[Federal Register Volume 74, Number 211 (Tuesday, November 3, 2009)]
[Rules and Regulations]
[Pages 56699-56702]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-26229]



13 CFR Part 126

RIN 3245-AF44

HUBZone and Government Contracting

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.


SUMMARY: This rule amends the U.S. Small Business Administration's 
(SBA's or Agency's) Historically Underutilized Business Zone (HUBZone) 
program's definition of the term ``employee.''

DATES: This rule is effective May 3, 2010.

FOR FURTHER INFORMATION CONTACT: Mariana Pardo, HUBZone Program Office, 
at (202) 205-2985 or by e-mail at: [email protected].

    On January 26, 2007, the SBA published in the Federal Register, 72 
FR 3750, a proposed rule to amend the HUBZone program's definition of 
the term ``employee.'' In this proposed rule, SBA sought to revise the 
definition of the term ``employee'' to: (1) Delete the full-time 
equivalency requirement; (2) specifically allow HUBZone small business 
concerns (SBCs) to count leased or temporary employees or employees 
obtained through a temporary agency, professional employee organization 
(PEO) arrangement or union agreement, as employees; (3) specifically 
state that SBA relies on the totality of circumstances as further 
defined by Size Policy Statement No. 1 when determining whether 
individuals are employees of a concern; (4) explain that volunteers are 
not employees; (5) define volunteers as those persons that receive no 
compensation; and (6) address the status of individuals that own all or 
part of the SBC but receive no compensation for work performed.
    The SBA received a total of eight comments on the proposed rule. 
Five comments supported the rule in general and three opposed the rule. 
These comments are discussed in detail below.

Summary of Comments and Response to Comments

    The SBA received one comment stating that the definition of the 
term ``employee'' should specifically address the issue of deferred 
compensation. The commenter wanted the SBA to clarify that a person 
that has agreed to defer his or her compensation will not be considered 
an employee.
    The SBA agrees with this comment and believes that if it permitted 
a non-owner individual to work for no compensation, or even deferred 
compensation, and be considered an employee for HUBZone program 
purposes, it would open up the program to potential abuse. Finding a 
person to be an employee where the individual has deferred compensation 
is contrary to the intent of the HUBZone program, which is to increase 
gainful employment in historically

[[Page 56700]]

underutilized business zones. Further, we note that the issue regarding 
deferred compensation was actually the subject of a recent Court of 
Federal Claims decision. In that case, the court ruled that SBA's 
interpretation of its regulation--that persons who have agreed to defer 
his or her compensation will not be considered an employee for HUBZone 
program purposes--is reasonable. Aeolus Systems, LLC v. United States, 
No. 07-581 C, slip op. (Fed. Cl. Oct. 31, 2007). Consequently, the SBA 
agrees with this comment, and has clarified the rule to specifically 
address deferred compensation.
    Another commenter recommended deleting the specific language in the 
proposed rule that refers to ``professional employee organization'' 
(PEO) and replacing it with the phrase ``or co-employed pursuant to a 
professional employer organization arrangement.'' The comment stated 
that the purpose of this amendment is to distinguish PEOs from leasing 
and temporary employment companies or agencies. According to the 
comment, with respect to PEOs, the PEO and the small business client 
co-employ the employees; in comparison, temporary agencies or leasing 
companies supply a pool of labor to the clients and the workers return 
to the temporary agency or leasing company for reassignment upon 
termination of the arrangement. The SBA agrees with this comment and 
has made the recommended change.
    In addition, the same commenter was concerned about references in 
the preamble to the proposed rule concerning SBA's Size Policy 
Statement and ``payment of wages.'' In the preamble to the proposed 
rule, the SBA explained that because of the numerous types of 
agreements in the public domain concerning temporary, leased, and co-
employees, SBA cannot state definitively that each of those types of 
employees are employees of the HUBZone SBC. 72 FR 3752. Therefore, the 
SBA will look to the totality of circumstances, including whether the 
HUBZone SBC pays the employees' wages. Id.
    The comment stated that the ``W-2 employer'' should not be the 
determinative factor in deciding who employs a worker. Specifically, 
with respect to PEOs, the commenter states that the client small 
business provides the payroll to the PEO, who in turn pays the 
employees. The SBA agrees, and the ``W-2 employer'' is not the 
determinative factor. As the comment noted, with respect to PEOs, the 
small business client provides the funding for the employees' wages 
when it provides the payroll to the PEO, who in turn remits payment to 
the co-employees. As explained in Size Policy Statement No. 1, the SBA 
will review many factors, including whether the HUBZone SBC pays the 
employees wages and/or withholds employment taxes and/or provides 
employment benefits. 72 FR at 3753. Consequently, the SBA does not 
believe any change to the proposed rule or other clarification is 
necessary to address this comment.
    The SBA received three comments opposing the proposal to count 
workers obtained through unions as employees of the HUBZone SBC and one 
comment specifically supporting the rule. One comment from a union 
stated its belief that the rule will prevent companies from using union 
workers and that the SBA does not have a sufficient basis for this 
proposal. Similarly, another commenter stated its belief that the rule 
will prevent small businesses from using unions because unions can not 
control the residency of the union members.
    The definition of the term ``employee'' includes all persons 
employed by a HUBZone SBC. With respect to union workers, the workers 
are performing work for the HUBZone SBC, not the union. The HUBZone SBC 
pays the wages of these employees and controls the employees' work. In 
at least one private letter ruling, the IRS has stated that ``when 
working on the targeted jobs, the workers are employees of the 
contractors for whom they perform services. They are not employees of 
the Union.'' I.R.S. Priv. Ltr. Rul. 91-06-047 (Nov. 15, 1990). The same 
is true here--the workers are employees of the HUBZone SBC for whom 
they perform services and are not employees of the union. In addition, 
if a HUBZone SBC were allowed to utilize union workers and not count 
them as employees, it would be inconsistent with SBA's treatment of 
other similar types of workers, including temporary workers and those 
provided via a PEO arrangement. Thus, the definition of the term 
employee includes those workers provided by a union and who perform 
services for the qualified HUBZone SBC.
    One commenter opposed the rule in general and believes that SBA has 
no basis to support the finding that any change is needed in the 
definition of the term ``employee'' to prevent abuse. This same 
commenter believes that the proposed rule creates uncertainty in who is 
counted as an employee and that the totality of circumstances test as 
proposed is different than the current test. This commenter believes 
that the rule will harm smaller businesses that can not maintain a 
large staff to meet the requirements of the program. In sum, the 
commenter believes that more time is needed before making a change to 
this definition.
    The SBA disagrees with this comment. First, the totality of 
circumstances test has been in the SBA rule since the inception of the 
program. 63 FR 31896, 31909 (June 11, 1998). Second, at least one court 
has affirmed the SBA's use of this test and ruled that SBA's 
incorporation of relevant factors from a previous policy statement into 
the regulation's ``totality of circumstances'' test is not erroneous or 
contrary to controlling statute or regulation. See Metro Machine Corp. 
v. SBA, 305 F.Supp.2d 614 (E.D. VA 2004). Finally, the agency has been 
reviewing the definition of the term employee for several years now, 
beginning with a proposed rule in 2002. The SBA has received a 
relatively few number of comments evidencing to the Agency that the 
proposal is acceptable to most HUBZone SBCs (who have now had 3 
opportunities to formally comment on the issue). The SBA has conducted 
thousands of program examinations and re-certifications and has 
examined this issue thoroughly. The SBA believes that it has a 
reasonable basis to support a change in the regulation, as set forth in 
the proposed and this final rule.
    One comment stated that the SBA should not allow employees working 
only 40 hours a month to be considered employees for HUBZone program 
purposes because such a rule would promote abuse and more non-HUBZone 
residents would end up getting higher paying full-time work. In 
contrast, one commenter specifically agreed with the proposed minimum 
of 40 hours per month. As explained in the proposed rule, the SBA 
believes that the 40 hours per month requirement precludes a firm from 
receiving HUBZone status if it merely hires a few HUBZone residents to 
work one or two hours a week. SBA believes that this minimum work 
requirement (40 hours a month) provides flexibility to the HUBZone SBCs 
and the employees who choose to work part-time, but at the same time 
minimizes possible abuses of the rule. The SBA notes that in order to 
determine whether an employee works 40 hours a month, the Agency will 
rely on the most recent payrolls of the small business.
    The SBA received two comments concerning the effect this rule will 
have on current HUBZone program participants and those participants 
that have already submitted an offer or are getting ready to submit an 
offer. One of these commenters suggested the SBA provide for a phase in 
period of one year for those firms that currently use leased

[[Page 56701]]

employees. After reviewing these comments, the SBA has provided for an 
effective date of this rule 6 months from its date of publication in 
the Federal Register. The SBA believes this would be sufficient time 
for HUBZone small businesses to make any necessary changes to address 
the new definition of the term employee.

Compliance With Executive Orders 12866, 12988, and 13132, the Paperwork 
Reduction Act (44 U.S.C. Ch. 35), and the Regulatory Flexibility Act (5 
U.S.C. 601-602)

    SBA has determined that this rule does not impose additional 
reporting or recordkeeping requirements under the Paperwork Reduction 
Act, 44 U.S.C., chapter 35. Further, this rule meets applicable 
standards set forth in section 3(a) and 3(b)(2) of Executive Order 
12988, Civil Justice Reform, to minimize litigation, eliminate 
ambiguity, and reduce burden. This action does not have retroactive or 
preemptive effect.
    OMB has determined that this rule constitutes a ``significant 
regulatory action'' under Executive Order 12866 and in the proposed 
rule, the SBA prepared a Regulatory Impact Analysis. The SBA received 
no comments on this analysis and continues to believe that our analysis 
is accurate.
    This rule will not have substantial direct effects on the States, 
on the relationship between the Federal government and the States, or 
on the distribution of power and responsibilities among the various 
levels of government. Therefore, for the purposes of Executive Order 
13132, SBA determines that this rule has no federalism implications 
warranting preparation of a federalism assessment.

Final Regulatory Flexibility Analysis for the HUBZone Regulations

    SBA has determined that this rule may have a significant economic 
impact on a substantial number of small entities within the meaning of 
the Regulatory Flexibility Act (RFA), 5 U.S.C. 601, et seq. In the 
proposed rule, the SBA prepared an Initial Regulatory Flexibility Act 
Analysis (IRFA). The SBA did not receive any comments on this IRFA. The 
RFA requires the SBA to prepare a Final Regulatory Flexibility Act 
Analysis (FRFA). The RFA provides that when preparing a FRFA, an agency 
shall address all of the following: A statement of the need for, and 
objectives of, the rule; a summary of the significant issues raised by 
the public in response to the IRFA; a description of the estimate of 
the number of small entities to which the rule will apply; a 
description of the projected reporting, recordkeeping and other 
compliance requirements; and a description of the steps taken to 
minimize the significant economic impact on small entities. This FRFA 
considers these points and the potential impact of the regulation on 
small entities.

(a) Need for, and Objectives of, the Rule

    SBA believes that the amendments to the definition of the term 
``employee'' will ease HUBZone program eligibility requirements 
perceived to be burdensome on concerns, and streamline the operation of 
the HUBZone Program.

(b) Summary of Significant Issues Raised by the Public in Response to 
the Initial RFA

    The SBA did not receive any comments on the IRFA. The SBA addressed 
all of the comments it received on the rule in the preamble, set forth 

(c) Estimate of the Number of Small Entities to Which the Rule May 

    The RFA directs agencies to provide a description of and, where 
feasible, an estimate of the number of small entities that may be 
affected by the rule. The RFA defines ``small entity'' to include 
``small businesses,'' ``small organizations,'' and ``small governmental 
jurisdictions.'' SBA's programs do not apply to ``small organizations'' 
or ``small governmental jurisdictions'' because they are non-profit or 
governmental entities and do not qualify as ``business concerns'' 
within the meaning of SBA's regulations. SBA's programs generally apply 
only to for-profit business concerns. Therefore, the regulation (like 
the regulation currently in effect) will not impact small organizations 
or small governmental jurisdictions.
    Small businesses that participate in Federal Government contracting 
are the specific group of small entities affected most by this rule. 
While there is no precise estimate for the number of SBCs that will be 
affected by this rule, there are approximately 368,000 SBCs registered 
in the Central Contractor Registration's (CCR's) Dynamic Small Business 
Search (DSBS) database (formerly known as PRO-Net). The DSBS contains 
profiles of SBCs that includes information from SBA's files and CCR. 
While there is no precise estimate for the number of SBCs that will be 
affected by this rule, SBA believes that over 30,000 SBCs will apply 
for certification as qualified HUBZone SBCs over the life of the 
program. This number is based upon 1992 census data, the number of 
HUBZone SBCs registered in CCR, and a reasonable extrapolation of this 
data to account for growth.
    In the past few years, SBA has received thousands of applications 
for the HUBZone Program and has certified over 10,000 SBCs into the 
program. SBA believes that the incentives available through 
participation in the program, i.e., HUBZone set-asides and price 
evaluation preferences, will result in additional SBCs relocating to 
HUBZones. SBA is unable to predict the number of SBCs that will 
relocate to HUBZones and be eligible for the program, but estimates 
that approximately 30,000 SBCs are now eligible or will become 
    Of the 30,000 SBCs that have a principal office located in a 
HUBZone, SBA believes that most will be directly affected by this rule. 
This is based on the fact that of the over 10,000 HUBZone SBCs listed 
in CCR, over 7,000 list services and construction as the general nature 
of their business. Thus, it appears that most qualified HUBZone SBCs 
are in those industries. According to the information received, SBCs in 
the construction and services industries use temporary and leased 
    The final amendment to the definition of the term employee will 
allow leased and temporary employees to be considered employees of a 
concern. These leased and temporary employees would be counted toward 
the 35% HUBZone residency and principal office requirements. At one 
point, such employees comprised approximately 2-5% of the work force in 
the U.S. economy. Labor Shortages, Needs, and Related Issues in Small 
and Large Businesses, Nov. 2, 1999 (report prepared for the Office of 
Advocacy) (available at: http://www.sba.gov/advo/research/rs195atot.pdf). In addition, the report stated that small businesses 
accounted for the employment of about 40% of such employees. Id. 
Although SBA does not know exactly how many SBCs eligible for the 
HUBZone Program use leased or temporary employees, this data further 
evidences that many concerns may be affected by this rule.

(d) Projected Reporting, Recordkeeping and Other Compliance 

    This final rule imposes no new reporting requirement on small 

(e) Steps Taken to Minimize the Significant Economic Impact on Small 

    SBA has decided that this rule will not take effect until six 
months after publication in the Federal Register.

[[Page 56702]]

This will allow HUBZone SBCs sufficient time to make any necessary 
changes to remain eligible for the program and for HUBZone contracts. 
SBA believes this will minimize the impact of this rule, if any, on 
HUBZone small businesses.

List of Subjects in 13 CFR Part 126

    Government procurement, Small businesses.

For the reasons set forth above, SBA amends 13 CFR part 126, as 


1. The authority citation for 13 CFR part 126 continues to read as 

    Authority: 15 U.S.C. 632(a), 632(j), 632(p) and 657a.

2. Amend Sec.  126.103 by revising the definition of the term 
``employee'' to read as follows:

Sec.  126.103  What definitions are important in the HUBZone program?

* * * * *
    Employee means all individuals employed on a full-time, part-time, 
or other basis, so long as that individual works a minimum of 40 hours 
per month. This includes employees obtained from a temporary employee 
agency, leasing concern, or through a union agreement or co-employed 
pursuant to a professional employer organization agreement. SBA will 
consider the totality of the circumstances, including criteria used by 
the IRS for Federal income tax purposes and those set forth in SBA's 
Size Policy Statement No. 1, in determining whether individuals are 
employees of a concern. Volunteers (i.e., individuals who receive 
deferred compensation or no compensation, including no in-kind 
compensation, for work performed) are not considered employees. 
However, if an individual has an ownership interest in and works for 
the HUBZone SBC a minimum of 40 hours per month, that owner is 
considered an employee regardless of whether or not the individual 
receives compensation.
* * * * *

    Dated: August 3, 2009.
Karen G. Mills,
[FR Doc. E9-26229 Filed 11-2-09; 8:45 am]