Article roundup
- A Professional Employer Organization (PEO) is a specialist HR company that takes care of 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 there are some differences. The term ‘EOR’ is more commonly used with companies that operate internationally.
- There are pros and cons to engaging a PEO: On one hand, it usually saves money, 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.
A Professional Employer Organization (PEO) is a third-party service provider that processes payroll, and carries out HR and compliance activities on behalf of 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 which 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 responsibilities of the employer are split between both 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 which has 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 clearly set out in the contracts that 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 recognize an EOR as the ‘statutory employer’. This means that EOR has the responsibility 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, they do so under their own name 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, in California, the Employer of Record of In-Home Supportive Services (IHSS) carers are “public authorities”. These quasi-governmental bodies, created by county governments, mean carers are covered by the National Labor Relations Act, 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 at all, and therefore not PEOs.
What is the connection between PEO and ’employee leasing’?
Prior to the 1990s, the terms PEO and EOR were not commonly used. However, a related concept known as ’employee leasing’ was popular. No one is quite sure when this practice first began, as it was not widely-publicized or well-known until 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 through transferring the most onerous employment responsibilities to another party, including responsibility for health insurance, 401k contributions, and workers’ compensation. From the perspective of the employee, 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 the lower health and safety risk profile of employee leasing company, artificially low workers’ compensation premiums could be paid. Those premiums did not reflect the actual risk for workers engaged on the worksite. This has been referred to as the ‘Workers Compensation Shuffle‘.
- It was used by client companies to avoid providing their workforce with the pension plans they would otherwise be entitled to: Under the Revenue Act of 1942, in order 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 has the benefit for client companies that they will no longer be liable for federal employment taxes as a ‘co-employer’ of workers.
In order 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 who have knowledge or experience regarding federal and state employment tax compliance and related business practices.
Once certified, the CPEO is required to post an annual bond of up to $ million guaranteeing payment of employment taxes.
Currently, 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, as well as 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 insurances
- 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 generally 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 differencing responsibilities, in co-employment, the client company is sometimes known as the ‘operational employer’ or ‘worksite employer’, while the PEO is known as the ‘legal employer’ or ‘administrative employer’.
As 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, the IRS observes that in the US, despite what is said in any PEO agreement, client companies can still be legally liable for employee taxes. The IRS does not recognise 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.
In exchange for the responsibilities and liabilities that it takes on, the PEO charges the business a fee for its services. The size of that fee depends on factors such as the number of employees and the type of HR services provided, and the chosen fee model of the company.
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 need to be weighed up before you commit to this option. We consider these below. In short companies interested in PEO solutions need to consider:
- How much more what it cost to hire and pay internal employees to pay these tasks?
- 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
What are the advantages of using a PEO?
1. PEOs are HR and payroll specialists
PEOs have the knowledge, equipment (such as specialist software), 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 sure-fire 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:
- Recruitment
- 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 which reduce the risk of data breach 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.
1. ASO
ASO stands for ‘Administrative Services Only‘. An ASO firm can take over administration for your employee health plans, but they do not have full reponsibility 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 of administrative tasks generally, not just health plans. Firms that fulfil 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.
2. HRO
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).
- Insperity. Insperity is a full-service PEO and HR company, serving businesses of all sizes. It has a special focus on the customer experience.
- 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.
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, they become the ‘Employer of Record’ and 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.
FAQ
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, PEOs can provide assistance with benefits administration and health insurance. In addition to providing access to employee benefits, PEOs can also help with compliance, payroll, and other HR functions.
