In this article
A PEO (Professional Employer Organization) is an outsourcing firm that provides comprehensive HR solutions for small and mid-size businesses. By entering into a co-employment arrangement with an employer, a PEO can manage various functions such as payroll, benefits, HR, tax administration, and regulatory compliance, allowing businesses to focus on their core operations. This relationship can help companies to offer better employee benefits and reduce administrative burdens.
- A Professional Employer Organization (PEO) is a specialist HR company that handles payroll processing, HR, and employment compliance on behalf of client companies.
- The concept of PEO is similar to the concept of EOR (‘Employer of Record’), though some differences exist. ‘EOR’ is commonly used with companies wishing to hire internationally.
- There are pros and cons to engaging a PEO: It usually saves money and time and allows employees access to better benefits. On the other hand, companies may be concerned about the potential loss of control and other risks associated with outsourcing business functions.
What is a PEO
A Professional Employer Organization (PEO) is a third-party service provider that processes payroll and carries out HR and compliance activities for corporate clients.
This often includes withholding and paying employment taxes and administering employee benefits. By doing so, they usually become the ‘Employer of Record’ for those employees (more on what this means below).
Carrying out these activities is the business of a PEO. They don’t do anything but payroll and HR-related tasks.
There is no single list of services that all PEOs provide. The services provided by a PEO will depend on the contract they sign with their corporate client, their chosen business model, and any laws and regulations that apply to that PEO under state or federal law.
Depending on the jurisdiction and the agreement between the client and PEO, both may be recognized as ‘co-employers.’ This means that the employer’s responsibilities are split between the PEO and the client company.
How does a PEO relate to an Employer of Record (EOR)?
A closely related concept to PEO is the concept of an ‘Employer of Record.’ An Employer of Record (EOR) is the entity with the legal responsibility or responsibilities of the employer. Often, the EOR is legally responsible for withholding income taxes and administering payroll taxes and employee benefits.
The EOR usually only takes on those legal responsibilities set out in the contracts they sign and as recognized under the law where they are based. For example, under the federal tax code, the Internal Revenue Service (IRS) may identify an EOR as the ‘statutory employer.’ EOR is responsible for withholding and submitting federal employment taxes and fulfilling associated compliance tasks. It also means that taxes are filed under the legal name of the PEO and using their own Employer Identification Number (EIN).
But EOR is not just a tax concept. For example, an EOR may be recognized as the legal employer for collective bargaining purposes. The key feature of an EOR is that their employer role is limited to specific legal duties.
In most cases, a PEO acts as an Employer of Record. Not only do they process payroll and manage taxes and benefits, but they do so under their name so authorities recognize them as the employer when they do so.
But the reverse is not always true: Not all Employers of Record are PEOs. For example, the Employer of Record of In-Home Supportive Services (IHSS) carers are “public authorities” in California. The National Labor Relations Act covers these quasi-governmental bodies. It creates menus, which means carers by county government can join unions and collectively bargain and have access to all the benefits that other employees would have access to. These public authorities are not private businesses and, therefore, not PEOs.
The history of PEO and its origin in employee leasing
Before the 1990s, the terms PEO and EOR were not commonly used. However, a related concept known as ’employee leasing’ was popular. When this practice first began, it was not widely publicized or well-known in the early 1970s, but by 1993, according to the New York State Inter-Agency Task Force on Employee Leasing, there were 15,000 leasing companies in the United States.
In its original form, employee leasing proceeded as follows: A regular company officially terminated its existing employees and arranged for an employee leasing company to hire those employees. The original company then ‘leased back’ those employees onto their worksite.
For the original company (the ‘client company’), this meant saving time and money by transferring the most onerous employment responsibilities to another party, including responsibility for health insurance, 401k contributions, and workers’ compensation. From the employee’s perspective, it would have looked as though little had changed, even though the underlying legal relationships had altered significantly.
In its unregulated 1970s form, employee leasing was controversial. It meant:
- Due to employee leasing companies’ lower health and safety risk profile, artificially low workers’ compensation premiums could be paid. Those premiums did not reflect the risk for workers on the worksite. This has been referred to as the ‘Workers Compensation Shuffle.’
- Client companies used it to avoid providing their workforce with the pension plans they would otherwise be entitled to: Under the Revenue Act of 1942, to use pension plans to offset their tax bills, businesses were prohibited from discriminating between employees with pension plans (I.e., the executives could not be generous to themselves and leave the rank-and-file employees with nothing). As a workaround, some companies used employee leasing to claim that some workers were ‘not their employee’ and, therefore, could be paid less than they would otherwise get (For an extensive discussion of these matters, see a recent article in the Berkeley Business Law Journal from law academics Katherine Sanford Goodner & Ursula Ramsey).
- If the employee leasing company went insolvent/bankrupt, employees could be deprived of their entitlements.
In light of these concerns, federal law changes in 1982 and 1986 substantially changed the rules regulating the industry.
What is a certified Professional Employer Organization?
In 2014, two new sections of the IRS Code were introduced to establish a voluntary certification program for PEOs. A certified Professional Employer Organization (CPEO) is a U.S.-based business entity that has met a set of requirements set out by the IRS.
Once certified by the IRS, the certified CPEO will be treated as the sole employer of a client’s workforce. This benefits client companies because they will no longer be liable for federal employment taxes as a ‘co-employer’ of workers.
To become certified, a PEO must:
- have a physical business location within the United States
- a history of financial responsibility and organizational integrity, and
- Be managed by individuals with knowledge or experience regarding federal and state employment tax compliance and related business practices.
Once certified, the CPEO must post an annual bond of up to $ million, guaranteeing payment of employment taxes.
Less than seven percent of PEOs in the U.S. are certified by the IRS.
How do PEOs operate?
How a PEO works depends on the chosen business model of the PEO, the engagement agreement between the client company and the PEO, and the laws and regulations that apply in a given state or country.
Generally speaking, the PEO and client company will agree that the PEO will provide the following services:
- Payroll processing
- Benefits administration, including pension contributions, workers’ compensation, and other employment-related insurance
- Employment tax compliance. This includes employee income tax withholding, payroll tax administration, and managing state unemployment taxes.
- Any other HR functions as agreed.
Once a business partners with a PEO, the PEO and client company generally become co-employers of the business’s employees. This means that both the client and company share employment responsibilities: The client company is usually responsible for the day-to-day direction of the employee, while the PEO is responsible for the administrative and compliance tasks related to employment.
Due to their different responsibilities, in co-employment, the client company is sometimes known as the ‘operational employer’ or ‘worksite employer.’ In contrast, the PEO is the ‘legal or ‘administrative employer.’
As a legal employer, the PEO usually becomes responsible for:
- Filing necessary tax and employment documentation with the authorities
- Withholding and paying employee income tax, payroll tax, unemployment tax, and so forth
- Providing compliant labor contracts
- Hiring and onboarding of employees
- Termination, severance, and offboarding, where appropriate.
In turn, the client company remains responsible for:
- Directing staff in their duties
- Health and Safety in the workplace
- Communicating with the PEO to ensure that administrative and compliance duties are fulfilled.
Note that the IRS observes that in the US, client companies can still be legally liable for employee taxes despite what is said in any PEO agreement. The IRS does not recognize the concept of ‘co-employment’ in its Tax Code and may find the client company liable as the “common law employer.”
The way to mitigate this legal liability is for a client company to engage a CPEO — as discussed earlier in this article.
The PEO charges the business a fee for its services in exchange for the responsibilities and liabilities it takes on. The fee amount depends on factors such as the number of employees, the type of HR services provided, and the company’s chosen fee model.
The most common charging models are:
- A flat fee per month per employee
- A percentage of gross payroll.
Why choose a PEO?
The alternative to using a PEO is to carry out the standard payroll and HR functions in-house. So why pass this to a third party? There are pros and cons to engaging a PEO that must be weighed before committing to this option. We consider these below. In short, companies interested in PEO solutions need to consider:
- How much more does hiring and paying internal employees for these tasks cost?
- What are the risks of performing the task internally versus outsourcing it
- Would other outsourcing solutions, such as payroll outsourcing, temp agencies, or staffing agencies, be a better option?
- Once the decision has been made to go PEO, which PEO should be chosen?
The National Association of Professional Employer Organizations (NAPEO) — why you need a PEO
Advantages of using a PEO?
1. PEOs are HR and payroll specialists
PEOs have the knowledge, infastructure (such as specialist PEO cloud platforms), and experience that many businesses (especially smaller businesses) don’t have. This means fewer payroll and HR errors. These errors are not only a compliance risk, which can result in penalties or fines, they are a surefire way to alienate your workforce.
2. PEOs can access better deals on benefits
Through economies of scale (PEOs serve many client companies, with employees often having similar benefits), a PEO can often access more competitively priced health insurance plans than those that would otherwise be available to the client company’s employees.
3. Compliance assurance
PEOs are familiar with applicable labor and tax laws, and any recent changes. It is difficult for all but the largest companies to have HR and payroll teams whose familiarity with legal requirements will rival that of a PEO.
4. Add-on services
PEOs may often provide a range of other services that can benefit client companies. These services may or may not be included in the standard PEO fee. These add-on services include:
- Background checks and drug testing
- Visa, work permit and relocation assistance
- Employee relations, employee handbooks, and dispute management
- Training and health, and health and safety
- Handling workers’ compensation and unemployment insurance claims.
- Administration of Retirement Plans
- Administration of Employee Assistance Programs.
While these additional services could be achieved by the client company using other providers (such as a recruitment agency), time and transaction costs are saved by taking advantage of the existing relationship with the PEO.
5. Cost savings
In many cases, it is cheaper to engage a PEO to provide payroll and HR functions than for a company to carry it out themselves. One analysis based on US Small Business Administration (SBA) figures, reported that businesses save 40 percent by outsourcing these tasks to a PEO.
According to a 2019 report from the National Association of Professional Employer Associations (NAPEO), a conservative estimate of the return on investment (ROI) of engaging a PEO is 27.2 percent.
What are the disadvantages of using a PEO?
Are there any downsides to engaging a PEO? This depends somewhat on the goals of the client company and the particular services offered by a chosen PEO. However, some potential downsides that have been reported include:
1. The loss of some control over HR functions and processes
When you engage a PEO to carry out HR and payroll tasks, you are essentially giving up some control over these important functions. This can be psychologically difficult for business owners who like to be in the driver’s seat when it comes to their company.
But it also carries an element of risk: For example, unresolved payroll errors may well have a major impact on staff turnover, yet the client company may have inadequate levers to immediately fix the issue.
The possibility is that the PEO might not be able to provide the same level of service as an in-house HR department. For this reason, it is crucial that companies choose a PEO with an excellent reputation for customer support.
2. The potential for increased costs if the PEO does not deliver on its promises
If a PEO does not deliver, it can end up costing the company more money in the long run. If there are an excessive number of payroll errors, or employees are unhappy with the service, the company may need to end the engagement. This means either starting up payroll and HR functions to match what the PEO provided or finding another PEO.
Any termination fees in the contract, plus the transaction costs of closing one engagement and starting a new one can quickly add up.
3. Limited choice in employee benefits
As mentioned, a PEO can often source more competitive benefits, such as health plans, than can be sourced by companies individually. However, it is also likely that they may have relatively ‘standardized’ benefits packages. This may end up giving your workforce less than they would otherwise receive.
4. Data compliance risk
PEOs deal with employee personal data: This means there is a risk of data breach or non-compliance under laws such as the General Data Protection Regulation (GDPR) or the CCPA. Whether or not this results in liability for the client company depends on the breach and the data processing agreement in place between the client company and the PEO.
Overcoming the potential PEO downsides
Are there ways to overcome these disadvantages? Yes, ultimately it is a matter of choosing the right PEO. A reputable PEO will have in place:
- Systems to quickly respond to and deal with errors, so that the loss of payroll/HR control is less problematic
- A reputation for excellence which means that the contract is unlikely to go awry
- Employee benefits that are genuinely competitive in both quality and price
- A level of service that exceeds that which would be provided by your own staff
- Compliance management systems reduce the risk of data breaches and can quickly manage a breach.
What are the alternatives to using a PEO?
Are you considering a professional employer organization (PEO) but not sure if it’s the right fit for your business? PEOs are not right for every business. Consider below some of the key alternatives.
ASO stands for ‘Administrative Services Only‘. An ASO firm can take over administration for your employee health plans, but they do not have full responsibility for managing plans, such as dealing with claims. Only a PEO or Employer of Record can take over full responsibility for that task.
Sometimes the term ASO is used to refer to ‘Administrative Services Outsourcing’, which means outsourcing administrative tasks generally, not just health plans. Firms that fulfill this task might take care of health insurance matters, pension contributions, workers’ compensation premiums, and more.
If you’re considering an ASO, take a look at our blog post comparing ASOs and PEOs.
Human resource outsourcing (HRO) is similar to using a PEO in that it allows you to outsource your HR functions to another company. However, a key difference is that HRO providers typically don’t assume co-employment or EOR responsibilities for a company’s employees as a PEO does. Think of HRO as an extension of your existing HR staff.
This means that HRO providers usually can’t offer certain employee benefits like health insurance or workers’ compensation coverage, nor withhold and file taxes on behalf of your workforce.
However, with a more streamlined service offering, HRO services are usually cheaper than ‘full PEO’.
Read more at HRO vs PEO: What’s the Difference?
3. Payroll Company/Payroll outsourcing
With payroll outsourcing, you outsource your entire payroll function—including data entry, tax filing, and check processing. This can save you money on payroll processing costs.
However, there are some potential drawbacks to using payroll outsourcing services as well— as with HRO, the service is limited and the payroll company will not be able to provide certain benefits or manage taxes on your behalf (unless they are also registered with the IRS as a third party payer). That requires co-employment of the sort provided by PEOs.
Examples of top-rated PEO companies
There are many reputable PEO companies out there, so it’s important to do your research to find the one that’s the best fit for your business. A few top-rated PEO companies include:
- G&A Partners. G&A Partners offers a full suite of HR solutions, including ASO, HRO and PEO. It also goes beyond the offerings of many providers with Recruitment Process and Accounting outsourcing as well.
- TriNet. Trinet integrates its own HR platform into its PEO and HR offerings and is focused on the SME market Since 1995 it has been accredited by the Employer Services Assurance Corporation (ESAC). Read more about this PEO and HR solution in our 2023 TriNet service breakdown and analysis.
- Insperity. Insperity is a full-service PEO and HR company, serving businesses of all sizes. It has a special focus on the customer experience. For more information, see our 2023 Insperity review.
- Justworks is a newer PEO with a state-of-the-art platform sporting comprehensive employee management tools, such as time-tracking.
- ADP is arguably the most established company in the industry, existing for over 70 years. It offers a comprehensive range of payroll, PEO, and HR solutions. Read more about the ADP PEO solution in our 2023 review.
PEO — the right solution for your business?
A Professional Employer Organization, or PEO, is a comprehensive HR and payroll solution. A PEO not only takes care of payroll, benefits, and HR compliance, but they become the ‘Employer of Record’ and are legally responsible for your employees.
The benefits of PEOs can be substantial: They can save businesses (especially SMEs) time and money while providing employees with better benefits. Any potential risks in engaging a PEO are best mitigated by a robust PEO agreement, and choosing a reputable PEO.
To find out more about which PEO might suit your company, check out our top 10 PEO guide.
Frequently Asked Questions
PEO stands for Professional Employer Organization. A PEO is a company that carries out HR and payroll functions on behalf of client companies.
PEOs can offer a number of advantages to businesses, including:
- Saving time and money on payroll processing, benefits and tax administration and HR
- Access to employee benefits that the company might not be able to provide on its own
- Compliance assistance with employment and tax laws and regulations
A PEO does usually provide payroll processing services, However, a PEO is much more than just a payroll company: In addition to handling payroll, PEOs can also provide access to employee benefits, compliance assistance, and other HR services.
PEOs are a great solution for small and medium-sized businesses that don't have the resources to handle all of their payroll and HR needs in-house. A payroll company, on the other hand, is often better for larger companies that already have a significant HR function in place.
A staffing company provides temporary or contract workers to businesses. If the worker is to become a fulltime employee they are usually hired directly by the client company.
A PEO, on the other hand, provides payroll, HR and compliance services to client companies and becomes the 'Employer of Record' for employees. The worker does not become a permanent employee of the client company.
Read more at PEO vs Staffing Company.
Yes, many PEOs offer services to assist with employee performance management, including the development of performance appraisal systems and strategies to improve employee productivity.
The National Association of Professional Employer Organizations (NAPEO) is a national organization based in the United States that represents the interests of Professional Employer Organizations (PEOs). PEOs are firms that provide comprehensive HR solutions for small and mid-sized businesses (SMBs), helping them streamline their HR management by offering services such as payroll processing, benefits administration, regulatory compliance assistance, and more.
NAPEO serves as an advocacy group, seeking to voice the concerns and interests of PEOs at both the state and federal levels. Apart from advocacy, NAPEO also provides a platform for PEOs to network, collaborate, and educate themselves on industry best practices. They work towards facilitating a favorable legislative and regulatory environment for the PEO industry to thrive in, fostering the growth and success of PEO businesses.
It hosts educational events, webinars, and conferences offering industry insights and the latest updates pertinent to PEOs. Furthermore, it produces research reports and other resources to support PEOs in their operations. NAPEO is an essential hub for PEO professionals, helping them navigate the complexities of the industry and stay abreast of trends and developments. It essentially works to foster the growth and innovation of the PEO industry in the US, promoting standards of excellence and ethical conduct among its member organizations. It is advisable to check the latest resources for the most recent updates regarding the role and initiatives of NAPEO as the information might change over time.
Yes, you can use a Professional Employer Organization (PEO) for just one employee. Many PEOs offer services to small businesses and startups with a minimal number of employees, including those with only one employee. Engaging a PEO for a single employee can still provide you with a range of benefits such as handling payroll, tax administration, and providing access to better health and benefits packages than a small business might be able to secure independently.
However, it's essential to note that different PEOs might have different minimum requirements, and while many are willing to work with very small businesses, others may cater primarily to organizations of a certain size. It is advisable to research and reach out to various PEOs to understand their offerings and whether they can accommodate a business with one employee.
Moreover, while utilizing PEO services for a single employee, it would be beneficial to analyze the cost-effectiveness of this approach, as the fees for PEO services might be substantial for a business with a very small number of employees. It is always a prudent strategy to carefully review any contractual obligations and the range of services provided to ensure alignment with your business needs and budget constraints.