There’s been a lot of discussion in the HR outsourcing world about certified professional employer organizations, or CPEOs. What are they and why does it matter, you may be asking.
Here’s the express version:
- Being certified means a PEO has applied to the IRS to be certified and after providing extensive information about its financials and other background information, received the CPEO designation from the IRS.
- A CPEO takes on added responsibility related to payroll administration and federal employment tax reporting and payments.
- A CPEO is responsible for paying the federal employment taxes on the wages it pays to worksite employees.
Essentially, it might provide you further peace of mind when working with a certified professional employer organization. Read on to understand the details and how it may affect your business.
A little background
The Small Business Efficiency Act (SBEA) of 2014 put things in motion when it set out to clarify the relationship between a certified professional employer organization and its customers for the purpose of federal payroll taxes. It is federal recognition that the PEO industry has needed since its early days more than 30 years ago.
A CPEO establishes a co-employment relationship with its customers. In it, the CPEO assumes many of the employee-related employer responsibilities, while the customer continues to manage and run the business.
Here’s a quick overview of the co-employment relationship:
Your company’s role
- Your company remains an employer.
- It maintains control over managing your employees’ daily to-dos and core job functions as well as maintaining your organizational structure.
- Your company’s leadership team remains focused on fulfilling the primary role they were hired for.
The CPEO’s role
- As the co-employer, the CPEO takes on specific employer obligations, as set forth in your service agreement.
- This allows the CPEO to provide benefits and handle functions such as payroll, tax remittance and related government filings.
- Because it acts as an employer for those purposes, the CPEO can assume a greater amount of responsibility than, for example, a payroll company.
Not everyone qualifies
It’s not a simple process to get certified by the IRS, and not every PEO will qualify. Here are some of the requirements of companies seeing certification:
- An audit of their financial statements
- CPA-affirmed documentation that they pay employment taxes in a timely manner
- Documentation that they have positive working capital
- Background reports of their individuals responsible for employment tax payments
The IRS wants to take a good look at the PEOs it certifies because they’re solely responsible for paying employment taxes on wages they pay to worksite employees. Previously, the IRS could have looked to the client company if the PEO did not pay the federal employment taxes. Basically, the IRS wants to be sure the taxes get paid.
Why it matters
The intent of the law was to give more structure to who is responsible for what and how eligibility for certain tax credits is defined. The highlights of the law and how it relates to CPEOs and their customers include:
- Payroll tax liability
- Double payment of taxes
- Retaining specified tax credits
Payroll tax liability
The IRS has traditionally taken the view that in a PEO arrangement, both the PEO and the customer are jointly and severally liable for paying federal employment taxes. Let’s say a small business hired a PEO, paid the invoice, which would have included the employment taxes, and the PEO didn’t pay the employment taxes. Before the SBEA, the IRS could have gone after the client company for the taxes – money that the company thought it had already paid to the PEO.
The SBEA makes it very clear that a CPEO, certified by the IRS, is solely liable for the payment of federal employment taxes on wages it pays to worksite employees. So once the customer pays the invoice, which includes the federal payroll taxes, to the CPEO, the IRS can’t come back to the customer to collect employment taxes if the customer is subject to a CPEO service contract or agreement. The CPEO is liable, not the customer.
Maintaining tax credits
Because many tax credits hinge on being the employer, oftentimes businesses entering into a PEO co-employer relationship would be concerned about potentially losing eligibility for those tax credits.
The SBEA clarifies a CPEO customer’s ability to maintain certain tax credits when they’re in a CPEO relationship.
There’s a list of tax credits in the SBEA that’s very clear that the customers get to retain within the CPEO relationship. Among them are:
- IRC sec. 41 credit for increasing research activity
- IRC sec. 45R credit for health insurance expenses
- IRC sec. 51 work opportunity credit
- IRC sec. 1396 empowerment zone employment credit
Wage-base restart
As an employer, federal employment taxes must be paid on a certain amount of each employee’s wage – referred to as the wage base.
When a company joins or leaves a PEO mid-year, there has been the issue of paying taxes on the wage base from both the company and the PEO. This is known as an employment tax or wage base restart and occurs when a new federal employer identification number (FEIN) is used. When a PEO begins paying wages (or a company leaves a PEO), it triggers a change in the FEIN of the entity paying wages.
For example, in June, a PEO takes on a new client that has been paying employment taxes since January. In June, the PEO would be considered a new employer under the Internal Revenue Code. So, paying federal employment taxes on the wage base starts over, resulting in double taxes being paid.
Under the SBEA, it’s clear that if you’re a CPEO customer subject to a CPEO contract, the wage base no longer starts over. The CPEO gets to succeed to the wage base of the employees at a customer coming into the relationship, so there’s no longer a double payment of taxes. While there are a lot of other meanings to the term “successor employer,” a CPEO would only be the successor employer with regard to the wage base for payment of employment taxes.
Additionally, if a company doing business with a CPEO pursuant to a CPEO contract or agreement leaves the relationship, it would benefit from the successor employer status and not have to restart the wage base for employees for purposes of federal employment taxes.
Peace of mind
The SBEA legislation was a long time coming. It gives structure, guidance and recognition to the PEO industry. It’s an industry that Insperity helped create, so we are passionate in seeing it move forward. After all, small and midsize businesses are the fabric of American business.
We embrace the added responsibility of being a CPEO because it signifies the way that we want to do business – with service and integrity. While it has been set forth by the federal government that CPEOs must be liable for paying payroll taxes, it’s an obligation we have always fulfilled. As a public company, we are audited to ensure that’s how we do business.
The SBEA and the certification process for PEOs are just added layers to the peace of mind that our customers have knowing that we are enthusiastic about our responsibility to them.
If you’re looking for a professional employer organization, you’ll likely have a list of questions for how it does business and what you can expect. Now, you can add one more to the list: Are you a certified professional employer organization?*
Have a PEO checklist
Do you need help evaluating a PEO? Check out our free e-book, A Buyer’s Checklist, How to Compare Professional Employer Organizations. In it, you’ll learn how to make shrewd comparisons between PEOs and learn which questions to ask to make sure you’re getting what you want before you sign on the dotted line.