Certified PEO Applications To Be Accepted Beginning July 1, 2016 | Practical Law

Certified PEO Applications To Be Accepted Beginning July 1, 2016 | Practical Law

The Internal Revenue Service (IRS) has issued final and temporary regulations addressing the requirements for "certified professional employer organizations" (CPEOs), which reflect a designation for PEOs added under the Tax Increase Prevention Act of 2014. The IRS also issued proposed regulations that would regulate CPEOs' federal employment tax liabilities and obligations.

Certified PEO Applications To Be Accepted Beginning July 1, 2016

Practical Law Legal Update w-002-2307 (Approx. 10 pages)

Certified PEO Applications To Be Accepted Beginning July 1, 2016

by Practical Law Employee Benefits & Executive Compensation
Law stated as of 06 May 2016 • USA (National/Federal)
The Internal Revenue Service (IRS) has issued final and temporary regulations addressing the requirements for "certified professional employer organizations" (CPEOs), which reflect a designation for PEOs added under the Tax Increase Prevention Act of 2014. The IRS also issued proposed regulations that would regulate CPEOs' federal employment tax liabilities and obligations.
On May 4, 2016, the Internal Revenue Service (IRS) issued final and temporary regulations that address requirements for becoming and remaining a "certified professional employer organization" (CPEO) (26 C.F.R. §§ 301.7705-1T and 301.7705-2T). The CPEO designation reflects legislation, the Tax Increase Prevention Act of 2014 (TIPA), intended to regulate PEOs (see Legal Update, Tax Relief Extension Includes Provisions on Multiemployer Pension Plans, Transportation Benefits and PEOs and Standard Document, PEO Client Service Agreement). The IRS also issued proposed regulations addressing the federal employment tax liabilities and requirements for CPEOs and their clients.

Becoming a CPEO

The regulations include a lengthy set of requirements that must be satisfied to become a CPEO and retain CPEO status.

CPEO Applications to Be Accepted Beginning July 1, 2016

The IRS plans to begin accepting applications for CPEO certification on July 1, 2016. The IRS's final and temporary regulations regarding CPEO certification became effective May 6, 2016.

Application Process

To become certified, CPEO applicants and their "responsible individuals" (see Responsible Individuals) must:
  • Submit to the IRS a completed application, along with other information required under the regulations and guidance yet to be issued.
  • Satisfy certification requirements (see Certification Requirements).
The IRS will review the application and inform the CPEO applicant whether its application was:
  • Approved, along with the certification's effective date.
  • Denied, along with reasons for the denial.

Public Disclosure of Certified CPEOs

The IRS will make publicly available the names and addresses of certified CPEOs, as well as the effective date of the CPEO's certification.

Responsible Individuals

Regarding CPEOs and CPEO applicants, a responsible individual generally refers to:
  • Certain owners, including:
    • in the case of a corporation, individuals owning 33% or more of the total combined voting power of all classes of stock of the corporation entitled to vote, or the total value of shares of all classes of stock of the corporation; or
    • in the case of a partnership, individuals owning 33% or more of the partnership's profits interest or capital interest.
  • Directors and officers.
  • Individuals with ultimate responsibility for:
    • implementing decisions of an entity's governing body;
    • an entity's management and operations; or
    • managing an entity's finances.
  • Managing members, general partners, and sole proprietors.
  • Other individuals with primary responsibility for an entity's federal employment tax compliance.

Certification Requirements

A CPEO applicant must:
  • Satisfy numerous requirements under the regulations to become a certified CPEO.
  • Meet certain requirements on an ongoing basis after becoming certified.
If a CPEO fails to comply with a requirement or if the IRS determines that a CPEO presents a "material risk" to the IRS's collection of federal employment taxes, the IRS may either:
  • Deny an application.
  • Revoke or suspend a certification.
A CPEO whose certification has been suspended or revoked must notify its clients of this fact. In addition, the IRS will make this information available to the public.

Suitability for Certification

The IRS views tax compliance as an important factor in determining whether a CPEO or CPEO applicant presents a material risk to the IRS's collection of federal employment taxes. As a result, the IRS may deny an application or suspend or revoke a certification if the CPEO or applicant, responsible individual, "related entity," or "precursor entity":
  • Failed to pay federal, state, or local taxes, or to timely file required returns in an accurate manner.
  • Was charged or convicted of any criminal offense under federal or state law (or the laws of a political subdivision), or is the subject of an active IRS criminal investigation.
(Regarding the meaning of these individuals and entities, see Responsible Individuals, Related Entity, and Precursor Entity.)
The IRS also may deny an application or suspend or revoke a certification if a CPEO or CPEO applicant, responsible individual, related entity, or precursor entity:
  • Has been sanctioned or had a license, registration, or accreditation (including relating to its status or ability to operate as a PEO) denied, suspended, or revoked by a court, licensing board, or other entity for misconduct involving the CPEO's or applicant's suitability to perform its professional functions.
  • Fails to demonstrate a history of financial responsibility, which may be evaluated through checks on credit history and similar indicators.
  • Fails to demonstrate adequate knowledge or experience regarding federal and state employment tax compliance and related business practices.
  • Gives, or participates in providing, false or misleading information to the IRS while knowing, or having reason to know, that the information is false or misleading. This includes intentionally omitting relevant information.
Under the regulations, a CPEO or applicant must permit the IRS to investigate the accuracy of its statements and submissions (including waiving confidentiality and privilege), and to conduct comprehensive background checks. Also, a responsible individual must provide his or her fingerprints (a requirement to be addressed in future guidance).

Financial Statements, Bonding, and Other Requirements

The regulations require CPEO applicants and CPEOs to:
  • Have one or more established physical business locations in the US where certain operations take place, a significant portion of CPEO-related functions are carried out, and administrative records are kept.
  • Provide the IRS audited financial statements on a recurring basis and at other specified times.
  • Provide the IRS an independent CPA's opinion that its financial statements reflect positive working capital for the fiscal year, subject to an exception. A similar statement must be periodically provided by a responsible individual, unless an exception applies.
  • Provide to the IRS an assertion and examination level attestation regarding its compliance with federal employment tax withholding and depositing requirements.
Regarding the physical business location rule, a majority of an applicant's or CPEO's responsible individuals must be US citizens or residents (see Responsible Individuals).
CPEOs also must post a bond, issued by a surety company that meets certain requirements, for the payment of federal employment taxes in an amount specified in the regulations.
CPEO applicants and CPEOs that are members of a controlled group are treated as a single CPEO applicant or CPEO for purposes of the financial statement, quarterly assertion and attestation, and bonding requirements.

Related Entity

A "related entity" under the regulations includes any entity that is a member of a controlled group of which the CPEO is a member. Subject to exceptions, the regulations apply the meaning of controlled group under the Internal Revenue Code and related regulations (see Practice Note, Controlled Group and Affiliated Service Group Rules).
A related entity also includes any provider of employment-related services if:
  • A majority of the directors or officers of the CPEO applicant or CPEO also are directors or officers of the provider of services.
  • The owner is a responsible individual of both the provider of services and the CPEO applicant or CPEO by virtue of the individual's ownership percentage.

Precursor Entity

A "precursor entity" includes:
  • A related entity of a CPEO applicant that is or was a provider of employment-related services and has ceased operations, dissolved, or made a substantial asset transfer to the CPEO applicant during the year the applicant applies for certification (or any of the three preceding years).
  • A related provider of employment-related services that plans to make a substantial asset transfer to the CPEO applicant either:
    • while the application is pending; or
    • in the 12-month period following the date of the application.

Maintaining Certification

A CPEO applicant or CPEO must:
  • Consent to IRS disclosure of certain confidential tax information to its clients and other necessary persons.
  • Periodically verify that it continues to meet the certification requirements.
  • Notify the IRS of any change that materially affects the accuracy of any agreement made or information provided to the IRS.
  • Make other required reports.

Federal Employment Tax Obligations for CPEOs (Proposed Regulations)

The TIPA included provisions governing the federal employment tax obligations of CPEOs. The IRS's proposed regulations further address the federal employment tax liabilities and related obligations for certified CPEOs.
As background regarding employment taxes, employers generally must:
According to the IRS, PEO arrangements typically provide that:
  • The PEO is the employer or "co-employer" of workers, and thereby responsible for paying workers and for the resulting federal employment tax withholding obligations.
  • A PEO remits wages to workers and files Forms 941 and 940, using its own name and employer identification number (EIN).
For federal employment taxes purposes, and regarding remuneration remitted to the individual by the CPEO, a CPEO generally is treated as the employer of any individual who:
  • Performs services for a CPEO's client that enters into a CPEO contract with a CPEO.
  • Is covered by a contract between the CPEO and the client.

Requirements for CPEO Contracts

The proposed regulations would require that CPEO contracts be in writing. CPEO contracts also would need to impose responsibility on CPEOs for:
  • Paying wages to individuals.
  • Reporting, withholding, and paying federal employment taxes regarding an individual's wages.
  • Any employee benefits that the contract requires the CPEO to provide.
The CPEO also would need to assume responsibility in a CPEO contract for:
  • Recruiting, hiring, and firing the individual (in addition to the client’s responsibility in that regard).
  • Maintaining employee records relating to the individual.
A CPEO contract would need to include the name and EIN of the CPEO that reports, withholds, and pays federal employment taxes regarding remuneration paid to individuals covered under the CPEO contract.
These contract requirements would apply regardless of whether the CPEO has been paid by its client or whether those payments are adequate.

New Annual Wage Base

Under the proposed regulations, for federal employment taxes purposes, a CPEO would be treated as the employer of any covered employee regarding remuneration remitted to the individual by the CPEO. As a result, according to the IRS, a CPEO would have an employment relationship with a client's covered employee during the term of the CPEO contract that is separate from and independent of the client's employment relationship with the employee.
Under the proposed regulations, remuneration received by a covered employee from a CPEO for performing services for the CPEO's client during the year would be subject to a separate annual wage base and withholding threshold. These amounts would be calculated without regard to remuneration received by a covered employee during the year from any other employers, including directly from the client receiving services from the employee.
As a result, upon entering into a CPEO contract with a client, the CPEO would need to start a new annual wage base and withholding threshold for the covered employee. Additionally, any remuneration paid by the client directly to a covered employee during the CPEO contract term:
  • Would not be paid by the CPEO.
  • Therefore would not be included in the CPEO's annual wage base and withholding threshold for the covered employee.
In addition, if a covered employee receives remuneration from a CPEO for services performed by the covered employee for more than one of the CPEO's clients, the annual wage base and withholding threshold would:
  • Not apply to the aggregate remuneration received by the employee from the CPEO for services performed for all the clients.
  • Apply separately to remuneration received by the employee for services performed by each client.

CPEO Recordkeeping and Reporting

The proposed regulations include reporting and recordkeeping requirements for CPEOs that are intended to ensure compliance with federal employment tax standards. For example, a CPEO would be required to report information involving the start or termination of any CPEO contract with a client, and the client's name and EIN. CPEOs also would be required to provide information about the CPEO's clients under service agreements that do not qualify as CPEO contracts.
Among other requirements, a CPEO would be required to provide the IRS:
  • Periodic verification that it continues to meet the CPEO certification requirements (see Certification Requirements).
  • Copies of its audited financial statements and a CPA's opinion regarding the financials.
CPEOs would be required to provide certain information to their clients, including notification:
  • If the CPEO contract is transferred (along with that entity's name and EIN).
  • Of any suspension or revocation of the CPEO's certification.

Practical Impact

Although "certified" PEO status may be a helpful credential, PEOs that wish to earn this designation should become familiar with the IRS's latest CPEO regulations, as there are some significant strings attached. As discussed above, these requirements include some fairly detailed and ongoing financial well-being and attestation standards that reach all the way to a responsible individual's fingerprints. In addition, the IRS intends to make CPEO suspension and revocation a very public matter – and one can imagine a special IRS webpage for this purpose.
Regarding the IRS's proposed regulations on federal employment tax liabilities, would-be CPEOs should note the regulations' separate annual wage base standard, which may require additional and different tracking and recordkeeping procedures for some PEOs. Comments on these proposed regulations are due August 4, 2016.
PEOs that nonetheless wish to become certified can formally start that process by submitting their applications to the IRS in just a few weeks. As noted, the IRS will begin accepting applications on July 1. Between now and then, the IRS likely will issue additional guidance on CPEO status, including the revenue procedure that is expressly referenced in this guidance.