Recent legislation creates professional employer organization status.

• Author: Mort, Kathy

Professional employer organizations (PEOs) provide comprehensive payroll, benefits, and human resource outsourcing solutions to unrelated third-party employers. PEOs are often also referred to as employee leasing companies or "co-employers." The model for providing those services, which has been relatively consistent for many decades, may change significantly because of recent legislation that will bifurcate PEOs into two categories.

At the end of 2014, Congress added Secs. 3511 and 7705 to the Internal Revenue Code, creating a new type of entity called a "certified professional employer organization" (CPEO), effective with respect to wages for services performed on or after Jan. 1, 2016 (Tax Increase Prevention Act of 2014, P.L. 113-295, [section]206(a)).To receive IRS certification, an existing PEO must meet certain GAAP and examination-level attestation standards, post a bond with the IRS, and meet certain other requirements.

The statute enacting Sec. 3511 also provides that the IRS will establish a certification process by July 2015. While existing PEOs are not required to seek certification, the new rules may result in a shift in the PEO industry, with larger PEOs becoming CPEOs (or offering CPEO as a distinct service) and citing this status to differentiate themselves from other organizations.

Existing PEO Service Model and "Co-Employment"

For federal employment taxes, the PEO and an employer typically enter into a service agreement whereby the PEO undertakes payroll tax obligations in the name and employer identification number (EIN) of the PEO, including obligations to pay wages; deposit taxes; report wages and taxes quarterly on Form 941, Employers Quarterly Federal Income Tax Return', provide the employee and government Forms W-2, Wage and Tax Statement, pay and deposit federal unemployment taxes (FUTA); and file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The PEO undertakes similar roles for state and local tax obligations.

According to the typical services agreement, the employer continues to provide daily supervision and direction over the employees, but its payroll tax obligations are transferred to the PEO. The PEO achieves economies of scale by offering this service to many employers and aggregating the payroll taxes onto single Forms 941 and 940. Many PEOs describe this arrangement as co-employment.

The IRS and Co-Employment

The Code does not recognize co-employment as such. For federal employment...