What Is a Leased Employee for 401(k) Plans?

The company issuing the worker's paycheck does not decide whether that worker counts in your 401(k) testing.

Section 414(n) can treat a person employed by a staffing or leasing organization as an employee of the business receiving the services—the recipient—for major retirement-plan qualification rules.^[1][2][3]

The rule has a narrow structure.

A worker falls within Section 414(n)'s employee-leasing rule only when the required elements line up:

1. is not already a common-law employee of the recipient
2. performs services under an agreement between the recipient and a leasing organization
3. completes the required full year of substantially full-time service
4. performs the work under the recipient's principal direction or control.^[1][3]

Miss one element and Section 414(n) may not apply.

But failure of Section 414(n) does not make the worker irrelevant. The common-law test may already classify that person as an employee of the business receiving the services.

That classification comes first.

Key Takeaways

• A staffing-company W-2 does not decide retirement-plan employee status.
• Section 414(n) applies only after common-law analysis shows that the service recipient is not already the worker's employer.^[1]
• The services must be provided under an agreement between the recipient and another person or organization.^[1]
• The worker generally must perform services substantially full time for at least one year.^[1][3]
• IRS administrative guidance treats substantially full-time service as:
• at least 1,500 hours over the relevant 12-month measurement period, or
• at least 75% of the hours customarily performed by an employee in that position during a 12-month period.^[4]
• The work must satisfy the statute's recipient-control requirement.^[1][5]
• Relevant control facts include who directs:
• when
• where
• how
• by whom
• in what order or sequence the work is performed.^[4][5]
• The power to hire or fire the worker is not by itself the decisive Section 414(n) control factor.^[4]
• Once Section 414(n) applies, the worker enters Recipient's employee population for major rules involving:
• coverage
• age and service
• vesting
• contribution and benefit limits
• top-heavy testing.^[1][2][3]
• Benefits provided by the leasing organization for services performed for the recipient can be treated as benefits provided by the recipient.^[1][3]
• A narrow safe harbor can remove qualifying leased employees from specified qualified-plan treatment if:
• the leasing organization maintains the required money purchase pension plan
• the leased-worker share of the recipient's defined nonhighly compensated workforce is 20% or less.^[1][3][4]
• A leasing-company 401(k) by itself does not satisfy that safe harbor.
• Being treated as an employee for testing does not automatically require enrollment in the recipient's 401(k). Coverage and plan eligibility still have to be analyzed.

Start With Common-Law Employee Status

Section 414(n) begins with a negative condition:

the service recipient is not already the person's common-law employer.^[1]

That matters because an employer cannot take someone who is actually its employee, place the person on another company's payroll and convert the worker into a statutory leased employee.

IRS guidance is explicit: a worker who already has an employer-employee relationship with the service recipient does not lose that status merely because a formal leasing agreement is signed.^[4]

The contract does not override the facts.

Example: PEO Contract Does Not Rewrite Employment

Operating Company hires managers.

Operating Company decides:

• their duties
• schedules
• compensation
• promotions
• performance standards
• termination

A PEO processes:

• payroll
• benefits
• HR administration

The service agreement calls the managers:

PEO employees

That label does not by itself determine qualified-plan status.

If the managers are common-law employees of Operating Company, analyze them as employees first.

Section 414(n) is not a mechanism for downgrading a common-law employee into a different category.

Leased Employee Is Not a Payroll Label

Employers often use leased employee loosely to mean:

• temp worker
• agency worker
• consultant
• PEO worksite employee
• outsourced employee
• contractor

Section 414(n) is more precise.

A person can work through a staffing company and never become a statutory leased employee.

Another person can become one after the required service period and control facts are met.

The commercial label is only the start of the review.

Gate 1: An Agreement With a Leasing Organization

The worker must provide services under an agreement between:

• the recipient
• another person—the leasing organization.^[1]

IRS administrative guidance says the agreement can be:

• written
• oral.^[4]

The existence of a written staffing contract is useful evidence.

Its absence is not necessarily fatal if the actual arrangement satisfies the statutory requirement.

The Agreement Does Not Need the Right Vocabulary

A contract can be titled:

• Staffing Services Agreement
• Professional Services Agreement
• Workforce Services Agreement
• PEO Agreement
• Personnel Supply Agreement

The statute does not require the title:

Employee Leasing Agreement

What matters is whether one person or organization supplies a worker to perform services for the recipient under the arrangement.

Gate 2: One Full Year of Substantially Full-Time Service

The worker must perform services for:

• the recipient, or
• the recipient and related persons

on a substantially full-time basis for the required one-year period.^[1]

This prevents short-term staffing from automatically pulling every temporary worker into qualified-plan testing.

The one-year requirement is not the same as a calendar-year requirement.

IRS guidance looks at a:

continuous 12-month measurement period.^[4]

What Does "Substantially Full Time" Mean?

IRS Publication 7003 uses the longstanding administrative benchmark from Notice 84-11.

IRS treats the substantial-full-time threshold as met when, over a continuous 12-month period, the person performs either:^[4]

• at least 1,500 hours of service for the recipient, or
• at least 75% of the average hours customarily performed by an employee of the recipient in that particular position.

The second test matters for positions that are not normally 40-hour-per-week jobs.

Example: 1,700-Hour Agency Engineer

Engineer is employed by StaffingCo.

Engineer performs:

1,700 hours

for Manufacturer during a 12-month period.

The position is supervised by Manufacturer's engineering director.

The substantial-full-time threshold is satisfied under the 1,500-hour benchmark.^[4]

The other Section 414(n) elements still need to be met.

Hours alone do not finish the test.

Example: 700 Hours Can Be Enough

Suppose a specialized role is customarily performed:

800 hours per year

for the recipient.

Worker performs:

700 hours

in a 12-month period.

Seventy-five percent of 800 hours:

600 hours

The worker exceeds that benchmark.

The person can satisfy the substantially-full-time element even without reaching 1,500 hours.^[4]

This is why:

"The contractor worked fewer than 1,000 hours"

does not automatically resolve Section 414(n).

The 1,000-Hour Eligibility Rule Is a Different Rule

Traditional 401(k) eligibility commonly uses a year-of-service framework involving 1,000 hours, subject to current long-term part-time rules and plan terms.

Section 414(n)'s substantial-full-time test is different.

Do not substitute:

1,000 hours

for:

1,500 hours or 75% of customary hours

when deciding whether someone is a leased employee.

Worker status and plan eligibility are separate steps.

Related-Person Service Can Count

Section 414(n) does not look only at hours performed for one recipient entity.

The statute can count service performed for:

• the recipient
• related persons determined under Section 414(n)(6).^[1]

That matters when workers rotate among businesses in a:

• controlled group
• affiliated service group
• other related arrangement covered by Section 414 rules.

A worker cannot necessarily avoid the one-year threshold because assignments move between related entities.

Gate 3: Primary Direction or Control

The worker's services must be performed under the recipient's primary direction or control.^[1]

This is a facts-and-circumstances test.

IRS's current determination procedure asks employers to describe whether the worker must comply with the recipient's instructions about:^[5]

• when to perform the work
• where to perform it
• how to perform it
• whether a particular person must perform it
• whether the recipient supervises the worker
• whether the recipient sets the order or sequence of work.

That list is more useful than a contract label.

"Primary" Does Not Mean "Any"

A client naturally gives vendors instructions.

That alone does not prove the recipient is the party principally directing the work.

A company can tell an outside accounting firm:

• filing deadline
• records to review
• expected deliverable

without directing:

• which accountant must do the work
• the firm's internal method
• daily schedule
• work sequence
• supervision.

The degree of operational direction matters.

Example: Direction Favors Leased-Employee Status

IT specialist is paid by StaffingCo.

Recipient requires the specialist to:

• report at 8:00 a.m.
• work at Recipient's office
• follow Recipient's daily ticket queue
• use Recipient's procedures
• report to Recipient's IT manager
• complete work in the order assigned by Recipient
• obtain Recipient approval before changing systems

Those facts strongly support the required recipient-control element.

The staffing company's payroll role does not change the day-to-day reality.

Example: Direction Is Weaker

Cybersecurity firm assigns a specialist to several clients.

For Recipient:

• specialist chooses working hours
• firm selects which employee performs each task
• firm determines testing methodology
• firm supervises the specialist
• Recipient receives only the final security report
• firm serves many other customers

The recipient controls the desired result more than the means of performing the work.

Those facts weaken the Section 414(n) direction-or-control case.

They do not independently establish contractor status.

That is a separate classification question.

Hire-and-Fire Power Is Not the Whole Test

Two facts employers often overrate are generally not decisive in the Section 414(n) direction-or-control analysis:

• has the right to hire or fire the individual
• whether the individual works for others.^[4]

That can feel counterintuitive.

The statute asks who primarily directs or controls the services.

A staffing company can technically employ and terminate the worker while the recipient controls the worker's daily performance.

When Does the Worker First Count?

Section 414(n)(4) addresses timing.

Recipient-side employee treatment begins for applicable qualification testing after the close of the one-year substantial-full-time period.^[1]

The first year is therefore a qualification threshold.

It is not necessarily lost service.

Prior Service Can Come Back Into the Calculation

After Section 414(n) status begins, subsection (4)(B) requires service to include periods during which the person would otherwise have qualified except that the one-year substantial-full-time requirement had not yet been completed.^[1]

IRS Publication 7003 makes the same point.^[4]

That creates a two-step result:

During initial period

Worker has not yet satisfied the one-year leased-employee threshold.

After threshold is met

Earlier qualifying service can matter for service-credit purposes.

The first year is not automatically erased.

Example: Worker Becomes Leased Employee in Month 13

Worker begins assignment:

January 1, 2026

Completes qualifying substantially-full-time service through:

December 31, 2026

Assume the direction/control and agreement requirements are satisfied.

Section 414(n) treatment applies after the close of that period.

For service-credit purposes, the earlier period can still be taken into account under Section 414(n)(4).^[1]

Do not start the worker's retirement-plan service clock at zero in January 2027.

What Rules Does Section 414(n) Affect?

For qualified retirement-plan purposes, Section 414(n)(3) reaches major qualification rules including:^[1][2][3]

• nondiscrimination
• minimum coverage
• age and service
• vesting
• compensation limits
• contribution and benefit limits
• top-heavy requirements.

IRS's current 401(k) qualification page summarizes the practical list as:^[2]

• coverage, contributions and benefits
• minimum age and service
• vesting
• limits on contributions and benefits
• top-heavy rules.

That is why leased-employee status belongs in the annual 401(k) census process.

Coverage Is Usually the First Visible Issue

INV-089 explains Section 410(b).

Suppose Recipient has:

• 15 direct employees
• 10 long-term leased workers

The plan sponsor sends the TPA only the 15 payroll employees.

The plan appears to cover:

100% of the workforce

If the 10 leased workers qualify under Section 414(n), that conclusion can be wrong.

The statutory testing population can be larger than the payroll population.

A Leased Employee Does Not Automatically Enter the Plan

This distinction matters.

Section 414(n) says the leased worker is treated as an employee for specified qualification requirements.^[1]

It does not say:

Every leased employee must immediately be enrolled in the recipient's 401(k).

A plan can potentially exclude a class of workers and still satisfy federal coverage and nondiscrimination requirements.

Excluding a leased employee from the recipient plan does not automatically disqualify the plan; Section 410 coverage can still be satisfied depending on the overall population.^[4]

The worker must be counted correctly before deciding whether the worker must receive benefits under the plan.

Example: Counted but Not Covered

Recipient has:

• 100 NHCE direct employees
• 5 NHCE leased employees
• all HCEs covered
• 100 direct NHCEs covered
• leased employees excluded under plan terms

The leased workers can still belong in the Section 410(b) testing population.

Whether the plan passes depends on the actual coverage calculation.

The right answer is not:

"They're leased, so ignore them."

Nor is it automatically:

"They're leased, so enroll them."

Test the plan.

Leasing-Organization Benefits Can Count

Section 414(n)(1)(B) prevents double-blindness.

Contributions or benefits provided by the leasing organization that are attributable to services performed for the recipient are treated as provided by the recipient for the applicable rules.^[1]

That means the recipient's testing analysis should ask:

What retirement benefits is the leasing organization already providing for this worker because of the recipient assignment?

Ignoring those benefits can understate what the worker receives.

Example: Staffing Firm Makes Employer Contributions

Leased employee works for Recipient.

StaffingCo contributes:

5% of compensation

to a qualified retirement plan attributable to the worker's service for Recipient.

For applicable Section 414(n) qualification analysis, those benefits can be treated as provided by Recipient.^[1][3]

That does not mean every StaffingCo plan contribution solves every Recipient testing problem.

Contribution type, eligibility, vesting and applicable testing rules still matter.

The Safe Harbor Is Narrower Than "Staffing Company Has a Plan"

Section 414(n)(5) contains a safe harbor for specified qualified-plan requirements.^[1]

It requires both:

1. a qualifying retirement plan maintained by the leasing organization
2. a workforce-composition test under which statutory leased workers make up no more than one-fifth of the recipient's defined NHCE workforce.^[1][3][4]

A normal staffing-company 401(k) does not automatically satisfy the first condition.

Safe-Harbor Plan Requirement

The leasing organization's plan generally must be a:

money purchase pension plan

with:^[1][3][4]

• a nonintegrated employer contribution rate of at least 10% of compensation
• full and immediate vesting
• immediate participation for the covered leasing-organization employees, subject to the statutory low-compensation exception.

That is a much richer and more specific design than:

"Our staffing firm offers a 401(k) match."

A 4% Match Is Not the Safe Harbor

Suppose LeasingCo offers:

• 401(k)
• 100% match on first 4% deferred
• six-year graded vesting

That may be a legitimate retirement plan.

It does not satisfy the Section 414(n)(5) safe-harbor design described in the statute.

The safe harbor calls for:

• money purchase pension plan
• at least 10% nonintegrated employer contribution
• immediate participation
• full immediate vesting.^[1]

Do not confuse "good benefits" with the statutory safe harbor.

The 20% Workforce Gate

Even if LeasingCo maintains the correct safe-harbor pension plan, leased employees must not constitute more than:

20%

of the recipient's nonhighly compensated workforce.^[1][3][4]

The denominator is not:

• all employees
• all workers
• all plan participants
• all NHCEs on Recipient payroll only.

Section 414(n)(5)(C) defines the nonhighly compensated workforce for this purpose.^[1]

The Workforce Denominator Includes Leased Employees

The statutory denominator generally includes non-HCE individuals who are:^[1]

• recipient employees who have performed substantially-full-time service for the required period
• leased employees, determined without applying the safe harbor.

That means the very workers being tested remain part of the percentage calculation.

You cannot remove the safe-harbor workers first and then calculate whether the safe harbor applies.

Example: Safe Harbor Passes at 20%

Recipient's applicable NHCE workforce:

• 80 qualifying direct NHCE employees
• 20 qualifying leased NHCE employees

Total:

100

Leased share:

20 ÷ 100 = 20%

Because the statute uses not more than 20%, a result of exactly 20.00% still satisfies this numerical gate.^[1]

The workforce percentage condition can be satisfied at exactly 20%, assuming the leasing-organization plan also qualifies.

Example: Safe Harbor Fails at 25%

Recipient has:

• 60 qualifying direct NHCE employees
• 20 qualifying leased NHCE employees

Total:

80

Leased percentage:

20 ÷ 80 = 25%

The workforce condition fails.

Even a perfect 10% money purchase pension plan at LeasingCo does not repair the 25% result.

Both safe-harbor gates must pass.

HCEs Do Not Drive the 20% Denominator the Same Way

The safe-harbor workforce calculation is specifically based on the recipient's:

nonhighly compensated workforce.^[1]

INV-084 explains HCE status.

A sponsor that simply divides:

all leased workers ÷ all workers

can calculate the wrong percentage.

Classify HCEs before calculating the safe-harbor workforce ratio.

The Plan Document Must Address Leased Employees

When an organization uses leased employees, IRS plan-review guidance expects the recipient's plan to specify how those workers are treated.^[4]

The document should not leave the issue to an annual spreadsheet.

Review provisions addressing:

• employee definition
• leased employees
• service credit
• exclusions
• benefits provided by leasing organization.

A plan can fail operationally by administering leased workers differently from its written terms.

PEO Arrangements Need Two Separate Questions

A Professional Employer Organization can provide:

• payroll
• tax administration
• HR support
• benefits
• workers' compensation
• co-employment services

Do not assume:

PEO worker automatically falls within Section 414(n)

Ask first:

Question 1

Who is the worker's common-law employer?

If common-law principles already make the worker an employee of Recipient, the statutory Section 414(n) definition is not the classification tool.

Question 2

If common-law principles do not establish employment with Recipient, does Section 414(n) apply?

The PEO agreement does not answer both questions automatically.

Common-Law Employee Beats the Leasing Label

IRS Publication 560 makes the priority clear: when the service relationship already creates common-law employment with Recipient, the worker is treated as Recipient's employee for retirement-plan purposes regardless of the leasing organization's pension arrangement.^[3]

That means the Section 414(n)(5) safe harbor cannot be used to make a true common-law employee disappear from the recipient's employee population.

Classification comes before safe harbor.

Independent Contractor Is Another Separate Question

A correctly classified independent contractor does not automatically fall within Section 414(n).

A worker labeled as an independent contractor can still be an employee of Recipient under common-law principles.

The analysis therefore has three possible routes:

Route 1

Common-law employee of Recipient

Route 2

Not a common-law employee, but treated as an employee under Section 414(n)

Route 3

Neither

The invoice label does not select the route.

Leased Employee vs Affiliated Service Group

INV-091 explains Section 414(m).

The distinction is structural.

Affiliated service group

Asks whether organizations should be treated as one employer.

Leased employee

Asks whether a person supplied through another organization should count in the recipient's employee population for specified requirements.

A staffing relationship can raise both issues.

Passing the ASG analysis does not decide Section 414(n).

Leased Employee vs Controlled Group

INV-090 explains Sections 414(b) and 414(c).

A controlled group aggregates employees because the businesses are under common control.

Section 414(n) can count a worker even when:

• recipient does not own the staffing company
• staffing company does not own recipient
• no controlled group exists.

Ownership between the companies is not a Section 414(n) requirement.

The Recipient's Related Businesses Can Still Matter

Section 414(n)(6) incorporates related-person rules and applies Sections:

• 414(b)
• 414(c)
• 414(m)
• 414(o)

to the employee-leasing analysis.^[1]

So the leased-employee test does not exist in isolation from controlled-group and affiliated-service-group rules.

A worker's service across related recipients can matter.

Section 415 Can Be Affected

Section 415 contribution and benefit limits are explicitly among the requirements covered by Section 414(n).^[1][2]

If a leased worker receives retirement benefits from LeasingCo attributable to Recipient service, those benefits can have to be considered in Recipient's Section 415 analysis.^[1]

A plan sponsor cannot assume:

"That contribution was made by another company, so it is outside our limit."

Section 414(n) was written to prevent exactly that kind of blind spot.

Vesting Service Can Be Affected

Section 411 is also covered.^[1][2]

Service that qualifies under Section 414(n) can therefore matter to vesting.

The initial one-year threshold does not mean prior qualifying service can be discarded forever.

Section 414(n)(4) specifically requires certain earlier service to be taken into account once the person is treated as an employee.^[1]

Top-Heavy Testing Can Be Affected

Section 416 is on the list.^[1][2]

INV-086 explains top-heavy testing.

Leased employees can change:

• employee population
• compensation data
• key/non-key analysis
• contribution treatment.

The impact depends on the facts.

The first step is recognizing that the worker exists in the statutory employer population.

ADP and ACP Effects Often Arrive Through Coverage and Eligibility

Section 414(n)(3) reaches the qualification provisions that underpin 401(k) nondiscrimination and coverage.^[1]

In practice, failing to identify leased workers can affect:

• who should have been considered for coverage
• who had service for eligibility
• which employees enter plan testing
• which benefits provided by LeasingCo need to be credited.

INV-087 and INV-088 explain the ADP and ACP calculations themselves.

Section 414(n) determines whether the data file feeding those tests is complete.

The One-Year Threshold Creates a Monitoring Problem

Temporary staffing is easy to ignore.

Long assignments are not.

A worker can start as:

"three-month temporary help"

then remain:

• six months
• nine months
• thirteen months
• two years.

The legal analysis can change while the contract name stays the same.

A year-end census should therefore track service duration, not only employment category.

Example: Temp Becomes a Section 414(n) Issue

Worker starts:

October 1, 2025

Expected duration:

90 days

Assignment repeatedly extended.

By September 30, 2026, worker has completed a qualifying 12-month substantial-full-time period.

Recipient controls:

• schedule
• location
• tasks
• supervision
• sequence.

The worker may now satisfy Section 414(n) even though the HR system still says:

TEMP

A stale status code is not a legal conclusion.

Direction or Control Can Change Mid-Assignment

The relationship can change even if hours do not.

First six months

Vendor supervises worker independently.

Next twelve months

Recipient absorbs worker into its operating team and directs daily work.

The direction-or-control analysis should reflect the actual period and facts.

Do not assume the relationship established on day one remains unchanged.

A Useful Annual Leased-Worker Census

For every worker supplied by another organization, capture:

A staffing invoice alone cannot supply most of that information.

What the IRS Would Ask For

Revenue Procedure 2026-4 gives a useful due-diligence checklist for employers seeking a formal leased-employee determination.^[5]

IRS asks for:

• description of Recipient's business
• leasing agreements
• functions performed by leased employees
• substantially-full-time service data
• direction/control facts
• details about leasing-organization retirement plans being relied upon.^[5]

The direction/control submission specifically asks about:

• when
• where
• how
• particular persons
• supervision
• work sequence.^[5]

That is a strong template even when the employer is not requesting a determination letter.

A Determination Letter Is Not Permanent Protection

IRS's 2026 procedure states that a leased-employee determination is based only on the facts submitted at the time.

The employer remains responsible for determining later whether Section 414(n) continues to apply.^[5]

That is important.

A favorable old determination does not immunize a changed workforce arrangement.

If:

• service hours change
• supervision changes
• supplier changes
• safe-harbor plan changes
• workforce percentage changes

the conclusion can change.

Safe Harbor Must Be Rechecked

Assume LeasingCo satisfied the 10% money-purchase-plan requirements last year.

This year:

• plan design changes
• vesting changes
• participation changes
• leased workers grow from 18% to 24% of Recipient's NHCE workforce.

The old safe-harbor conclusion no longer answers the current year.

Both the leasing plan and workforce percentage need monitoring.

A Recipient Should Not Outsource the Legal Population Question

The staffing company knows:

• who it pays
• its retirement plan
• assignment dates.

Recipient knows:

• who supervises the worker
• how work is directed
• related entities
• actual job role
• whether the person became integrated into operations.

The TPA knows:

• plan terms
• testing mechanics
• correction rules.

No one party has every fact automatically.

The recipient has to assemble the file.

Frequently Asked Questions

What is a leased employee for 401(k) purposes?

The rule generally applies when the person is not already employed by Recipient under common-law principles, works through an agreement with a leasing organization, completes the required full-year service threshold, and is principally directed or controlled by Recipient.^[1][3]

Does the staffing company issuing my W-2 mean I am a leased employee?

Not by itself. Payroll source does not establish Section 414(n) status.

What if common-law rules already establish employment with Recipient?

Then common-law employee status controls. Section 414(n) is not a mechanism for converting that person into a nonemployee.^[3][4]

What counts as substantially full time?

IRS administrative guidance treats the substantial-full-time requirement as satisfied when the worker completes at least 1,500 hours in the relevant 12-month period or reaches at least 75% of the customary annual hours for that position.^[4]

Is the leased-employee threshold 1,000 hours?

No. The 1,000-hour concept used in other retirement-plan eligibility rules is not the Section 414(n) substantial-full-time benchmark.

How does the recipient-control requirement work?

It is a facts-and-circumstances test focusing on whether the recipient exercises the majority of direction or control over the services, including instructions about when, where and how work is performed, supervision and work sequence.^[4][5]

Does the recipient have to hire or fire the worker?

IRS administrative guidance says hire/fire authority is generally not the decisive factor in the Section 414(n) direction-or-control analysis.^[4]

When does the leased worker first enter Recipient's employee population?

Section 414(n) treatment generally applies after the worker completes the required substantially-full-time period, although prior qualifying service can later count for service-credit purposes.^[1]

Does a leased employee automatically have to join the recipient's 401(k)?

No. The worker must be treated correctly for the applicable qualification rules, but the recipient plan can still satisfy coverage without covering every leased employee depending on plan design and demographics.^[4]

Can benefits from the staffing company count?

Yes. Contributions or benefits provided by the leasing organization that are attributable to services for the recipient are treated as provided by the recipient for the applicable Section 414(n) rules.^[1][3]

What is the leased-employee safe harbor?

For specified qualified-plan requirements, the exception can apply only if the leasing organization maintains the prescribed money purchase pension plan and the recipient stays within the statutory workforce-composition ceiling.^[1][3]

Is a staffing-company 401(k) enough?

Not automatically. The statutory safe harbor generally requires a nonintegrated money purchase pension plan with at least a 10% employer contribution, immediate participation and full immediate vesting.^[1]

Is exactly 20% allowed?

Yes. The statutory phrase is not more than 20%, so a 20.00% leased-worker share passes that numerical condition; 20.01% does not.^[1]

Does the 20% test use total workforce?

No. It uses the specially defined nonhighly compensated workforce under Section 414(n)(5)(C).^[1]

Is a PEO worker automatically a leased employee?

No. Common-law employment must be analyzed first, followed by Section 414(n) if the worker is not already Recipient's employee.

Is a leased employee the same as an affiliated-service-group employee?

No. Section 414(m) asks whether organizations are aggregated. Section 414(n) asks whether a particular worker is deemed an employee of the service recipient for specified requirements.

Can controlled-group relationships affect leased-employee analysis?

Yes. Section 414(n)(6) incorporates related-person and employer-aggregation rules that can make service to related recipients relevant.^[1]

Can the IRS issue a determination on leased-employee status?

Yes, in qualifying circumstances through the determination-letter procedures described in Revenue Procedure 2026-4. IRS requires the employer to request the determination and supply detailed facts.^[5]

Does an IRS determination settle future years permanently?

No. IRS states that the employer remains responsible for determining continuing Section 414(n) status when facts change.^[5]

The Worker Review to Run Before Annual Testing

For every long-term worker outside direct payroll, answer in order:

1. Is this person already our common-law employee?
2. Who is the leasing or staffing organization?
3. What agreement supplies the worker?
4. How many hours has the worker performed in each 12-month period?
5. What are customary hours for this position?
6. Who directs when, where and how the work is done?
7. Who supervises and sequences the work?
8. Has service been performed for related recipients?
9. What retirement benefits does the leasing organization provide?
10. Does the Section 414(n)(5) safe harbor actually satisfy both its plan-design and 20% workforce tests?
11. How does our own plan document treat leased employees?

Only then send the census to the TPA.

A worker can be absent from payroll and still belong in the retirement-plan analysis.

Sources & References

1. 26 U.S.C. §414(n) — Employee Leasing
2. IRS: 401(k) Plan Qualification Requirements
3. IRS Publication 560: Retirement Plans for Small Business
4. IRS Publication 7003: Leased Employee Worksheet and Explanation
5. IRS Revenue Procedure 2026-4: Determination of Leased Employee Status
6. IRS: Defined Contribution Listing of Required Modifications
7. IRS Publication 6088: Defined Contribution Plan LRM

Educational Disclaimer

ROIStreet publishes educational content about retirement-plan employee classification and compliance. This article is not legal, tax, employment, fiduciary or plan-administration advice. Leased-employee status depends on common-law employment, service agreements, hours, direction and control, related employers, leasing-organization benefits, plan terms and current law.

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