Fancy packaging doesn’t necessarily render a gift valuable. The same can be said for employee leasing companies, also called Professional Employer Organizations (PEOs). On the surface, a PEO appears to be just what you need in a human capital management (HCM) solution. But looking deeper, you find that things aren’t as they seemed, and leaving can come with a costly caveat.
Until recently, if you dropped your PEO midyear, it could have meant double taxation, due to the wage-base reset on FICA and FUTA taxes. But the Small Business Efficiency Act (SBEA) has changed that, making it easier for unhappy PEO customers to leave that relationship.
How PEOs Work
PEOs oversee their clients’ HR-related functions – including payroll, benefits, tax administration, regulatory compliance and, typically, workers’ compensation. Essentially, the PEO becomes the “employer of record” for its customers’ employees, who are paid through the PEO’s payroll, instead of their employer’s. In turn, the customer becomes the “worksite employer,” who pays the PEO directly for its services.
Sound harmless?
Dangers of Using PEOs
PEOs often state that the worksite employer retains all day-to-day control and direction of its workers. Until this legislation, employers in a contract with a PEO would be hit with double taxation along with a large exit penalty for leaving mid-calendar year, unless theirs happened to run on the calendar year. In addition:
- For insurance purposes, PEOs market all of their customers as one. If any of those other clients make enough claims, causing their rates to increase, your rates will go up as well.
- The PEO has significant control over its clients’ benefits plans and carriers. If your employees are happy with a certain carrier, but the PEO wants to switch, there isn’t much you can do about it, if anything.
- If the PEO suddenly goes out of business without compensating your employees or remitting your taxes, you’re responsible for the costs. Since PEOs require upfront payment, this puts you at financial risk.
- The PEO has significant control because employees are being paid by the provider not the company. This is referred to as “employee leasing.”
It’s not uncommon for PEO customers to seek a different HR solution simply because the PEO relationship isn’t what they imagined.
Tax Concern for PEO Customers
As an employer, you must pay FICA and FUTA taxes on a certain amount of each employee’s wages for the year.
For example, most employers pay 0.6 percent of the first $7,000 paid to an employee in FUTA taxes for the year. A client that wants to leave a PEO relationship midyear and has already met the annual FUTA wage base would be subject to double taxation.
Same goes for FICA tax. Double taxation occurs because the annual wage bases for FUTA and FICA taxes restart when employees are paid under a different EIN midyear.
The SBEA Eliminates Double Taxation
The Small Business Efficiency Act is game-changing legislation that allows PEOs to gain certification through the IRS and makes it easier for customers to leave a PEO relationship. Switching to another HCM company will be simpler because the SBEA eliminates the wage-base restarts for FUTA and FICA taxes. PEO customers no longer need to fear double taxation when switching HCMs midyear.
Despite formally taking effect on Jan. 1, 2016, the SBEA will not be implemented fully by the IRS until July 1. Still, now is the time for PEO customers to seek a more viable, peace-inducing HCM solution that leaves control of your business where it belongs: with you.