A company sold half its employees to a new, commonly-owned company and now leases those employees back at cost plus a markup — is that lease of employees exempt from sales tax as staff leasing?

Plain-English summary

A corporation with 75 employees ("Company A") set up a new, commonly-owned company ("Company B") at the start of 2000. Company A sold 50 of its 75 employees to Company B, and now leases those 50 employees back from Company B for cost plus a small markup. The taxpayer believed this lease of employees was nontaxable under Rule 3.364 (staff leasing services) and asked the Comptroller to confirm.

The Comptroller confirmed: the arrangement appears to qualify under Rule 3.364 relating to staff leasing services — but with two conditions:

1. The leasing company (Company B) must meet the legitimate staff-leasing-company requirements in Rule 3.364(a)(5).
2. Once that's met, the exemption also requires the client company (Company A) to satisfy the requirements of Rule 3.364(b)(1) — with a special provision in (b)(2) for client companies that have been in existence less than a year (relevant since Company A restructured at the start of 2000).

The letter adds an important safety-net point: failing these staff-leasing tests does NOT automatically convert an otherwise-nontaxable service into a taxable one. The example given: nontaxable new construction labor remains nontaxable even if the staff-leasing tests aren't satisfied — the staff-leasing rule only determines whether the employee lease itself qualifies for its own exemption, it doesn't retroactively tax unrelated nontaxable services.

Note on later law changes: effective August 28, 2016, the Tax Code's "staff leasing services" terminology was renamed "professional employer organization" and/or "professional employer services," following related Labor Code changes effective September 1, 2013 (83rd Legislature, Senate Bill 1286). This letter predates that rename and uses the older terminology throughout — confirm current Rule 3.364 (or its PEO successor) still applies the same substantive test before relying on this 2000-era guidance.

What this means for you

Businesses restructuring around a commonly-owned staffing entity

Selling employees to a related company and leasing them back can qualify as exempt staff leasing, but only if BOTH the leasing company and the client company independently satisfy their respective Rule 3.364 requirements — common ownership alone doesn't automatically qualify or disqualify the arrangement. Pay particular attention to the "less than a year" provision if your restructuring is recent.

Companies unsure whether they meet the staff-leasing tests

Even if you're not sure your arrangement passes Rule 3.364, don't assume that failure taxes everything else about your services — the letter is explicit that genuinely nontaxable services (like new construction labor) stay nontaxable regardless of the staff-leasing test outcome.

Accountants and tax professionals

Since this letter is from 2000 and uses now-outdated "staff leasing services" terminology (renamed to "professional employer organization/services" in 2016), verify the current version of Rule 3.364 or its PEO successor provisions before applying this letter's holding to a present-day arrangement.

Common questions

Q: Can I sell employees to a related company and lease them back tax-free?
A: Potentially yes, as exempt staff leasing under Rule 3.364 — but both the leasing company and the client company must independently satisfy their respective requirements under 3.364(a)(5) and (b)(1)/(b)(2).

Q: What if my client company has existed less than a year?
A: Rule 3.364(b)(2) has a specific provision for that situation — check it directly.

Q: If I fail the staff-leasing tests, does that make my other nontaxable services taxable?
A: No. Failing the staff-leasing tests doesn't convert normally nontaxable services (like new construction labor) into taxable ones.

Q: Does "staff leasing services" still mean the same thing today?
A: The terminology changed to "professional employer organization"/"professional employer services" effective August 28, 2016. Confirm the current rule's substance before relying on this 2000 letter.

Q: Can I rely on this letter for my own arrangement?
A: No. This opinion is based on the facts presented; additional or different facts may change this opinion.

Citations and references

Rules:

• 34 Tex. Admin. Code Rule 3.364 (staff leasing services / professional employer services)
• 34 Tex. Admin. Code Rule 3.364(a)(5) (legitimate staff-leasing-company requirements)
• 34 Tex. Admin. Code Rule 3.364(b)(1) (client company exemption requirements)
• 34 Tex. Admin. Code Rule 3.364(b)(2) (client companies in existence less than a year)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200003148L

Original ruling text

NOTE: Effective 08/28/2016, the Tax Code's reference to "staff leasing services" was changed to "professional employer organization" and/or "professional employer services" per related changes made to the Labor Code effective 09/01/2013 by the 83rd Legislative Session (2013), Senate Bill 1286.

March 29, 2000

To: **

<**>

Subject: Staff Leasing

Dear **:

Thank you for your e-mail regarding staff leasing services.

Situation: Company A is a corporation with 75 employees. At the beginning of

2000, Company B was created which is owned in part by owners of Company A.

Company A sold 50 of the original 75 employees to Company B. Company A now

leases the 50 employees from Company B for cost plus a small mark up.

Question: After a brief conversation with **, it appears the under

Section 3.364 of the law, that the lease of the employees is not taxable.

Please confirm based upon the above statements whether this is true or not.

Response: The above arrangement appears to qualify under Rule 3.364 relating

to staff leasing services. Please be aware that in order to be a legitimate

staff leasing service company, you must meet the requirements of Rule 3.364

(a)(5). Once that requirement is met, the staff leasing service will be exempt

from tax providing that the requirements of section (b)(1) are met. See

section (b)(2) concerning client companies that have been in existence less

than a year.

Please note that failing the above tests will not make normally nontaxable

services into taxable services. For example, nontaxable new construction labor

continues to be nontaxable even if the above tests are not met.

A copy of rule 3.364 can be found on the Window on State Government web site at

www.window.state.tx.us. After clicking on "Texas Taxes," click on "The Sales

Tax" to get to the Comptroller's rules. You will want to click on "State Sales

Tax" under the Current Tax Rules index to find the sales tax rules.

This opinion is based on the facts presented. Additional or different facts

may change this opinion.

If you have any questions, please call me at 1-800-531-5441, extension 5-9913.

You may also write Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Elias Amaya

Tax Policy Division

cc: **