A professional employer organization (PEO) is a single source provider of integrated services which enable business owners to cost-effectively outsource the management of human resources, employee benefits, payroll and workers’ compensation and other strategic services, such as recruiting, risk/safety management, and training and development.It does this by hiring a client company’s employees, thus becoming their employer of record for tax purposes and insurance purposes. This practice is known as co-employment
As of 2010, there were more than 700 PEOs operating in the United States, covering 2-3 million workers.[1] PEOs operate in all fifty U.S. states. Similar services are described in Sweden,[2] Germany,[3]
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In a co-employment contract, the PEO becomes the employer of record for tax purposes, filing paperwork under its own identification numbers. The client company continues to direct the employees’ day-to-day activities. PEOs charge a service fee for taking over the human resources and payroll functions of the client company: typically, this is from 3 to 15% of total payroll.[4] This fee is in addition to the normal employee overhead costs, such as the employer's share of FICA, Medicare, and unemployment insurance withholding.
One key service usually provided by a PEO is to secure Workers Compensation insurance coverage for client companies. This is normally one of the key selling points stressed by a PEO, that a PEO can provide Workers Compensation insurance coverage at lower cost than client companies can obtain on an individual basis. While there is some merit to this assertion, it has also been an area of considerable controversy and litigation.
Essentially, a PEO obtains Workers Compensation coverage for its clients by negotiating insurance coverage that covers not just the PEO but also the client companies. This is allowed because legally the PEO is the co-employer of the workers at the client companies. There can be economies of scale that come into play, allowing a PEO to obtain Workers Compensation insurance at a cost lower than the individual client companies can obtain on their own. However, there have also been instances of PEOs using improper means to lower their Workers Compensation insurance costs. Some principals of PEOs have been found criminally liable for fraud for using improper means to lower Workers Compensation insurance premiums.
Effectively, PEO companies maintain a relationship with their clients on keeping updates of employee information. In light of this, Professional Employer Organizations successfully engage in improving practices of employment—this includes compliance, risk management reducing liabilities. Also, it lifts up the burden of employers to maintain bulk work of management systems. With the professionalism of PEOs, they provide management solutions that can benefit their clientele. Lastly, an important service is the presence of strategy and knowledge of the labor market. With this key aspect in mind, the PEO will opt to maximizing the competency in the labor market. PEOs can also offer basic levels of background & drug screening.
The value proposition to client companies is that the use of a PEO saves time and staff that would be used to prepare payroll and administer benefits plans, and may reduce legal liabilities or obligations to employees that it would otherwise have. The client company may also be able to offer a better overall package of benefits, and thus attract more skilled employees. The PEO model is therefore attractive to small and mid-sized businesses and associations, and PEO marketing is typically directed toward this segment.[4]
In the United States, many small to medium size professional services firms utilize PEOs to allow them to provide the kinds of benefit plans which otherwise could only be made available at a prohibitively high cost to both the employer and the employee.
Several variations on the PEO model exist, differing in the nature of the relationship formed between PEO and client company.
Employee leasing in the United States began in the late 1960's by 3 business men, Eugene Boffa Sr, Louis Calmare, Sr. and Joseph Martinez Sr. The concept was popularized by Marvin R. Selter,[8] who leased the employees of a doctor's office in Southern California.[9] The Employee Retirement Income Security Act of 1974 (ERISA) contained an exemption for multiple employer welfare arrangements (MEWA), which provided a loophole for employers with leased employees to claim they were exempt from the ERISA requirements. Passage of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) further encouraged employee leasing by providing a tax shelter for employers who contributed a minimum amount to employee plans. More stringent guidelines in the Tax Reform Act of 1986 later eliminated most of the TEFRA incentive, however.
By 1985, there were approximately 275 staff leasing companies in the United States.[10]
A new business has also developed recently, in which a marketing or brokering company serves to connect businesses with professional employer organizations. Many of these sites receive a commission if they arrange a contract between a PEO and a new business client. These sites earn their money by "brokering" for various PEOs and receiving compensation for contracting PEO relationships.
Each state in the U.S. has differing regulations for workers’ compensation insurance and state unemployment insurance, so PEOs are typically regulated at the state level.[12]
In 2004, President George W. Bush signed into law the SUTA Dumping Protection Act of 2004, which requires that all 50 states enact anti-SUTA-dumping legislation by 2007.[13] Most states have now done so;[14] however, federal law does not prohibit companies from using a PEO to obtain more favorable SUTA rates.[15]
The staff leasing industry itself has also taken steps to address abuses. It formed its first trade association, the National Staff Leasing Association, in 1985. The association changed its name to the National Association of Professional Employer Organizations in 1994 to reflect the term in current usage.
As part of the industry's efforts to self regulate, an independent accreditation body, Employer Services Assurance Corporation (ESAC), was formed in 1995. ESAC's purpose is to verify PEO compliance with important ethical, financial, and operational standards and to provide financial assurance backing the performance of its accredited PEOs.[16]
PEOs may also undergo a certification process conducted by the independent Certification Institute (CI) formed in 2002. This certification verifies that a PEO's workers' compensation (WC) program is meeting proven insurance industry risk management best practices to reduce work-related accidents and health exposures and control WC insurance losses.[17]