This past May (2016) the IRS announced new regulations aimed at jump-starting a new voluntary certification program for companies doing business as professional employer organizations (PEOs). Despite certification being voluntary, some see the new government regulations as a stepping stone to mandatory certification in the future. Any such move would lead to the inevitable question of whether payroll services and PEOs are substantially different. Right now, they are under federal law.
The concern is that even though payroll services and PEOs are distinctly different in the way they treat employees the government may eventually decide to lump them both together for the purposes of requiring certification. That could make for more paperwork and bureaucratic red tape. For now, however, certification remains voluntary and only applies to PEOs.
How the Two Entities Differ
To understand the government’s voluntary certification of PEOs, it is helpful to understand how these entities differ from standard payroll services. Knowing the differences is also helpful toward understanding why the IRS is pushing certification.
Standard payroll services provide a limited set of services to customers. They calculate payroll, issue paychecks, collect and pay taxes, and furnish the reports clients need to maintain regulatory compliance. In some cases, payroll services also help administer health insurance plans, retirement plans, and workers’ compensation insurance. Any employees covered by the provided services remain employed by the client, not the payroll service provider. And therein lies the difference.
A PEO may offer all of the same services as a standard payroll provider with one key difference: the PEO actually hires the employees of the client. Those workers become employees of the PEO for tax and insurance purposes. For all other purposes, they remain employees of the companies for whom they work. This arrangement is known as co-employment.
From a practical standpoint, contracting with a PEO would mean the following:
- Employee tax records would be filed using the PEO’s tax identification number
- The PEO would essentially assume responsibility for all human resource and payroll functions
- The PEO would also provide workers comp insurance for all workers
- The client would be relieved of most legal liabilities relating to payroll, taxes and benefits
- The client would still maintain control over the day-to-day work of employees.
Circumstances Dictate the Better Option
There are currently hundreds of PEOs operating in the United States. However, the PEO business model is not a good fit for every company. To begin with, PEO contracts are very expensive. PEOs charge substantial fees for their services because they are essentially taking over human resources and payroll entirely. Clients also lose some control over benefits packages when they contract with a PEO.
For the average small business without extensive payroll and benefits needs, standard payroll services are a better fit. The average payroll company now offers a range of services that clients can choose from to create a package that is well-suited to their requirements. For example, one client may choose a full-service package that requires nothing but entering weekly work hours into a computer system. Another client may use the payroll provider to handle withholding and issue paychecks, but keep everything else, including benefits and workers comp, in-house.
Only time will tell if the government will decide to impose mandatory certification on both PEOs and payroll services. For now, PEO certification is entirely voluntary. Companies willing to get on board can use certification to their benefit by being able to market themselves as certified. As for payroll services, they can keep doing what they do without having to address the certification question.