To a business owner looking to outsource functions of payroll and human resources, “PEO” might be a familiar term. PEOs, or Professional Employer Organizations, offer ‘co-employment’ agreements with their clients, which essentially means the PEO becomes the employer of record for tax purposes. When the PEO becomes the employer of record, it becomes the legal employer and takes on the responsibility of paying employees, withholding and remitting the appropriate payroll taxes, and providing workers’ compensation insurance. Employees of businesses who enter into these co-employment agreements become employees of the PEO, and this is reflected on their pay statements and W-2 forms.
Partnering with a PEO can provide a range of benefits. Since the PEO’s employee count includes that of their clients, they may be able to negotiate more favorable rates when it comes to healthcare and other employee benefits. These cost savings may be passed on to their clients, who may otherwise have to take on higher premium costs or plans that may not be as rich as those offered by the PEO. PEOs may also offer retirement vehicles such as 401(k) plans which may have been too expensive or difficult for some smaller employers to provide. Having access to these benefits could help companies attract skilled employees, and makes PEOs an appealing option for many small and medium-sized businesses.
However, there can be some drawbacks to the PEO model. While a PEO may be able to leverage its size and employee count for better rates on certain insurance products, the cost savings might not always be passed on to their clients. Since starting a PEO relationship essentially means employees are being hired by a new company, businesses joining a PEO mid-year will have their taxable wage bases reset for FICA taxes and federal and state unemployment taxes (FUTA and SUTA). This means that even if wage limits were previously met, companies will have to pay for these taxes all over again.
Some PEOs may collect on federal and state unemployment taxes even after wage limits have been met, by charging admin fees based on flat percentages or amounts without providing a detailed breakdown of fees, which may allow them to hide these costs from their clients. Oftentimes clients will see “taxes” on their invoice, when some of this money is being pocketed by the PEO. To do a quick check, see if you’ve paid more than $42 per employee for federal unemployment tax (FUTA) this year. If so, those “taxes” are really fees. PEOs can also tack on additional amounts to workers’ compensation, and even healthcare premiums to collect additional revenue from clients.
Business owners should also consider that there can be some loss of control over the business. PEOs may implement additional requirements or restrictions for their clients when it comes to certain employment practices or policies. This might be something a PEO may choose to do in order to protect their business since they are assuming risk by becoming the employer of record. PEOs can sometimes have very aggressive deadlines for funding payroll and tax remittances, which could pose cash flow challenges for a smaller business. Being at the mercy of the PEO and losing control of certain aspects of the company’s culture, plans, and internal policies can be a huge disadvantage for many organizations, and is something that should be kept in mind when considering whether joining a PEO is the right decision for the business.
While it may seem like an easy way to streamline the business, there can be drawbacks to the PEO model as well, and joining a PEO may not be the best move for every company. There can be both advantages and disadvantages with joining a PEO, and many factors to consider before choosing to work with a PEO. Organizations should take their time to research and weigh the options before taking the plunge. Contact Valor Payroll Solutions, a small business payroll specialist, if you have any PEO questions!