SECTION 3. BACKGROUND

.01 In general . An employee leasing arrangement typically involves the interaction among three parties: the PEO, the CO, and the Worksite Employees. In a typical situation, a PEO enters into an agreement with a CO whereby employees become Worksite Employees and continue to provide services to the CO.

.02 Employment relationship . The issue of whether a worker is an employee of a particular entity for employment tax purposes is determined by reference to § 3121(d), which incorporates the common law definition of employee. The Supreme Court has also applied this common law definition of employee for purposes of determining whether a worker is an employee entitled to receive benefits under a retirement plan. See Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318 (1992). Courts have also found that common law factors are applicable to determine which of two entities is the employer for purposes of retirement plans. The critical issue in determining who is the employer of an individual is which entity has the right to direct and control the individual performing the services. If it is found that the CO, not the PEO, is the employer, the plan maintained by a PEO that benefits Worksite Employees of the CO would fail to satisfy the exclusive benefit rule. See Profes- sional and Executive Leasing, Inc. v. Commissioner, 89 T.C. 225 (1987), aff’d, 862 F.2d 751 (9 ^th Cir. 1988). .03 Exclusive benefit rule . Section 401(a)(2) provides that a trust forming a part of a qualified pension, profit-sharing, or stock bonus plan must be a trust established and maintained by an employer for the exclusive benefit of that employer’s employees and their beneficiaries (“exclusive benefit rule”). Therefore, a retirement plan that provides benefits for individuals who are not employees of the employer maintaining the plan (and who are not otherwise treated as employees under rules such as those under § 414) violates the exclusive benefit rule and does not satisfy the requirements of § 401(a).

.04 Leased employees . Section 414(n) does not permit PEOs to maintain plans for Worksite Employees who are not the common law employees of the PEO. Section 414(n) deals with individuals who are not common law employees of the entity for which they perform services (“recipient”) but who might have to be taken into account in determining whether a retirement plan maintained by the recipient satisfies the requirements of § 401(a). Notice 84–11 (1984–2 C.B. 469) provides questions and answers relating to § 414(n). Section 414(n)

addresses the relationship between the recipient and the leased workers, but it does not apply to situations in which a worker is the common law employee of the recipient.

.05 Multiple employer plan . Section 413(c) provides rules for the qualification of a plan maintained by more than one employer ( i.e., a “multiple employer plan”). Under § 413(c)(2), in determining whether a multiple employer plan complies with the exclusive benefit rule, all employees benefitting under the multiple employer plan are treated as the employees of all employers who maintain the plan. Additionally, an employee’s service with all of the employers participating in the plan is taken into account for purposes of vesting under § 411 and plan participation under § 410(a). See § 413 (c)(1) and (3). Similarly, for purposes of the contribution and benefit limitations of § 415, an employee’s compensation from all employers participating in the plan is taken into account. See § 1.415–1(e)(1) of the Income Tax Regulations. Other rules apply separately to each participating employer and its employees. For example, nondiscrimination testing under § 401(a)(4) and § 401(k), and coverage testing under § 410(b), are performed separately for each employer maintaining the multiple employer plan. See § 1.401(a)(4)–1(c)(4), § 1.413–2(a)(3)(ii) and § 1.401(k)–1(g)(11). Top-heavy requirements under § 416 also apply separately to each employer. See § 1.416–1, Q&A G–2.