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By Karen E. Klein

When Is an Employee not an Employee?
Second in a series on contract arrangements that blur the definition of staff

Tuesday's Smart Answers query from S.K. of Atlanta dealt with restrictions on granting options to so-called leased employees ("No, You Can't Give Leased Employees Incentive Stock Options," Business Week frontier Online, Jan. 4, 2000). This column will address the broader issues that arise under this increasingly common practice — placing staff on the payroll of a professional employer organization (PEO) to take advantage of administrative help and lower group insurance rates.

Staff leasing is controversial, and employment and legal experts disagree on its validity. PEOs defend the practice as benign — seeing it as an extended form of outsourced payroll processing. "Employee leasing is a great way for small businesses and other organizations to make sure that all the mandatory employee reports, insurance, and tax withholding is done by writing one check to their vendor," says Patty DeDominic, CEO of, a Los Angeles-based staffing agency that offers PEO contracts. "It enables a small-business person to focus on their core competency."

Others, including Kirk Maldonado, an attorney who specializes in employee benefits and executive compensation at the Los Angeles law firm of Riordan McKinzie, see staff leasing as a pernicious trend. Maldonado thinks the PEOs put employers at risk by aggressively pushing the limits of the law: "Virtually all of the leasing arrangements that I've seen for small employers stink," he says. Companies should be particularly wary of efforts to reclassify regular employees as contingent, or freelance, workers with the idea of escaping responsibility for paying employment taxes or pension benefits, Maldonado stresses. Such schemes beg for trouble from the IRS and state or federal labor agencies. Moreover, full-timers who feel the purpose is to cheat them of benefits may be inclined to sue.

"You see it a lot now in the high-tech arena," says Eli M. Kantor, a labor and employment attorney based in Beverly Hills, Calif. "Employers are turning to the contingent workforce to replace their regular workers and avoid paying worker's compensation and taxes, and to escape unionization and liability for employment discrimination. The problem is that if labor officials or the IRS look closely at companies doing this illegally, there will be substantial fines and penalties imposed, as well as legal exposure."

According to guidelines issued by the U.S. Supreme Court and the Equal Employment Opportunity Commission, a host of factors determine whether a worker is a full-fledged employee or an independent contractor, most having to do with who controls the employee's workplace, hours, performance, and job security. In most PEO situations, the staffing agency and the business that uses the workers are considered co-employers, the EEOC guidelines say, sharing responsibility and liability for the employees.

Employers should investigate the PEO's service record carefully and have the proposed contract reviewed by an attorney or CPA, Kantor recommends.

Read the fine print for hidden liabilities, says Richard Leisner, chair of the American Bar Assn.'s small-business committee and a corporate and securities lawyer with the Tampa-based law firm of Trenam Kemker. "Make sure you ask how the PEO will handle all aspects of its relationship with employees. If there's a sexual harassment lawsuit, for instance, how will the organization respond? Who's liable?" Adds Leisner: "You'll get a glossy brochure and a free steak lunch, and you'll get a contract. And the details in the last thing may be very different from what you get in the first two things."

You can get more information on staffing agencies and employee leasing at the Web sites of the National Association of Professional Employer Organizations (, and the American Staffing Assn. (

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