plan to those worksite employees would be via a multiple employer plan. The reasoning was that those worksite employees were the common law employees of the business that hired the PEOs rather than the PEOs themselves.
Based on that ruling, a number of PEOs have done just that…offered a multiple employer plan to the employees of their employer clients. The potential hiccup with that approach has been with a different agency – the Department of Labor. According to longstanding DOL guidance, the structures of many PEO retirement plans lacked the commonality and control among participating companies that the DOL said were required in order to maintain a MEP. Some PEOs reviewed their structures and kept going down the same path; others unwound their MEPs and treated each adopting employer as having its own plan. We’re not here to say that anyone did anything right or wrong, only to illustrate that there have not been consistent opinions within the practitioner community when it comes to PEO plans.
The new DOL regulations remove much of that ambiguity and pave the way for a more consistent approach.
The regulations describe four requirements that a PEO must satisfy in order to be a “bona fide” PEO that may “act indirectly in the interest of [its client] employers.” This is critical, because it is that ability to act on behalf of its employer clients that grants the PEO the ability to offer a MEP.
Here are the requirements:
- The PEO must control the MEP as the plan sponsor, the 3(16) plan administrator, and as a named fiduciary.
- The PEO must limit participation in the plan to current and former employees of its employer clients.
- The PEO must make certain that each employer client participating in the plan has at least one employee (other than the owner) covered by the plan.
- The PEO must perform substantial employment functions on behalf of its employer clients.
Now, let’s explore each of these in a little more detail.
PEO Control of the MEP
The buck stops with the PEO. Given that the whole basis for allowing PEOs to sponsor MEPs is that they act on behalf of their employer clients, this one seems fairly obvious. The final regulations do make it clear that a PEO’s obligations to plan participants (as plan administrator and named fiduciary) continue with respect to those participants even after the employer no longer contracts with the PEO. Those responsibilities end only when a participant receives full payment of all of his or her benefits from the MEP. Until then, the PEO retains full ongoing responsibility for required disclosures and to maintain the plan prudently.
Only current and former employees of the PEO’s employer clients are allowed to participate in the plan. Similar to pretty much any other plan, this also includes any beneficiaries or alternate payees who become entitled to plan benefits due to their relationships with those participants. Pretty clear-cut.
Unlike association MEPs that can now be made available to so-called working owners (owners of business that do not have any employees), PEOs can only offer their MEPs to companies that have at least one employee other than the owner(s). A number of commenters on the proposed regulations took issue with this position and felt that working owners should be able to participate in any type of MEP. The DOL disagreed, noting that a PEO’s primary business is to handle many day-to-day functions that arise between employers and employees. Obviously, an employer without any employees does not need that type of assistance, so it’s hard to make the case that the PEO could be acting in the interest of such a company in this context.
Another commenter asked about a situation in which a business with employees is a PEO client and subsequently terminates all of its employees except the owner. The DOL still declines to extend the working owner provisions to PEOs, noting that the working owner (and his or her former employees) would be treated as participants with regard to their existing account balances (similar to any other former employee with a remaining balance) but that the working owner would not be able to continue as a participating employer with respect to any ongoing future contributions.
So, companies with employees are in; owner-only companies are out.
Substantial Employment Functions
This is where we get a bit further into the weeds. The DOL’s reasoning for including this requirement is best explained in their own words:
“Requiring the PEO to stand in the shoes of the participating client employers – by assuming and performing substantial employment functions that the client-employers otherwise would fulfill with respect to their employees – is what distinguishes bona fide PEOs under the final rule from service providers or other entrepreneurial ventures that in substance merely market or offer client-employers access to retirement plan services and products.”
While the proposed rule had the same requirement, it offered a number of different avenues to satisfy it – multiple safe harbor options as well as facts and circumstances. The final rule retains a facts and circumstances option but includes a single safe harbor standard that applies across the board.
The new version of the safe harbor standard includes four criteria, all of which must be satisfied.
Payment of Wages The PEO must be responsible to pay the employees of its employer clients who participate in the MEP. Seems pretty straight-forward, right? But wait, there’s more. The PEO must be responsible to pay those wages regardless of whether or not it receives payment from those employer clients. In other words, the PEO is still on the hook even if the client does not pay its bill on time.
Payroll Taxes The PEO must also take on full responsibility to withhold, remit, and perform reporting on federal employment taxes for the MEP’s adopting employers. Similar to the previous requirement, this mandate applies even if the adopting employers do not pay their bills to the PEO.
Benefits If the contract between the PEO and its client employers calls for the PEO to provide certain employee benefits, the PEO must take full responsibility for, and exercise control over, the operation of those benefit plans. Yep, even if the adopting employers do not pay their share of the costs associated with those benefits.
Recruiting, Hiring, and Firing With regard to any participating employers in the MEP, the PEO must play a “definite and contractually specified role” in recruiting, hiring, and firing their employees. That does not mean the participating employers are necessarily cut out of that process. The preamble to the regulations discusses that the various responsibilities around hiring and firing can be allocated between the PEO and the employer as long as the PEO retains the ability to recruit, hire, and fire as may be necessary to fulfil its contractual obligations and/or to comply with any applicable state laws.
Unlike the proposed regulations, the DOL removed a PEO’s status as a Certified PEO under the Tax Code rules as being relevant to determining whether it is a bona fide PEO eligible to sponsor a MEP. They also removed a reference from the proposed regulations that indicated satisfying a single one of the safe harbor criteria could be enough to demonstrate compliance under the facts and circumstances test.
Looking Back or Looking Ahead
As we referenced above, there have been various interpretations over recent years as to whether or not existing PEO MEPs satisfied the DOL’s commonality and control requirements. Although these new regulations provide clarity going forward, the DOL has not provided any relief with respect to any prior incorrect interpretations or plan operations. Some may decide that it is unlikely the DOL would take any enforcement action over something that may have been prohibited before but is now acceptable. Others may decide that it makes more sense to tie up any historical loose ends to ensure a “clean” MEP going forward.
There may be valid business reasons on either side of that decision process. We only mention it here to clarify that the DOL has not granted any sort of free pass. Since joining a MEP is a fiduciary decision (and continues to be one under the new rules), companies that are presently part of PEO MEPs or that are considering joining an existing one may want to ask additional questions with regard to past operations to ensure they are making a prudent selection.
Join us next week when we take a look at corporate MEPs.