PEO questions employers ask about co-employment, payroll taxes and liability
The IRS describes a professional employer organization (PEO) as one that agrees with a client to perform some or all of the client’s federal employment tax withholding, reporting and payment functions. The IRS says an employer that outsources payroll and related tax duties to a third-party payer will generally remain responsible for those duties, including liability for the taxes, with an exception for certified professional employer organizations. Who files, and under which employer identification number (EIN), depends on the arrangement.
What is a PEO?
The IRS describes a PEO, which it says is sometimes referred to as an employee leasing company, as an organization that agrees with a client to perform some or all of the client’s federal employment tax withholding, reporting and payment functions, and that may also manage human resources, employee benefits, workers compensation claims and unemployment insurance claims, according to the Internal Revenue Manual.
What is an ASO, and is it the same as a PEO?
The IRS and the Department of Labor do not define “administrative services organization” for payroll or HR. Under Treasury Regulation 31.3504-2, a payor is party to a service agreement only when it asserts it is the employer (or “co-employer”) of the individuals, pays them wages or compensation and assumes responsibility to collect, report and pay the taxes or assumes liability for them. A payor that meets all three is designated to perform the acts required of an employer for the wages it pays, except in the cases the regulation lists, such as wages reported on a return filed under the client’s EIN. The same regulation’s own example of a payroll services provider that pays wages, assumes responsibility for the taxes and files under the employer’s EIN, but “did not assert it was the employer,” finds that provider is not designated and not liable for the employment taxes under that section, and the employer remains subject to all provisions of law applicable to employers.
Is a PEO worth it for a small business?
Four questions drawn from the IRS’s own facts help an employer weigh a PEO before signing, and each one can be put in writing.
* Who directs the work. To decide whether the client is the common law employer in a PEO arrangement, the IRS asks whether the client directs and controls the day-to-day performance of the workers’ duties, retains the authority to hire and fire workers and sets the hourly wage or salary, according to the Internal Revenue Manual.
* Which arrangement applies. Ask whether the PEO is a certified professional employer organization (CPEO), under what exact name and EIN, and which returns it will file under which EIN, because the filing EIN differs by arrangement.
* What stays with the employer. Ask what the employer will still do itself, since the IRS says liability is set by the Internal Revenue Code and cannot be changed by a private agreement or contract.
* What the fee is based on. The IRS says PEOs are typically paid a fee based on payroll costs, so ask which payroll costs the fee is based on, as described in IRS Publication 15.
IRS audit guidance tells its examiners to advise a client to use due diligence in selecting and continuing with a PEO, according to the IRS page on third party payer arrangements for PEOs.
How is a PEO different from a payroll provider?
The IRS compares four arrangements by the form involved, which is none for a payroll service provider, Form 8655 for a reporting agent, Form 2678 for a section 3504 agent and Form 8973 for a CPEO, in its third party arrangement chart.
* Payroll service provider or reporting agent. A payroll service provider or reporting agent works under the employer’s own EIN, and the IRS says neither is liable as an employer or an agent for the employer’s employment taxes, according to IRS Publication 15. A reporting agent must also give the client a written statement when the contract starts and at least quarterly, and the statement says the client remains responsible for the timely filing of employment tax returns and payment of employment taxes, under Revenue Procedure 2012-32.
* CPEO. Section 3511 sets when a CPEO is treated as the employer. The CPEO reports wages under the CPEO’s EIN and allocates them to each customer by the customer’s EIN on Schedule R, according to the IRS CPEO customer page and the Instructions for Schedule R.
* PEO that is not a CPEO. A PEO that is not a CPEO and meets the service-agreement definition in Treasury Regulation 31.3504-2 is designated to perform employer acts for the wages it pays.
What does co-employment mean for my business?
Industry usage describes a PEO as a co-employment model, but the IRS says the Code does not define “co-employer” and the concept is not recognized under federal tax law, according to the IRS page on PEOs as third party payers. A PEO that is not a CPEO and meets the service-agreement definition in Treasury Regulation 31.3504-2 is designated to perform employer acts for the wages it pays, and the IRS says the PEO and its client are concurrently liable.
Who is the employer when I use a PEO?
In the arrangement the IRS describes for a PEO, in which the client’s workers are hired by the PEO and leased back and the PEO pays them and the taxes with client funds and files returns under its own EIN, the IRS says the client typically remains the common law employer and the PEO is not the section 3401(d)(1) employer, because a PEO that is merely a conduit for the funds used to pay wages does not control the payment of wages, as the IRS explains. A worker is an employee under the common-law test if the business can control what will be done and how it will be done, even if it gives the worker freedom of action, according to the IRS page on the common-law employee. A CPEO is the exception, and section 3511 sets when a CPEO is treated as the employer.
Who is liable for payroll taxes if I use a PEO?
The IRS says liability depends on the facts and circumstances and the type of third-party arrangement, and an employer may remain solely liable or become jointly and severally liable, and in certain situations an employer that is a CPEO customer is relieved of liability for income tax withholding and social security and Medicare taxes, according to its page on outsourcing payroll and third-party payers. The IRS says an employer that outsources payroll and related tax duties to a third-party payer will generally remain responsible for those duties, including liability for the taxes, with an exception for certified professional employer organizations. Under Internal Revenue Code section 3511, a CPEO is treated as the employer of a worksite employee for federal employment taxes, but only for pay the CPEO remits to that employee. A PEO that is not a CPEO and meets the service-agreement definition in Treasury Regulation 31.3504-2 is designated to perform employer acts for the wages it pays, and the IRS says the PEO and its client are concurrently liable.
For individuals covered by a CPEO contract who are not worksite employees, the CPEO is treated as an employer under section 3511 for its own liability, and the IRS says a CPEO and its customer may both be liable for the remuneration the CPEO pays them, as set out on its CPEO customer page.
Does a PEO file my payroll taxes?
Whether a PEO files an employer’s payroll tax returns, and under which EIN, depends on the arrangement.
* Payroll service provider or reporting agent. A payroll service provider or reporting agent works under the employer’s own EIN, and the IRS says neither is liable as an employer or an agent for the employer’s employment taxes, per IRS Publication 15.
* CPEO. A CPEO files aggregate employment tax returns under its own EIN and allocates each customer’s wages on Schedule R by the customer’s EIN, according to the IRS CPEO customer page. Schedule R allocates aggregate Form 941 information to each client, and column a is the client’s EIN. A CPEO also files Forms W-2 and W-3 under its own EIN, according to the Internal Revenue Manual, and the IRS says the EIN on a Form W-2 should be the same number the employer used on its federal employment tax returns, per the General Instructions for Forms W-2 and W-3.
* PEO that is not a CPEO. A non-certified PEO filing an aggregate Form 941 must check the “Other Third Party” box, per the Instructions for Form 941.
Can a contract change who is liable for payroll taxes?
The IRS says liability is set by the Internal Revenue Code and cannot be changed by a private agreement or contract. The IRS adds that it is not generally bound by any agreement between an employer and a third party, and that a contract cannot release an employer from its responsibility to withhold, report and pay applicable employment taxes, according to the Internal Revenue Manual.
What is a certified professional employer organization (CPEO)?
The CPEO program is a voluntary IRS certification for PEOs, according to the IRS CPEO program page. Under Internal Revenue Code section 3511, a CPEO is treated as the employer of a worksite employee for federal employment taxes, but only for pay the CPEO remits to that employee.
How can I check whether a PEO is a CPEO?
The IRS says existing and potential customers can verify a CPEO’s certification status by reviewing the IRS published CPEO public listings, which show certified, suspended and revoked CPEOs, and it updates the certified list by the 15th day of the first month of every calendar quarter. A PEO is not required to become certified under the Code, according to the Internal Revenue Manual, so a PEO’s status is something to check rather than assume.
The names of many CPEOs are similar and one brand name can cover more than one entity, so the listing needs a careful read, per the IRS page what you need to know about CPEOs. A CPEO contract must also contain the exact name and EIN of the CPEO fulfilling the federal employment tax obligations covered by the contract, according to the IRS CPEO customer page.
What is a worksite employee?
A worksite employee is a covered employee, meaning an individual covered by a CPEO contract other than a self-employed individual, who works at a work site where at least 85 percent of the individuals performing services for the customer at that work site are covered by CPEO contracts, not counting employees excluded under section 414(q)(5), as defined in Internal Revenue Code section 7705 and Treasury Regulation 301.7705-1. The regulation makes the test separately for each work site and each customer, and an employee who qualifies at any time in a calendar quarter is a worksite employee for that whole quarter.
What do I sign and receive when I become a CPEO customer?
A CPEO customer signs Part 5 of Form 8973 when the service contract starts, and the CPEO must give the customer a copy of the form’s instructions before the customer signs and a copy of the fully completed and signed form, according to the Instructions for Form 8973.
* Start and end reporting. A CPEO uses Form 8973 to tell the IRS that a service contract with a customer has started or ended, generally within 30 days of starting or ending it. Only the CPEO’s signature is needed to report an end, and the customer may separately file its own Form 8973 to report the end, though that is not required.
* The customer’s EIN. The customer’s EIN on the form must match the EIN the IRS assigned to it, and the IRS says a business should have only one EIN.
* Disclosure consent. The form includes a CPEO consent letting the IRS disclose information from the CPEO’s returns about that customer for the listed years or periods only, which is no more than 3 years or 12 quarters, and the CPEO must renew the consent before the last listed year or period ends if the contract continues.
If a customer under a CPEO contract does not sign Form 8973, section 3511 does not apply to that customer, as the IRS CPEO help page states. A filed Form 8973 alone does not show that section 3511 applies, because the form also covers service agreements under Treasury Regulation 31.3504-2 that are not CPEO contracts.
What notices does a CPEO owe its customers?
The Treasury regulation on CPEO treatment under section 3511 requires a CPEO to give customers credit information and notices of a contract transfer, of a suspension or revocation of certification, and of covered employees who are not worksite employees, and a CPEO contract must require the CPEO to give them.
* Credit information. The CPEO must give the customer the information necessary to claim the specified credits.
* Transfer. The CPEO must notify a customer if its CPEO contract has been transferred or another person will report under its own EIN, with that person’s name and EIN.
* Suspension or revocation. The CPEO must notify a customer of a suspension or revocation of its certification.
* Covered employees who are not worksite employees. The CPEO must notify the customer when covered employees are not, or cease to be, worksite employees because a location misses the 85 percent threshold, and that the customer may also be liable for federal employment taxes on remuneration the CPEO remits to those covered employees.
The CPEO public listings page sets the timing for suspension and revocation. A CPEO whose certification is suspended must give each customer written notice within 10 days of the effective date of suspension, and a CPEO whose certification is revoked must give written notice within 10 days after the notice of final revocation and no less than 30 days before the revocation takes effect. A CPEO that leaves the program voluntarily must notify each customer in writing of its intention and the proposed date before it asks to terminate, according to the IRS page what you need to know about CPEOs.
A CPEO’s service agreement with a client that is not a CPEO contract must notify the client, or be accompanied by a notification to the client, that it is not covered by section 3511 and “does not alter the client’s liability” for federal employment taxes on remuneration remitted by the CPEO, per the same regulation.
What stays with the employer when a provider runs payroll?
IRS Publication 15 says an employer that contracts with a third party generally remains responsible if the third party fails to perform any required action, with an exception for a CPEO, and the IRS page on outsourcing payroll and third-party payers adds that in the event of default by a third party the employer remains responsible for the deposit of the federal tax liabilities and timely filing of returns. Using a reporting agent or other third-party payroll provider does not relieve an employer of the responsibility to ensure that Forms W-2 go to employees and that Forms W-2 and W-3 reach the Social Security Administration correctly and on time, according to the General Instructions for Forms W-2 and W-3. Publication 15 also tells employers to keep employment tax records for at least 4 years.
How do I keep watch on my own IRS account?
An employer that uses a payroll service provider or reporting agent to make deposits should enroll in the Electronic Federal Tax Payment System (EFTPS), activate its Inquiry PIN and use it to monitor the account and ensure the provider is making the required deposits, according to IRS Publication 15 and the IRS page on outsourcing payroll duties. CPEO customers cannot view federal tax deposits and payments made by the CPEO in EFTPS, according to the IRS CPEO customer page.
The IRS strongly recommends that the employer keep its own address as its address of record, because IRS correspondence goes there, and Form 8822-B updates it, according to IRS Publication 15. An employer can also register for its own IRS Business Tax Account, where available for its type of business, to view payment history and read IRS notices.
How do I leave a PEO, and what should I confirm first?
Before leaving a PEO, an employer should confirm whether the PEO was a CPEO and under what exact name and EIN, because if it was, the CPEO reports the end of the contract on Form 8973 and, for a worksite employee, the customer is treated as a successor employer and the CPEO as the predecessor for the annual wage limits, as Internal Revenue Code section 3511 provides.
Is a PEO the employer, or is my business?
In IRS terms, who is the employer turns on the facts of the arrangement, and IRS Publication 15 says that if an employer-employee relationship exists, it does not matter what it is called. Section 3511 is the exception for a CPEO, and only for federal employment taxes on pay the CPEO remits to a worksite employee. Section 7705 says nothing in it affects who is an employee or employer under the Code except as needed for section 3511, and Treasury Regulation 31.3511-1 says the presumption it sets for applying type-of-employer rules to a CPEO’s pay creates no inference about who is an employer or employee for federal tax purposes or for any other provision of law.
Talk to an expert at Asure
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