Contract Employees and Plan Participation

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in South Carolina] is representative of a common question on covering contract employees in a 401(k) plan

"My client has allowed contract employees to participate in their 401(k) plan. Is this permitted?"

Highlights of the discussion

Allowing contract employees (a.k.a., independent contractors) to participate in a company’s 401(k) plan effectively makes the plan a multiple employer plan (MEP). A MEP is one in which employees of more than one noncontrolled employer participate. Government regulations consider contract employees as self-employed individuals and, therefore, a distinct employer from the plan sponsor.

The distinction between an employee and a contract employee is complex and beyond the scope of this article. For more details on the employee/contract employee distinctions please see the IRS guidance on this issue at Independent contractor (self-employed) or employee?. For more certainty, a person or entity can ask the IRS to make a formal determination on a worker’s status by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

If the plan covers contract employees the MEP rules may apply and can impact the plan in many ways, including, but not limited to, the plan document, plan testing and Form 5500 reporting. In our experience, few plan sponsors who are covering contract employees in their plans are aware of the MEP requirements and, generally, will have multiple compliance issues. Therefore, we encouraged plan sponsors to carefully review plan document provisions, plan testing, operations, and Form 5500 reporting to ensure they comply with applicable MEP rules. If not, we advised them to seek ERISA counsel and consider utilizing the Employee Plans Compliance Resolution System to correct compliance issues.

Conclusion

Allowing contract employees to participate in a company’s 401(k) plan effectively makes the plan a MEP, and subject to MEP compliance rules.