On December 19, 2014, President Obama signed into law the Tax Increase Prevention Act of 2014 (TIPA), which, in part, authorizes the Internal Revenue Service (IRS) to create a voluntary certification program for professional employer organizations (PEOs) to become recognized as "certified" PEOs (CPEOs) for purposes of the Internal Revenue Code (IRC).

Effective January 1, 2016, PEOs that choose to become certified will be treated as the employer of "work site employees" (as defined in the new law) for federal employment tax purposes (for more details about the new law, see Legal Update, Tax Relief Extension Includes Provisions on Multiemployer Pension Plans, Transportation Benefits and PEOs). Practical Law asked Ted N. Kazaglis of Jackson Lewis P.C. to outline the implications of the new law for PEOs and organizations contracting with PEOs.

Ted is the Office Managing Shareholder of the Raleigh-Durham, North Carolina office of Jackson Lewis. He handles diverse employment law issues for clients in the alternative staffing industries, such as PEOs and temporary staffing companies. He helps clients define their relationship with their customers, and defend against legal claims, including those that involve joint employer issues. In particular, for more than 20 years, Ted has represented PEOs on a wide array of issues affecting the co-employment relationship. He is an active member of the National Association of Professional Employer Organizations (NAPEO) and former Chair of its Legal Advisory Council.

The definition of a "professional employer organization" or "PEO" has evolved over the years since the phrase was first coined in 1993. A PEO is an entity that enters into a contractual agreement with a customer where employer responsibilities for the customer's worksite employees, who are subject to the agreement, are shared or allocated (but not delegated) between the customer and the PEO. The PEO co-employs those workers and issues their Federal Form W-2 Wage and Tax Statements on the PEO's Federal Employer Identification Number (FEIN), but is not a joint employer of those workers.

The PEO is entitled to enforce only those employer rights, and is subject to only those obligations specifically allocated to the PEO under the agreement with the customer and applicable law. PEOs provide services for existing and subsequent new worksite employees co-employed under the PEO agreement. Unlike temporary or other staffing services, the PEO does not provide new workers for the worksite employer.

Yes, there is a difference between PEOs and employee leasing. Employee leasing is a model that requires the employee be employed by the leasing company and work at a customer location on a long-term basis. For example, a company might use leased workers to run a particular segment of the business, such as a shipping department.

The reason the terms are used interchangeably in certain circumstances requires some understanding of the history and evolution of PEOs. Before 1993, "employee leasing" or "staff leasing" was used by some businesses to attempt to avoid discrimination testing rules for certain employee benefits. The idea was that Company A would "lease" their employees to an employee leasing company, meaning the employees supposedly no longer worked for Company A and were technically employed by the leasing company. Therefore, the employees would not need to be included for purposes of discrimination testing under the IRC. Section 414(n) of the IRC was passed to curtail this circumvention of the law. Section 414(n), in part, requires that a customer of a leasing organization (or Company A, which is referred to as a recipient in the IRC) must treat any leased workers as an employee of the customer for certain purposes if all of the following are true:

In addition, states started passing licensing laws for employee leasing companies. For example, Florida passed the Employee Leasing Licensing Act and Texas passed the Staff Leasing Services Act.

In 1993, the industry adopted the term PEO to differentiate itself from employee leasing and the negative connotation that came with that term. Unlike employee leasing, a PEO enters into a contract with the customer where the PEO shares some of the customer's employer responsibilities in relation to the employees who are already working at the customer worksite. The PEO customer at all times remains an employer of the worksite employees. The PEO is merely a co-employer of the worksite employees, which is the essential difference between PEOs and employee leasing, in which the leasing company is purportedly the sole employer.

The passage of the Small Business Efficiency Act (SBEA), a subsection of TIPA creating CPEO organizations, is a watershed mark in the PEO industry. Before the SBEA, the PEO industry was well recognized at the state level, and certain federal agencies had created regulations for situations involving PEOs (for example, the Department of Labor's Family and Medical Leave Act regulations and the IRS revenue procedures relating to the qualified status of defined contribution plans maintained by PEOs). However, there was no specific federal recognition of PEOs for purposes of wages and payroll taxes. In addition, there was uncertainty about the application of tax credits, as well as business challenges in relation to the restart of certain taxes when a PEO obtained a new customer mid-year.

The SBEA now provides legal certainty to PEOs on a federal level that should result in an expansion of the PEO industry and an increase in market share. The key provisions include:

This provision should not raise joint employer liability issues. PEOs are not joint employers, as PEOs do not direct and control employees in their work. In my opinion, this contract requirement does not create joint employer liability, which means that one party is responsible for the acts of the other. That is not what this requirement provides and both the PEO and customer retain their own responsibility to hire and fire. In fact, in that same section of the statute it is made clear that "nothing in this section shall be construed to affect the determination of who is an employee or employer for purposes of this title." Each party remains responsible for their own actions. Furthermore, the SBEA applies solely in relation to employment taxes. The SBEA will not affect how PEOs and their customers are viewed under other laws or by courts for purposes of other employer responsibilities.

Again, the SBEA only affects the application of federal employment taxes. State laws, including laws in approximately 40 states with licensing or registration requirements, will continue to apply.