IRS, court make it safer to have pension plans that exclude certain workers

Many fleets that are tempted to add pension benefits as a way of retaining drivers or office personnel have beenscared off by a combination of tax law, labor law and common law. Recently, the Internal Revenue Service and a federal court have offered some comfort, or at least clarity, in the murky area of which workers must be covered by pension plans.

Both the tax code and the Employee Retirement Income Security Act (ERISA) govern pension coverage. In addition, the common law, which is not a statute passed by Congress but instead represents the cumulative interpretation by courts and agency rulings, determines whether a worker is an employee or an independent contractor for employment tax purposes.

Companies have increasingly turned to "alternative staffing firms" for short- or long-term employees and for benefits administration. The advantages for the fleet owner can include having a larger organization to do recruiting and having specialized expertise to administer benefits and stay on top of complex, changing rules.

However, a major risk of such practices has been that the workers could ultimately be considered employees. The consequences of such a reclassification could result in a major tax bill, even if the fleet received credit for taxes the staffing company paid. Even worse, if the workers should have been included in a pension plan operated by the firm for its common-law employees, that plan could be disqualified, triggering a large income tax liability and/or a huge retroactive contribution to the plan to cover the newly eligible workers.

This worry became a reality for many companies after the Federal Court of Appeals for the 9th Circuit decided that workers whom Microsoft had treated as contractors were employees and therefore eligible to participate in its lucrative employee stock purchase plan.

Now the IRS has told an unnamed company in a Technical Advice Memorandum (TAM) that it can specify that its pension plan covers only "those employees being employed within a specific job classification." Thus, workers who were treated as independent contractors could be excluded even if the IRS (or a court) later determines that they are employees. A company cannot exclude workers on the basis of age or length of service, but may use other criteria.

Reinforcing the TAM in a separate case (Casey v. Atlantic Richfield Co.), the U.S. District Court for the Central District of California dismissed a class action suit by a group of leased employees who claimed they were entitled to benefits under ERISA. The court ruled that the company had lawfully written its benefits plans to exclude leased employees and independent contractors.

The bottom line: Pension law remains a complex and changeable field. These two decisions are very small steps in the direction of clarification. The TAM applies only to the taxpayer for whom it was written, although TAMs can give an indication of how the IRS would rule if other taxpayers present similar facts. The court decision applies only within part of California, unless higher courts review and affirm the decision. Nevertheless, both rulings indicate that regulators and courts are sympathetic to firms that want to provide benefits to a clearly defined set of workers and exclude others for legitimate reasons, even if the workers whom they exclude later are reclassified. The rulings thus make well-written pension plans a safer option.