Professional Employer Organizations, also known as “PEOs,” are becoming more popular every year. PEOs service businesses with only one employee and up to hundreds, and in almost any industry imaginable. They also recently obtained long-awaited federal recognition with President Obama’s signing of the Small Business Efficiency Act. This law, among other things, provides for IRS certification of eligible PEOs, thereby validating the industry and giving its customers new confidence in the PEO relationship. It is curious, however, that many business owners are unaware of or misunderstand this valuable resource. In this article, we will take a quick look at the way PEOs operate, the services they offer and their potential benefits. In later articles we will examine the principle terms of the client service agreements used by PEOs, the details of the Small Business Efficiency Act, and other topics of concern to PEOs and their clients.
A typical client of a PEO is a small or medium sized business which chooses to outsource various human resource functions. These functions include payroll, human resources administration, workers’ compensation, unemployment and other benefits administration, tax administration and regulatory compliance. The PEO enters into a contract with the client pursuant to which they share employer responsibilities for the client’s worksite employees. The PEO and the client become co-employers of those worksite employees, and the respective rights and obligations of the PEO and the client are set forth in their agreement. The PEO is not a staffing service; its fundamental role is to provide human resource and benefits functions, not to provide workers. As for compensation, the PEO usually is paid either a percentage of payroll or on a per-employee basis.
PEOs can be enormously helpful to a small or medium sized business owner. Start with the simple requirement of administering payroll. As any business owner knows, this is not as simple as merely calculating pay and arranging for checks or direct deposits to be made. There is additional work which includes, at a minimum, tracking vacation and sick leave, withholding and remitting federal, state and local taxes, issuing year end W2s and W3s, and handling all other federal, state and local reporting and compliance. Relieving the business owner of these responsibilities will be a huge help, but it is only the beginning.
Management of workers’ compensation and unemployment claims is a critical PEO function. Procuring workers’ compensation insurance, claims review and administration, and billing functions all drain valuable management resources. In addition, improperly managing claims can have a profound effect on a company’s bottom line. Having a PEO as a co-employer to undertake these responsibilities often makes good business sense.
Another essential benefit of using a PEO is to take advantage of the purchasing power it acquires by aggregating all of its clients’ worksite employees to obtain health insurance, 401(k) and other employee benefits. The rates and terms that a PEO can command are often far more beneficial than those that can be obtained by a small employer. The client can avoid committing valuable resources searching for and investigating medical and dental plans, as well as administering numerous other employee benefits plans.
PEOs also provide human resources services and often provide consultation services in the areas of recruiting, interviewing, hiring and firing, performance reviews, and preparation of employment policies and handbooks. Finally, federal, state and local compliance requirements are complex and constantly changing, as evidenced by the Affordable Care Act. Without a dedicated HR department, it is risky for an employer to attempt to keep up with the changes, and also requires time and energy to meet compliance requirements.
One misconception about PEOs is that the employer will lose control over its employees. The reality, however, is that the PEO issues paychecks and administers benefits under its own name, but the day-to-day management of the worksite employees generally is left to the worksite employer. There are times when a PEO gets directly involved in the hiring, discipline or termination of worksite employees, but typically that occurs after the employer requests such assistance from the PEO. Sometimes there are concerns about the reliability and trustworthiness of the PEO to pay the worksite employees and remit taxes to the authorities. The employer transfers these funds to the PEO with the expectation they will be paid, and there have been instances of PEOs failing to honor their obligations. But many PEOs are accredited by ESAC –the Employer Services Assurance Corporation – which serves as a financial backstop to PEOs much the same way that the FDIC protects bank depositors. Also, the newly enacted Small Business Efficiency Act protects employers who engage an IRS certified PEO by absolving them of liability for payroll taxes if their PEO fails to remit.
PEOs may not be suitable for every business. But given their benefits, they certainly deserve serious consideration because they free up more time for a business owner to concentrate on the business’s core strengths. Stay tuned for more on this rapidly expanding business development.