A bill that would create a new certification option for professional employer organizations, and shield client companies from possible federal employment-tax liabilities, was introduced by Senate Finance Committee Chairman Charles Grassley (R-Iowa) and the Committee’s Ranking Democrat, Max Baucus (D-Mont.) on May 19, 2006.
The bill, S. 2913, named the Small Business Efficiency Act of 2006, would create a new type of entity denominated a certified professional employer organization (“certified PEO”). It is a companion to a bill introduced in the House of Representatives on March 16, 2006.
The bill does not define the term professional employer organization (“PEO”). In broad terms, a PEO is in the business of becoming the employer of record for a customer’s entire workforce, or division thereof.
The bill provides that in a three-party arrangement involving a certified PEO, a client company and a worker, the certified PEO would be treated for purposes of federal employment taxes as the sole employer with respect to compensation that the certified PEO disburses to worksite employees who perform services for the client company – thus insulating the client company against potential liability for the taxes.
For these purposes, a worksite employee would be defined as an individual who performs services for a client company pursuant to a contract between the client company and the certified PEO that contains specified criteria. In addition, the individual must perform services at a work site where at least 85 percent of the individuals performing services for the client company are subject to one or more similar contracts with certified PEOs. An individual with self-employment income derived form the client company is ineligible for worksite employee status. Also, the special treatment provided by the bill would not apply to arrangements in which the certified PEO and the client company are related parties, based upon a 10 percent common-ownership threshold.
If workers in a three-party arrangement as just described do not qualify as worksite employees, the bill provides that the certified PEO would be treated as the employer of the individuals for federal employment-tax purposes, but not necessarily the sole employer, thus leaving the client company exposed to possible liability.
The bill also would protect against workers being subject to multiple wage base limitations for purposes of the Federal Insurance Contributions Act (“FICA”) and the Federal Unemployment Tax Act (“FUTA”) during their transition from a client company to a certified PEO, and from a certified PEO back to a client company. For these purposes, a wage base limitation is the maximum amount of wages that an employee earns during a calendar year that is subject to a particular type of employment tax, such as FICA taxes and FUTA taxes. To accomplish this, the bill provides that a certified PEO would be treated as a successor employer and the client company the predecessor employer during a transition to a certified PEO, and that the client company would be treated as a successor employer and the certified PEO the predecessor employer during a transition from a certified PEO back to a client company.
To acquire certified PEO status, a professional employer organization must apply for the status and meet specified requirements. The principal requirements include:
- Eligibility criteria involving tax status, background, experience, business location, and annual financial audits,
- Independent financial review requirements,
- Reporting obligations,
- Accrual method of accounting for federal-tax purposes, and
- Other requirements to be established by the Treasury Department.
A bond would required in an amount equal to the greater of (i) 5 percent of the entity's federal employment tax liability attributable to its client companies (but not to exceed $1,000,000) or (ii) $50,000.
The principal requirements of the contract between the certified PEO and the client company are that the certified PEO:
- assumes responsibility – without regard to the receipt or adequacy of payment from the client company for such services:
- for payment of wages to the individual,
- for reporting, withholding, and paying any applicable federal employment taxes with respect to the individual's wages, and
- for any employee benefits which the service contract may require the certified PEO to provide,
- assumes responsibility for hiring, firing, and recruiting workers in addition to the client company's responsibility for hiring, firing and recruiting workers,
- maintains employee records relating to the individual, and
- agrees to be treated as a certified professional employer organization with respect to such individual.
The bill would be effective on January 1st of the first calendar year beginning more than 12 months after the date of the enactment, and the Secretary of the Treasury would be required to establish the certification program not later than 6 months before the effective date.
