New IRS Program offers advantages to PEOs who meet certain criteria
When a business has joined a PEO, the co-employment model makes the PEO responsible for the collection and remittance of employment related taxes for both the client and the worksite employees.
Effective July 2016, The United States Internal Revenue Services will implement a voluntary program for Professional Employer Organizations that establishes in law certain operating advantages for PEOs that obtain IRS certification.
On December 19th, 2014, President Obama signed a bill in known as the Small Business Efficiency Act (SBEA) that provides Federal statutory recognition of the Professional Employer Organization (PEO) business model. The SBEA bill required the IRS to define the PEO certification process by January 1, 2016, but that date has been pushed back to July 1, 2016.
It is important to note that this law does not require a PEO to obtain certification with the IRS.
For a PEO to be eligible for the IRS certification program, a PEO must:
PEO must have annual financial audits conducted by an independent Certified Public Accounting firm.
Employment Tax Payments
Quarterly assertions and CPA confirmation regarding payment of all employment taxes.
PEO must obtain a third party surety bond of a minimum $50,000 or an for an amount equal to 5% of the federal employment tax liabilities for the prior year. Surety bond amount is capped at $1,000,000.
PEO and controlling persons at the PEO must complete a background check to ensure no prior felony convictions.
Client Service Agreements
PEO must have a client service agreement with their customers that meets certain IRS standards.
PEO must pay a $1000 annual fee to the IRS.
What’s in it for a PEO? In exchange for the additional cost and administrative burden of meeting the IRS PEO Certification requirements, certified PEOs get certain benefits in return:
The PEO industry has long sought recognition of the co-employment model in the US Tax code. CPEOs will have clear authority to collect and remit federal employment taxes (Social Security, Medicare, Federal Unemployment Taxes, etc.) for the worksite employees and to do so under the EIN of the CPEO.
Wage Base Restarts Eliminated
A certified PEO will be allowed to act as a successor employer regarding employment taxes. FICA and FUTA wage bases will not be reset when a new company joins (or leaves) a PEO midyear. Without this treatment, many potential PEO clients with higher wage employees have been reluctant to join a PEO mid-year due to the increased cost for tax withholding. For clients of a certified PEO this disincentive is eliminated.
FUTA Tax Credit
When a certified PEO makes a payment to any state UI fund (SUTA) for its worksite employees in that state, the certified PEO will receive federal tax credit for FUTA.
Unaffected Tax Credits for CPEO clients
A provision in the SBEA ensures that any special tax credit programs designed for small business clients will not be adversely impacted by the businesses joining a certified PEO. This ensures that small business will not be denied tax credit eligibility due having co-employees that are part of a larger company.
Customer Confidence Boosting
PEOs that seek IRS certification are certainly hoping that the IRS “seal of approval” helps them instill confidence with prospective clients that they are responsible custodians of their federal tax deposits and are solid financial partners for their clients.
While the overall outline of the certification program is still being defined, questions remain about how it will be implemented and administered. The IRS has until July 1, 2016 to publish those guidelines.
It is axiomatic that more government regulation = more costs.
As the implementation of the SBEA Certified PEO rules are rolled out in 2016, many PEOs in the USA will be assessing the value of applying for IRS certification and becoming a “Certified PEO”. Because the participation in the IRS program is voluntary, each PEO’s decision will be based on:
Application and participation in the IRS Certified PEO program requires the PEO to incur additional costs for program application, annual fee, CPA auditing and surety bonding.
The awareness and demand in the marketplace for the additional assurances to clients and prospective clients that their PEO meets a high standard of integrity. That in turn may help convince prospective customers that their PEO is superior to other (non-certified) alternatives.
In short, beginning in July 2016, many PEOs will be making a basic cost/benefit investment decision whether to purse IRS certification.
The two major cost drivers for PEO certification are surety bonding and the cost of an annual external CPA audit.
Per the terms of the Small Business Efficiency Act (SBEA), a certified PEO must maintain a surety bond representing 5% of the PEO federal employment tax liability, with a minimum value of $50,000 and a maximum capped at $1 million. Our analysis demonstrates that a PEO with as few as 1,300 worksite employees can generate roughly $20 million in federal tax liability and thus reach the surety bond capped amount. This means that per unit (worksite employee) costs will drop in a linear fashion for PEOs who with over 1,300 worksite employees.
According to a Jason Jenkins a surety bond broker writing in the NAPEO insider, surety bonding costs for a PEO can vary widely based on: tangible equity on the PEO’s balance sheet, profitability, working capital, revenue, cash on hand and short and long term debt. He notes that for the lowest bonding costs (.75%) a PEO should demonstrate twice the value of the bond in tangible equity. However, without significant collateral the annual surety bonding cost could go as high as 10% of the bonded amount. For smaller PEOs and start up PEOs, this will be a significant cost.
Another requirement for IRS certification is an annual audit of the PEO conducted by and independent CPA. Because the requirements for certification have not yet been clarified by the IRS, it remains unclear if the independent CPA financial audit requirement covers all aspects of a PEO finances or only the aspects related to federal tax payments. Also unclear is who is who is allowed to view the results of the CPA audit. Most PEOs are privately held companies and may be reticent to share full financial audit results with the IRS. According to an article at accountingweb.com, the average cost to audit a privately held company is $145,000 per year. This amount is just an estimate and could be higher for a PEO due to the complexity and increased scrutiny of the audit results. The increased audit costs will have a greater impact on smaller PEOs. Conversely, for a large publicly traded PEO, who already has audited financial statements as required by the SEC, this is not a new cost.
In our 17 years of experience advising small business about PEOs, we know that many owners appreciate the personal attention that a smaller PEO can offer. However, if those same small business customers also insist that their PEO be IRS certified, they should be prepared to pay a higher price in service fees.
If your company has more questions about the SBEA and PEO Certification, contact StaffMarket to get our Certified PEO whitepaper and cost analysis.