PEO’s and Tax Payments: Buyer Beware

The most basic and beautiful fundamental of capitalism is a free market society creating a fertile foundation for innovation and creativity which are incentivized by financial reward; however, even in America, arguably the world’s poster child for capitalism and pursuit of self-interest, governmental rules and regulations have created a hazardous playing field for business growth and development. Over the past 50 years the cost and complexities involved in running a small to medium sized business in the United States have spiraled out of control. The drudgery of labor law compliance and the hard dollars spent to retain and maintain proper business insurance and competitive employee benefits programs can rob the small business owner of his dwindling profits. With a strained economy and the growing difficulties associated with human resource administration, how does a small business compete with a large corporation? Most Professional Employer Organizations (PEOs) would tell you they have the answer. What I can tell you is, “BUYER BEWARE!”

The PEO industry was born over 3 decades ago on the basic concept that pooling risk and buying power between is capable of solving the cost issues associated with workers’ compensation, a concept later applied to employee benefits. A PEO is a business that is contracted to hire the existing employees of client companies and subsequently lease those same employees back to the original entity. Through self-insurance, group buying power and economies of scale in providing payroll and human resource functions, the theory goes that these organizations can ultimately increase the efficiency and profitability of small to medium sized businesses. This sounds great, and in many cases it all works out, but the bottom line remains that there is joint exposure to the experience of other companies within the group and more importantly, there is joint liability for the practices of the PEO itself.

In the ideal case, a PEO is run properly, the owners are selective about the clients that are brought into the pool, the groups within the PEO are not detrimental to one another and the increased buying power saves some hard dollars for client companies. In the short term this often works, but it is likely that there will be a cost associated with employing PEO services in today’s environment. And even when there seems to be an immediate savings, there is often fuzzy math associated with the proposal process and undisclosed secrets about the pass through of tax benefits and other items that should be presented more honestly and transparently, but the real concern a PEO prospect should raise goes far beyond price and premium dollars.

When a business owner turns over payroll, benefits, 401(K) and human resource administration to a third party, there needs to be a high level of trust that accounting is accurate, and most importantly, that money flows to the right places after leaving client accounts. With most service providers it is quite simple for a business owner to verify that taxes and premiums are being paid through transparent reporting functions and verifiable deposits, but with a PEO things are quite different. Co-employment within a PEO relationship creates a situation in which the service provider files on behalf of all the groups within the pool. There is no way for a client company to verify that the taxes and premiums are being paid in full, or at all for that matter. A client company has no way of knowing exactly what is going on behind the scenes. You may ask, “If the PEO is the employer of record, does that matter from a liability standpoint?” Many PEO owners and salespeople would tell you no, but that is simply not the case. Your business is and you are on the hook.

A recent episode with a PEO in Indiana has led the Indiana Department of Workforce development to decide that all clients within a PEO are “jointly and severally” liable for tax payments. In plain English, this means that a client who leaves a PEO that is found to be deficient in State Unemployment Insurance payments will hold all of that liability. You read this correctly. Each client carries the entire liability. The government wants its money and will not take a loss because of opaque accounting techniques or fuzzy math nor will the State of Indiana fall for a client company claiming ignorance. It is ultimately the individual business owner’s responsibility to ensure that tax payments and insurance premiums are being paid, and engaging in co-employment does not relieve you of that liability but exposes you to increased risk of breakdown.

If you are currently in a PEO relationship in the State of Indiana, I suggest you kick the tires a bit to see how much air there is. Ask your PEO for credentials such as ESAC accreditation or audited financials since you will never have anyway of real time verification of the flow of cash or payments. If you are interested in transparent alternatives, they do exist.

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