What is a PEO or Professional Employer Organization?
IRC section 3401(d)(1) defines the term “employer” as the person for whom an individual performs or performed any service as the employee of such person (the CLE), except that if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services, the term “employer” means the person having control of the payment of such wages. A person who is not the CLE but is considered the employer because it has exclusive control of the payment of wages is sometimes referred to as the “statutory employer.”
If a third party, such as a PEO, is a statutory employer, it will be the person responsible for the employment taxes on the wage payments that it had exclusive control of. Significantly, if the third party is merely a conduit for the funds used to pay wages, it is not a Section 3401(d)(1) employer. It is important to remember that the Section 3401(d)(1) employer is only liable for employment taxes on wage payments over which it had control.
A PEO is sometimes referred to as an employee leasing organization. The contract between the PEO and the employer will provide that the PEO will perform some or all of the employment tax withholding, reporting and payment activities related to workers performing services for the employer. In some cases, the employer who contracts with a PEO purports to fire its employees, who are allegedly then hired by the PEO and leased back to the CLE (the PEO’s client). The PEO pays the employees as well as the employment tax liabilities with funds received from the client and files employment tax returns using its (the PEO’s) EIN. Typically, the client remains the CLE and the PEO is not the Section 3401(d)(1) employer because it does not control the payment of wages.
In many cases, the PEO claims to share control over the employees as a “co-employer”.
- Recruit and hire employees for the client or assign employees as permanent or temporary members of the client’s work force, or participate with the client in these actions;
- Hire the client’s employees as its own and then lease them back to the client to perform services for the client; or
- File employment tax returns using its own EIN that include wages or compensation paid to the individuals performing services for the client.
Even after the creation of the certification process, there may be many organizations which function as PEOs but do not become certified. (Source: Third Party Payer Arrangements – Professional Employer Organizations | Internal Revenue Service (irs.gov))