When a temporary worker's staffing contract is renewed until the worker becomes a 'leased employee,' can the agency stop charging Connecticut sales tax on the worker's wages and benefits?

Plain-English summary

A company hired workers through personnel agencies. The workers did the kind of jobs the company would normally fill with its own full-time employees, and although the agency contracts started as three- or six-month engagements, the company renewed them — so some workers ended up providing full-time services for a year or more.

In Connecticut, an agency providing personnel services makes a taxable "sale" under § 12-407(2)(i)(C), and the tax normally applies to the whole charge, including the worker's compensation and employment-related expenses (§ 12-407(8) and (9)). But a 1993 law change (1993 Conn. Pub. Acts 332, § 28) added an exclusion: for "leased employees," the agency's separately stated employee costs — compensation, fringe benefits, workers' compensation, and payroll taxes — come out of the taxable base. The question was when that exclusion kicks in for a worker who only becomes a leased employee partway through.

DRS anchored the answer in the federal definition. A "leased employee" under 26 U.S.C. § 414(n) is someone who has performed services for the recipient on a substantially full-time basis for at least one year (among other conditions), and § 414(n)(4) says that status is determined after that one-year period closes. So:

• During the first year, the worker is not yet a leased employee. The agency is providing taxable personnel services, and the full charge — including the employee's wages and benefits — is subject to sales and use tax.
• After the worker crosses the one-year, substantially-full-time threshold and becomes a leased employee, the agency may exclude the separately stated compensation, fringe benefits, workers' compensation, and payroll taxes from "sales price" and "gross receipts."

Crucially, the shrinking of the tax base is prospective only — "the measure of the tax will change after the first year elapses, but it will not change retroactively." (The one-year clock can include time the person worked full-time as the recipient's own direct employee before moving to the agency; see I.R.S. Notice 84-11.)

What this means for you

Staffing and employee-leasing agencies

You can only strip a worker's separately stated wages and benefits out of your Connecticut taxable receipts once that worker actually qualifies as a leased employee — i.e., after a full year of substantially full-time service for the client. Until then, tax the full charge. And you must separately state those employee costs to exclude them. Don't apply the exclusion retroactively to the first year.

Companies that use long-term temps

Understand the timing: for roughly the first year of a renewed engagement, expect Connecticut sales tax on the entire staffing charge, including the worker's pay and benefits. After the worker becomes a leased employee, the taxable portion should drop to essentially the agency's markup/service fee, with the pass-through employee costs excluded if separately stated.

Accountants and payroll/tax professionals

Track each worker's start of substantially-full-time service (including any prior stint as the client's direct employee, per I.R.S. Notice 84-11) to pinpoint the one-year mark. The exclusion is a creature of the 1993 amendment effective July 1, 1993, and applies only to leased employees as defined in § 414(n). This Ruling clarifies Policy Statement 93(3.1).

Common questions

Q: When can the agency stop charging sales tax on a worker's wages and benefits?
A: Only after the worker becomes a "leased employee" — at least one year of substantially full-time service for the client. Before that, the agency's full charge, including wages and benefits, is taxable personnel services.

Q: Does qualifying as a leased employee wipe out the tax on the first year?
A: No. The change is prospective. The first year's charges stay taxable; only charges for services performed after the worker qualifies get the exclusion.

Q: What has to be separately stated?
A: The compensation, fringe benefits, workers' compensation, and payroll taxes paid to or on behalf of the leased employee. Those separately stated items are excluded from "sales price" and "gross receipts" once the worker qualifies.

Q: Can time the person worked directly for the client count toward the year?
A: Yes. Per I.R.S. Notice 84-11, the one-year period can include substantially full-time work done as the client's own direct employee before the person moved onto the agency's payroll to do the same job.

Citations and references

Statutes and regulations:

• Conn. Gen. Stat. § 12-407(2)(i)(C) (employment-agency / personnel services taxable)
• Conn. Gen. Stat. § 12-407(8), (9) ("sales price" / "gross receipts" include employee compensation and employment-related expenses unless excluded)
• Conn. Agencies Regs. § 12-426-27(b)(3)(c) (definition of "personnel services")
• 1993 Conn. Pub. Acts 332, § 28 (leased-employee exclusion)
• 26 U.S.C. § 414(n) (leased employee); § 414(n)(2)(B) (one-year, substantially full-time test); § 414(n)(4) (status determined after the period)

Related guidance (described in prose, not linked):

• Policy Statement 93(3.1) (clarified by this Ruling; providers of leased employees are personnel-service agencies under § 12-407(2)(i)(C))
• I.R.S. Notice 84-11, 1984-2 C.B. 469 (counting prior direct-employment toward the one-year period)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 94-18

Original ruling text

Ruling 94-18, Sales and Use Taxes / Personnel Services / Leased Employees

FACTS:

The Company engages personnel agencies that provide individuals to perform services for the Company. The services rendered by such individuals are of a type historically performed, in the Company's business field, by employees on substantially a full-time basis.

Pursuant to its contracts with the personnel agencies, the Company generally receives the services of the individuals for three- or six-month periods. The contracts are subject to renewal. The Company has renewed, and intends to renew in the future, some of these contracts so that some of the individuals have or will provide services on a substantially full-time basis for a period of one year or more.

ISSUE:

Whether the amounts charged for separately stated compensation, fringe benefits, workers' compensation, and payroll taxes or assessments paid to or on behalf of individuals who initially are contracted to provide services for periods of less than one year, but whose contracts with the Company are renewed so that subsequently they qualify as "leased employees" under 26 U.S.C. § 414(n), are excluded from the measure of "sales price" and "gross receipts" as defined in Conn. Gen. Stat. §12-407(8) and (9), respectively, with regard to the services performed after such individuals qualify as "leased employees."

DISCUSSION:

Conn. Gen. Stat. §12-407(2)(i)(C) provides that for purposes of the Sales and Use Taxes Act, "sale" and "selling" mean and include "services by employment agencies and agencies providing personnel services ..." Conn. Agencies Regs. § 12-426-27(b)(3)(c) provides that "'personnel services' mean and include furnishing temporary or part-time help to others by means of employing such temporary and part-time help directly."

Under Conn. Gen. Stat. §12-407(8) and (9), "sales price" and "gross receipts" include "all compensation and all employment related expenses, whether or not separately stated, paid to or on behalf of employees of a retailer of any service described in [Conn. Gen. Stat. §12-407(2)(i)] . . . " unless specifically excluded. Section 28 of 1993 Conn. Pub. Acts 332 amended Conn. Gen. Stat. §12-407(8) and (9) to exclude from the measure of sales and use taxes for employee leasing all separately stated employee-related expenses of the service provider for all employees who qualify as "leased employees" under the definition in 26 U.S.C. § 414(n).

A leased employee is defined generally in 26 U.S.C. § 414(n) as an employee of a service provider who provides services to a service recipient, if (a) such services are performed pursuant to an agreement between the service provider and the service recipient, (b) the employee has performed such services for the service recipient (or for the recipient and related persons) on a substantially full-time basis for a period of at least one year, and (c) such services are of a type historically performed, in the business field of the service recipient, by employees. See 26 U.S.C. § 414(n)(2)(B). Providers of leased employees are agencies providing personnel services under Conn. Gen. Stat. §12-407(2)(i)(C). See Policy Statement 93(3.1), p. 3 of 4.

Section 414(n)(4) of the Internal Revenue Code indicates that whether an employee is a leased employee is determined " after the close of the period referred to in [26 U.S.C. § 414(n)(2)(B)] ..." (Emphasis added.) Therefore, an employee cannot become a "leased employee" until after the close of a period of at least one year of substantially full-time work for the service recipient. (This one-year period may include substantially full-time work performed by an individual employed directly by the service recipient, who later becomes employed by the service provider to provide the same services for the same service recipient. See I.R.S. Notice 84-11, 1984-2 C.B. 469.)

Accordingly, when the Company initially contracts to receive a personnel service for less than one year, but through extensions of the contract the agency's employee provides services to the Company on a substantially full-time basis for one year, the agency's employee becomes a "leased employee." During that employee's first year, the agency is providing taxable personnel services under Conn. Gen. Stat. §12-407(2)(i)(C) and continues to provide personnel services thereafter. The measure of the tax will change after the first year elapses, but it will not change retroactively.

Therefore, on or after July 1, 1993, amounts charged by the agency to the Company for separately stated compensation, fringe benefits, workers' compensation and payroll taxes or assessments paid to or on behalf of a leased employee may be excluded from "sales price" and "gross receipts."

RULING:

Amounts charged for separately stated compensation, fringe benefits, workers' compensation, and payroll taxes or assessments paid to or on behalf of individuals who initially are contracted to provide services for periods of less than one year, but whose contracts with the Company are renewed so that subsequently they qualify as "leased employees" under 26 U.S.C. §414(n), are excluded from the measure of "sales price" and "gross receipts" as defined in Conn. Gen. Stat. §12-407(8) and (9), respectively, with regard to the services performed after they qualify as "leased employees." Accordingly, such separately stated items are not subject to sales and use taxes under Conn. Gen. Stat. §12-407(2)(i)(C).

This Ruling clarifies Policy Statement 93(3.1).

LEGAL DIVISION

September 26, 1994