Given the history of the Professional Employer Organization (PEO) industry, it is understandable why any opportunity for a PEO to demonstrate its professional and fiscal integrity would be welcomed by responsible PEOs and those they serve. PEOs assist clients with payroll processing, tax administration, employee benefits design and administration, human resources administration and regulatory compliance. In the mid-70s and 80s, there were minimal controls. PEOs’ roots lie in the “employee leasing” concept which first became popular with the enactment of the Employee Retirement Income Security Act of 1974 (ERISA). The law provided an exemption for multiple employer welfare arrangements through a loophole for employers with “leased employees”. It enabled these employers to claim their exemption from ERISA requirements. An additional incentive for this employee leasing and co-employment arrangement came with the passage of The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). It provided a tax shelter for employers who contributed a minimum amount to their employee benefit plans. The incentives, coupled with the lack of controls, left the door open for some unscrupulous firms which failed to meet their obligations. They left their clients with considerable financial liabilities by not paying their taxes and/ or funding their benefit plans, and left a small stigma on the industry, which has since lifted due to the decades of reliable performance, professionalism and fiscal integrity of the growing number of PEOs. This has been achieved in no small part through standards and regulations largely promulgated by the industry itself.
“Standards and Regulations Driven from Within the Industry”
The National Association of Professional Employer Organizations (NAPEO) has been at the forefront of PEO standards and regulations. NAPEO’s current data reports that there are between 780 to 980 PEOs in the United States generating gross revenues in the range of $136 to $156 billion dollars. Collectively, they serve a client base of an estimated 156,000 to 180,000 small and mid-size businesses that employ a total of between 2.7 and 3.4 million workers. The top tier PEOs all hold E.S.A.C. Certification. These E.S.A.C. accredited PEOs bring to their clients the added assurance of their fiscal responsibility. They are backed by over $15 million of financial assurance (surety bond). In addition to covering federal tax liabilities, it also covers reimbursement to the PEO’s clients, worksite employees, taxing authorities, and insurers should the PEO fail to pay wages, state and local taxes, payroll taxes, contributions to employee retirement plans, workers compensation premiums, group life and health insurance premiums or plan contributions. Of course, PEOs that subject their firm to the extensive due diligence required to secure the E.S.A.C. certification and meet the ongoing financial, professional and ethical standards required to maintain this accreditation, are not likely to fail in meeting their obligations.
“State Licensing and Registration Requirements”
In addition to the E.S.A.C. credential, there are licensing and registration requirements in a large number of states, although some states have no licensing or registration requirements. PEOs are also specified in some states’ unemployment codes, workers compensation acts and other statutes. Along with the E.S.A.C. accreditation, state licensing and registration requirements, some PEOs also secure certificates in Workers’ Compensation Risk Management from the Certification Institute, an independent nonprofit entity formed to provide assistance to industries for industry-specific certification programs. The PEO Workers’ Compensation Program provides the CI’s independent verification that the PEO’s risk management program meet proven insurance industry risk management best practices designed to reduce work-related accidents and health exposures, while control workers compensation insurance losses.
Below is a breakdown of the various states’ PEO requirements.
States with No Licensing or Registration Requirements:
Washington, Idaho, Wyoming, South Dakota, Iowa, Missouri, Mississippi, Georgia, Pennsylvania, Maryland, Delaware and Alaska
States with Licensing Requirements Only:
Oregon, Montana, North Dakota, Michigan, Vermont, New Hampshire, Rhode Island, West Virginia, North Carolina, South Carolina, Florida, Arkansas and Texas
States with Registration Requirements:
Maine, Massachusetts, Connecticut, New York, New Jersey, Virginia, Ohio, Indiana, Illinois, Kentucky, Tennessee, Alabama, Louisiana, Wisconsin, Minnesota, Nebraska, Kansas, Oklahoma, Colorado, New Mexico, Utah, Arizona, Nevada and California
“The Latest Credential – Voluntary Certification by the IRS”
With these licensing, registration and certificate programs in place, one might wonder why it was important for the U.S. Internal Revenue Service (IRS) to create its own certification for PEOs. In December 2014, Congress passed the “Small Business Efficiency Act” under which PEOs could voluntarily apply for certification which substantially affects the employment tax liabilities of both the Certified PEO (CPEO) and its clients. Generally, the IRS has issued a series of regulations and forms attendant to this law. On December 22, 2016, NAPEO filed its comments on the IRS’ CPEO Application Form. This was followed on December 29, 2016 with the IRS’ release of new, detailed Revenue Procedure for PEOs to maintain their certification. The Procedure also included measures pertaining to the suspension and revocation of the certification. On January 5, 2017, the IRS issued a new draft of the Certified Professional Employer Organization/Customer Reporting Agreement.
As it currently stands, when a business enters into a qualifying relationship with a CPEO that business is not liable for obligations regarding their federal employment and payroll taxes once they have promptly paid their full federal tax liability to the CPEO for remittances to the IRS. From a client’s perspective, this significantly reduces any real or perceived risks a business may have for using a PEO. From a PEO’s perspective, it further conveys a level of fiscal prudence and integrity to potential clients and their accountants.
“Stringent Requirements”
PEOs must perform considerable due diligence to obtain the CPEO certification. Only PEOs that have the following credentials are eligible to apply for certification:
- Being a business entity with at least one physical location within the United States;
- Having a history of federal, state and local tax compliance, financial responsibility, and organizational integrity; and
- Being managed by individuals (the majority of whom are U.S. citizens or residents) who have knowledge or experience regarding federal and state employment tax compliance and business practices relating to those compliance requirements.
There are also bonding requirements for CPEO applicants. They are given 30 days from the date of the notice of certification to submit proof of a bond to the IRS. The amount of bond must be at least equal to the greater of 5% of the CPEO’s liability under section 3511 of the Internal Revenue Code (the Code) during the preceding calendar year (up to $1 million) or $50,000. By March 1st of any calendar year, the requirement calls for the CPEO to determine if there should be an increase in the bond amount for the new bond period starting April 1st of that calendar year and where it is determined there should be, the CPEO is required to increase the bond amount.
CPEOs must submit to annual financial statement audits by an independent Certified Public Accountant. These financial statements must be prepared in accordance with accepted GAAP methods; a requirement which must be upheld to maintain the CPEO credential. There also are reporting requirements, specifically requiring a CPEO to inform the IRS of any start or termination of a customer contract, as well as employment tax reporting and related recordkeeping since the CPEO is regarded as the employer of a “covered” employee under Section 3511 of the Code. Another reporting requirement is that the CPEO notify customers in writing if its contract has been transferred to another entity and to provide customers with all relevant information including the name and Employer Identification Number (EIN) within ten days after the transfer. Further, the CPEO is required to provide its customers with information they need to claim credits specified in section 3511 of the Code, as well as information necessary to accurate report employees’ tips in accordance with section 6053(c)(8) of the Code. The suspension or revocation of a CPEO’s certification must also be reported by the CPEO in a written notice to each of its customers within 10 days of the certification suspension’s or revocation’s effective date. When a covered employee ceases to be an employee of the PEO (worksite employee), the CPEO also is required to notify its customer in writing within 30 days following the end of the applicable calendar quarter for which the customer also may be liable for federal employment taxes imposed on the compensation remitted by the CPEO to the covered employee.
“The Significance of the IRS Voluntary Certification Program for PEOs”
Beyond the assurances to businesses that enter into a relationship with a PEO, the CPEO program has important benefits to PEOs. Most important, the IRS certification gave PEO and their shared employment business model statutory recognition in the Code. With this recognition, CPEOs now have the authority to collect and remit federal employment taxes, including Social Security, Federal Unemployment Taxes, Medicare, etc.) for the worksite employees of their of their qualified clients under their Employer Identification Number. A CPEO will be deemed a successor employer for the purpose of their clients’ employment taxes. This is important because it eliminates the obstacle for a business with highly compensated employees to sign on with a PEO mid-year because of the increased costs for tax withholding.
For CPAs, who previously may have been reluctant to recognize the value proposition PEOs offer their clients, this latest certification should be a strong indicator of a PEO’s total commitment to their clients and the extent to which the Certified PEO has gone to demonstrate that it takes its responsibilities very seriously.
