Professional Employer Organization Pros And Cons

professional employer organization tax issues

Although the PEO administered the payroll, the IRS held that it was not in control of the payment of wages because it had not assumed legal responsibility for the payment of the wages to the employees. This is because the taxpayer was required to fund the payroll account prior to each payroll date and was also required to provide a letter of credit or security deposit naming the PEO as beneficiary. The PEO contract provided that the PEO could terminate the contract immediately without notice and that, in such event, the taxpayer would be responsible for payment of all wages, salaries and employment-related taxes. The employer/taxpayer entered into a contract with a professional employer organization to staff its workforce. Under the agreement, the taxpayer assumed the responsibility for the day-to-day supervision and control of the employees. The taxpayer was also required to deposit, one day prior to each payroll date, an amount equal to all wages, salaries and other amounts to be paid to or with respect to the employees.

professional employer organization tax issues

The PEO and client company share and allocate responsibilities and liabilities. The PEO assumes much of the responsibility and liability for the business of employment, such as risk management, human resource management, and payroll and employee tax compliance. The client company retains responsibility for and manages product development and production, business operations, marketing, sales, and service. The PEO and the client will share certain responsibilities for employment law compliance. As a co-employer, the PEO will often provide a complete human resource and benefit package for worksite employees. Proposed §1.199A-2 provides a rule for wages paid by a person other than the common law employer that is substantially similar to the rule in §1.199-2.

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(The PEO is responsible for paying these taxes whether or not the client actually pays the PEO.) The PEO also must provide employees with workers’ compensation, federal and state unemployment and statutory disability coverage. In addition, the PEO administers any employee benefit programs including retirement plans; cafeteria and health care plans; life, disability, accidental death and dismemberment insurance; credit unions; fitness club memberships; child care; and tuition reimbursement programs. MORE THAN EVER BEFORE, BOTTOM-LINE-CONSCIOUS companies are outsourcing HR functions by making use of professional employer organizations. PEOs perform a wide variety of tasks ranging from payroll management and employee benefit design and administration to tax filings and compliance with state and federal workplace legislation.

Recent data suggests that between 780 to 980 PEOs exist industry-wide and provide services for 156,000 to 180,000 clients. Even more staggering is the $136 billion to $156 billion in client payroll and PEO fees that make up the gross revenues of these PEOs. These PEOs, often referred to as “co-employers,” are generally responsible for the remittance of the taxpayer’s employment taxes as a part of the PEO’s payroll services. Once a client company contracts with a PEO, the PEO will then co-employ the client’s worksite employees. In the arrangement among a PEO, a worksite employee and a client company, there exists a co-employment relationship in which both the PEO and client company have an employment relationship with the worker.

professional employer organization tax issues

They offer businesses a wide variety of services—including payroll management, employee benefit design and administration, tax filing and administration and compliance with state and federal workplace legislation. PEOs also take responsibility for developing and administering lawful employment policies and procedures; employee recruitment and disciplinary actions; recordkeeping; and unemployment, disability and workers’ compensation claims and administration. A typical client of a PEO is a small or medium-sized business which chooses to outsource various human resource functions.

A PEO may also provide additional benefits based on economies of scale, such as managing human resources, employee benefits, workers’ compensation claims, and unemployment insurance claims. Congress is addressing the PEO’s responsibility to its workers for employment taxes and for other employee benefits such as 401 and other retirement plans. The Staffing Firm Worker Benefits Act , sponsored by Congressman Rob Portman (R-Ohio) and cosponsored by 65 other representatives, was referred to the House Committee on Ways and Means in June 1997 but has not yet come to the House floor. In addition, the legislation would enable client companies to recognize contributions a PEO makes to its benefit plan. Some states recognize them as “coemployers” since they assume certain legal rights and duties related to employees who work at client locations. (The IRS does not use the term coemployer—it recognizes PEOs as employers.) The rights and duties PEOs assume are set forth in a contract between the PEO and the client company. Typically, a PEO’s responsibilities include the general aspects of the employer’s role—for example, paying employee wages and associated withholding taxes.

Irs Provides Tax Guidance For Businesses Using A Professional Employer Organization

Through the use of a PEO relationship, client companies make a long-term investment in their workers, because in most cases, the PEO provides access to health insurance, retirement savings plans, and other critical employee benefits for their worksite employees. If a PEO relationship is terminated, the co-employees will cease to work for the PEO but will continue as employees of the client. By comparison, a leasing or staffing service supplies new workers on a temporary or project-specific basis. These leased employees return to the staffing service for reassignment after completion of their work with the client company. Some would define employee leasing as a supplemental, temporary employment arrangement where one or more workers are assigned to a customer for a fixed period of time, often for a specific project.

This concept creates little long-term equity or investment between the worker and customer.Some older statutes governing PEOs still use the leasing terminology. The IRS finalized regulations governing certified professional employer organizations , which allow employee leasing companies and other professional employer organizations to be solely liable for payroll taxes on wages they pay to their customers’ employees (T.D. 9860). The rules allow a CPEO to, in effect, be the employer for employment tax and payroll obligations, while the customer provides direction to and control over the employees and remains the common law employer for other purposes. The client retains ownership of the company and control over its operations. As co-employers, the PEO and client will contractually share or allocate employer responsibilities and liabilities.

The PEO is not a staffing service; its fundamental role is to provide human resource and benefits functions, not to provide workers. As for compensation, the PEO usually is paid either a percentage of payroll or on a per-employee basis.

Historically, the answer has depended upon a variety of situationally specific variables and changing laws regarding co-employment. Significantly, the IRS often found, and courts agreed, that the customer was the common law employer for purposes of tax liability and generally remained liable for the employment taxes, regardless of an arrangement between the customer and a PEO. In many cases, these laws would not apply to workers at small businesses without the PEO relationship, since many statutes have exemptions based upon the number of workers in a work force. Once included in the PEO’s workforce, the workers are protected by these laws. PEOs give small-group markets access to many benefits and employment amenities they would not have otherwise. The IRS disagreed, holding the taxpayer responsible for the unpaid employment taxes. In reaching this conclusion, the IRS noted that under Code Section 3401, if the common-law employer does not have control of the payment of wages, then for withholding and employment tax purposes, “employer” means the person having control over the payment of wages.

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In such cases, the person paying the W-2 wages and reporting the W-2 wages on Forms W-2 is precluded from taking into account such wages for purposes of determining W-2 wages with respect to that person. Persons that pay and report W-2 wages on behalf of or with respect to others can include certified professional employer organizations under section 7705, statutory employers under section 3401, and agents under section 3504. Under this rule, persons who otherwise qualify for the deduction under section 199A are not limited in applying the deduction merely because they use a third party payor to pay and report wages to their employees. However, with respect to individuals who taxpayers assert are their common law employees for purposes of section 199A, taxpayers are reminded of their duty to file returns and apply the tax law on a consistent basis.

professional employer organization tax issues

The PEO will generally only assume responsibilities and liabilities associated with a “general” employer for purposes of administration, payroll, taxes and benefits. The client will continue to have responsibility for worksite safety and compliance. The PEO will be responsible for payroll and employment taxes, will maintain employee records and reserves a right to hire and fire. Because the PEO also may be responsible for workers’ compensation, many PEOs also focus on and improve safety and compliance. In general terms, the PEO will focus on employment-related issues and the client will be responsible for the actual business operations. Professional employer organizations handle various payroll administration and tax reporting responsibilities for their business clients, and consider themselves to be a co-employer of their clients’ employees.

These functions include payroll, human resources administration, workers’ compensation, unemployment, and other benefits administration, tax administration and regulatory compliance. The PEO enters into a contract with the client pursuant to which they share employer responsibilities for the client’s worksite employees. The PEO and the client become co-employers of those worksite employees, and the respective rights and obligations of the PEO and the client are set forth in their agreement.

In such situations, the familiar story is that although the customer provided the funds to the PEO to cover the employment taxes, the PEO failed to pay the taxes owed and instead, as seen in many cases, used the money for the PEO owners’ personal use and expenditures. Once these cases made their way into the courtroom, the central issue became whether the customer or the PEO bore responsibility for the employment taxes owed.

  • Through co-employment, the PEO becomes the employer of record for tax purposes through filing payroll taxes under its own tax identification numbers.
  • A PEO or co-employment arrangement involves all or a significant number of the client’s existing worksite employees in a long-term, non-project related, employment relationship.
  • The PEO enters into a contractual co-employment agreement with its clientele.
  • A professional employer organization is an outsourcing firm that provides services to small and medium-sized businesses .
  • As the legal employer, the PEO is responsible for withholding proper taxes, paying unemployment insurance taxes and providing workers’ compensation coverage.
  • The PEO brings services to the client, including the management of human resources, employee benefits, payroll and worker’s compensation.

A professional employer organization is an outsourcing firm that provides services to small and medium-sized businesses . The PEO enters into a contractual co-employment agreement with its clientele. Through co-employment, the PEO becomes the employer of record for tax purposes through filing payroll taxes under its own tax identification numbers. As the legal employer, the PEO is responsible for withholding proper taxes, paying unemployment insurance taxes and providing workers’ compensation coverage.

What Are Some Professional Employer Organization Disadvantages?

Forms W-2 are typically issued to the employees in the name of the PEO, and the PEO takes responsibility for remitting federal employment taxes. However, under federal employment tax rules, the PEO’s clients remain ultimately responsible for employment taxes.

A PEO or co-employment arrangement involves all or a significant number of the client’s existing worksite employees in a long-term, non-project related, employment relationship. The PEO brings services to the client, including the management of human resources, employee benefits, payroll and worker’s compensation. The PEO assumes employer responsibility for employment tax, benefit plans and other human resource purposes.