When a corporation restructures its employees into a partnership's general-partner entity to satisfy an employee stock purchase plan requirement, is that arrangement an exempt staff-leasing arrangement or a taxable one?

Plain-English summary

A corporation (Corporation A) was set to acquire the assets and liabilities of a Texas culinary school, previously run by a nonprofit, through a newly formed for-profit partnership. Corporation A had an employee stock purchase plan (ESPP) that, per its plan document and Internal Revenue Code § 423, could only include actual corporate employees — not partnership employees. To satisfy that requirement while still bringing the culinary school's staff on board, Corporation A proposed having the school's employees formally employed by the partnership's general partner, a separate corporation (Corporation B), rather than by the partnership itself. The former nonprofit employees would become Corporation B employees the day after the asset transfer closed, with Corporation B having no prior Texas nexus until that point.

The company argued its structure met the staff-leasing exemption in Rule 3.364: it believed it satisfied the shared-employment-relationship condition (b)(1)(B) and the definitional condition (b)(1)(C), plus the new-business exception in (b)(2)(A) since the client partnership had been operating less than a year.

The Comptroller agreed the company met the Rule 3.364(b)(1)(B) condition and the new-business exception in (b)(2)(A) — but disagreed that (b)(1)(C) was satisfied. That subsection requires "a shared employment relationship" between the client company and the staff leasing company as to the assigned employees. The company's own standard personnel agreement, however, stated on its page 5 that the service provider and the client are independent contractors — the opposite of a shared employment relationship. Rule 3.364(c) is explicit that staff leasing services do not include services performed by an independent contractor, regardless of whether that contractor is a licensed staff leasing company. The Comptroller also noted the company confirmed by phone that it was not a licensed staff leasing firm, and pointed it to the Texas Department of Licensing and Regulation for separate licensing questions.

What this means for you

Companies restructuring employment to meet ESPP or other plan requirements

Moving employees into a general-partner entity or similar structure to satisfy stock-plan or tax-code eligibility rules doesn't automatically create a tax-favorable staff-leasing arrangement. What matters for Rule 3.364 purposes is the actual legal relationship in your contract — if your own agreement labels the parties "independent contractors," that language alone can defeat the exemption regardless of your intent.

HR and benefits administrators

Watch for tension between employee benefit plan structuring (which may push toward a corporate-employer model) and sales tax staff-leasing rules (which require proof of a genuinely shared employment relationship, not an independent-contractor relationship). The two goals can pull in different directions in your contract drafting.

Accountants and tax professionals

The controlling text is Rule 3.364(a)(4)'s definition of "shared employment relationship" (a written-contract-and-in-fact sharing of employment responsibilities between client company and staff leasing company) versus (c)'s carve-out for independent contractors. Review the actual personnel agreement's characterization of the parties before assuming a staffing arrangement qualifies for exemption.

Common questions

Q: Does meeting some of Rule 3.364's conditions guarantee the staff-leasing exemption?
A: No — per this ruling, all applicable conditions must be met, including a genuine shared employment relationship. Failing just one condition (here, because the contract called the parties independent contractors) defeats the exemption.

Q: Does being a licensed staff leasing company automatically make an arrangement exempt?
A: No — Rule 3.364(c) excludes services performed by an independent contractor from staff leasing services regardless of the contractor's licensing status.

Q: Can another company restructuring for ESPP purposes rely on this letter?
A: No. This letter addresses one company's specific facts and contract language; a different personnel agreement describing a genuinely shared employment relationship could reach a different result.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.364 (Employee Staff Leasing Services), subsections (a)(4), (a)(5), (b)(1)(B)-(C), (b)(2)(A), (c)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200107381L

Original ruling text

July 17, 2001

Dear **:

Thank you for your letter concerning whether a proposed transaction would be
considered a staff leasing arrangement.

You ask if a proposed transaction would be subject to sales tax as staff
leasing services, and if you are required to register with the Department of
Labor as a staff leasing company?
Facts: CORPORATION A has been offered the opportunity to acquire the assets and
liabilities (only) of a culinary school in Texas. The school is currently run
by a not-for-profit entity. The current proposed structure would have a
for-profit partnership formed to acquire the assets and liabilities of the
school.
** (CORPORATION A) has an employee stock purchase plan. The plan
document has a requirement that all employees of CORPORATION A, and its
subsidiaries, be allowed to participate in the employee stock purchase plan
(ESPP). Internal Revenue Code Sec. 423. specifically allows that only employees
of corporations may participate. Therefore employees of partnerships may not
participate in ESPP's.
In order to meet the requirements of CORPORATION A's plan document, as well as
the Internal Revenue Service Code, CORPORATION A proposes that the employees of
the Texas culinary school be employed by the general partner in the
partnership, ** (CORPORATION B).
The partnership was formed in June of 2001. The transfer of assets is intended
to take place on July 31, 2001. The former employees of the not-for profit
entity will become employees of CORPORATION B on August 1, 2001. We intend to
keep a substantial majority of the employees at the culinary institute intact.
CORPORATION B does not currently have nexus in Texas but understands nexus will
exist on 8/1/01 if it hires the Texas culinary school employees.

You believe that you meet two of the three conditions to be exempt (paragraph
Rule 3.364(1)(B) and (C)) and also believe you may meet the exception as noted
in paragraph (2)(A) as the client company (the partnership) will have been in
operation for less than a year. A copy of your standard personnel agreement
(Exhibit A) was submitted with your request. This agreement would be entered
into between the CORPORATION B and the Texas culinary school.

Response. I agree that your firm meets the condition for exemption in Rule
3.364 (b)(1)(B) and meets the exception for new businesses noted in Section
(b)(2)(A). However, Section (b)(1)(C) states that "a shared employment
relationship exists between the client company and the staff leasing company as
to the assigned employees."

On Page 5 Section (c) of your contract, it states that the service provider and
the client are independent contractors. There is no evidence that a shared
employment relationship exists under this contract.

Rule 3.364 (c) states that "staff leasing services do not include services
performed by an independent contractor regardless of the status of the
contractor as a licensed staff leasing company."

Section (a)(4) defines a shared employment relationship as "an employment
relationship among an assigned employee, client company, and staff leasing
company in which by written contract and in fact the staff leasing company and
client company share employment responsibilities."

Section (a)(5) defines staff leasing company as "a business that offers staff
leasing services and is licensed under the Labor Code, Chapter 91, or a
business that offers staff leasing services but is exempt from the licensing
requirements of the Labor Code." In our phone conversation, you stated that
your firm is not a licensed staff leasing firm. If you wish to contact the
Texas Department of Licensing and Regulation concerning staff leasing
regulations, you can find their website as: http://www.license.state.tx.us/

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change. You may call me toll free at
1-800-531-5441, ext. 5-0613. The direct line is 512/475-0613. You may also
write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Kevin Koller
Tax Policy Division