By Carrie B. Cherveny and Cory Jorbin

Over 175,000 employers today avail themselves of the services of Preferred Employer Organizations (PEOs), businesses that have evolved considerably since their genesis in employee leasing in the late 1960s.

Today, Preferred Employer Organizations provide a wide range of human resources services and outsourcing options, from payroll processing and tax filings to employee benefits plans and administration and regulatory guidance. These can be particularly attractive to small- to mid-sized firms that prefer turnkey HR solutions over growing their internal HR infrastructures.

But there are complexities to the business that make it important to do your homework before entering into a PEO relationship. Here are key things you need to know:

A quick look at how PEOs work

Many of their services require you to utilize the PEO’s tax identification number for your business and all your employees. That means new W-4s, I-9s and other new employee documentation must be completed. It allows you to take advantage of the PEO’s insurance plans, like health insurance and workers compensation and also means your employees are “co-employed” by you and the Preferred Employer Organization.

Understand, though, that the definition and related liability of the co-employment relationship vary by state and PEO. Additionally, state statutes specify which services PEOs must provide. Most require payroll services, workers compensation and state unemployment tax (SUTA). Some states allow PEO client-employers to carve out certain programs like SUTA. And many PEOs have their own requirements for clients, like utilizing the PEO’s cafeteria plan for employee benefits.

...and how they make their money

There are complexities to how PEOs structure their fees and revenue streams, making it valuable to secure expert guidance to walk you through your considerations.

Start with the administrative fee that PEOs generally charge for their services. One option is per-employee-per-month, which varies based on the employee count with each payroll. The second is as a percentage of payroll, based on total gross wages submitted each month. This means fees go up with each raise or bonus.

But there’s more. For example, PEOs may place clients with varying SUTA and workers’ compensation experience in different legal entities under their corporate umbrella as a way to affect the SUTA rate and workers compensation modification factor. Done right, this placement can dilute the risk of poor performers and retain an attractive SUTA rate and workers’ comp modification factor. The tax rate and insurance rates are based on the PEO (not the client), which divides the billing among its clients, often adding in additional administrative fees. So the PEO is not necessarily billing the clients the rate it’s getting charged by the carrier and/or tax authority.

Other areas to question include how Cafeteria Plan tax savings are treated by the PEO, commissions taken on employee benefits offerings and markups on HR products and services.

Understanding PEO service agreements

While specific agreements will vary, it’s important to be aware of some common provisions. For example, many contracts call for auto-renewal with a limited window for cancellation. Significant early termination fees may be specified to enforce the termination provisions. Also be aware of additional fees for various services like manual checks, off-cycle payroll runs and late funding, among others.

should guide your response. This may include:

  • All liability for proper employee classifications under workers compensation, Fair Labor Standards Act and the Affordable Care Act (ACA), along with OSHA health and safety risks and obligations. The client, not the PEO, would be responsible for Department of Labor citations or penalties in the event of audits or inspections.
  • All employee-relations liability. While PEOs provide employee relations advice and counsel, any related legal claims are the client’s liability. They hold that as providers only of administrative services, not being the day-to-day employer insulates them from employment litigation liability.
  • Responsibility and liability for ACA penalties. This may be the case even when the client utilizes the PEO’s own master plan, as the PEO may take the position that the plan’s affordability is the client’s responsibility and so is the obligation of ensuring the offer of coverage to employees. This makes it critical to ensure the PEO is providing complete ACA compliance and monitoring in its services.

Next up: Part 2 – When you’ve outgrown your PEO relationship, here’s how to manage the exit.

HUB International’s team is available to work with you on a diverse range of HR needs, from risk management and regulatory compliance to benefits strategy, program design and workplace culture.