With passage of the Tax Increase Prevention Act of 2014 (“TIPA”), enacted December 19, 2014, Congress substantially modified existing law as it relates to businesses and their interaction with professional employer organizations, or PEOs. According to the National Association of Professional Employer Organizations, approximately 2 to 3 million people are currently covered under a PEO arrangement. After TIPA is fully implemented, with many provisions effective January 1, 2016, expect these numbers to increase in the coming years.
Small-to-midsize businesses often find Federal employment tax filing and reporting obligations difficult to comply with and opt instead to use PEOs to provide these services on their behalf for a fee. As explained in the Joint Committee report accompanying TIPA, a PEO often enters into a contract to provide employees to perform services for the business with the PEO agreeing to not only be considered the employer of the employees but also agreeing to pay the employees’ related employment taxes. The business often pays the PEO a fee based on payroll costs plus an additional predetermined amount that serves as a profit for the PEO. Often times, the business already has employees, but the PEO agrees to act as the employer and to pay the corresponding employment taxes on these employees.
Under existing law, the contract entered into between the PEO and the business generally did not absolve the business of its employment tax liabilities. In other words, if the PEO failed to remit the employment taxes to the IRS, the IRS could look to the business to satisfy the employment taxes owed. This was because a taxpayer’s employment tax obligations were generally determined not based on contract law but rather on a common-law test incorporated into Treas. Regs. §§ 31.3121(d)-1(c)(1), 31.3306(i)-1(a), and 31.3401(c)-1. The Regulations focused on the degree of control a taxpayer exercised over an employee as well as the right to control the employee, irrespective of any private agreement made between the PEO and the business. As indicated in a recent IRS memorandum discussing existing law pre-TIPA, “an employer cannot contract away its responsibility to withhold, report and pay applicable employment taxes.” At most, the business could designate the PEO to be responsible for certain employment taxes by filing Form 2678, but the PEO and the business remained jointly liable. Finding it inherently unfair for businesses to remain liable for employment taxes in these situations, often the result of a PEO’s failure to remit the taxes owed on account of the PEO’s negligence or sometimes fraudulent activities, Congress elected to modify current law through passage of TIPA.
Under TIPA, a business may generally avoid employment tax liabilities with respect to “work site employees” if the business contracts with a certified PEO ("CPEO") to provide employment tax services with respect to those employees. A work site employee is an individual who performs services for the business under a contract between the business and the CPEO and that performs those services at a work site that meets the work site coverage requirements. The work site coverage requirements are generally met if at least 85% of the employees performing services for the employee at the work site are subject to one or more contracts with the CPEO, which meets the service contract requirements. The service contract requirements require the CPEO to, among other things, assume responsibility for payment of wages to the business’ employees as well as responsibility for the reporting, withholding, and paying of employment taxes. In the case of employees that are not work site employees, the CPEO and the business remain liable for the employment taxes.
A CPEO is required to meet certain certification requirements as well as receive approval from the IRS. The certification requirements require, among other things, that the PEO agree to satisfy certain bond, reporting, and independent financial review requirements. Although the IRS was required under TIPA to create a PEO certification program by July 1, 2015, the IRS has announced that it will begin accepting applications for CPEOs one year later, or July 1, 2016.
Federal employment tax filing and reporting requirements will remain an arduous task for most small-to-midsize businesses. TIPA offers welcomed relief for those businesses that wish to rely on employment tax services of a CPEO.