Shifting employer payroll tax liabilities

August 22, 2016

 

jason harrel

Jason Harrel

Many businesses today use professional employer organizations to handle federal employment tax withholding, reporting and payments pertaining to their workers.

Those organizations often provide other services to a client business such as human resources management, employee benefits, workers’ compensation claims and unemployment insurance claims.

The professional employer organization usually charges the business a fee based on payroll costs plus an additional amount.

From a federal tax perspective, an issue can arise when a business pays an organization its payroll costs (which includes withholding taxes and the business’ portion of the taxes) and the fee but the organization fails to properly turn over those payroll taxes to the IRS. Usually the business will still be held liable for payroll taxes by the IRS even though the business paid the money over to the PEO.

To address that problem, Congress passed, and the president signed into law, the Tax Increase Prevention Act of 2014.  That act provided for Internal Revenue Code Sections 3511 and 7705, which created the certified professional employer organization.

To become certified, a professional employer organization must meet various requirements, post a bond and meet certain generally accepted accounting principles and examination-level attestation standards.

The main benefit to the customer business of using a certified professional employer organization rather than one that is not certified, is that a certified organization is deemed to be the sole employer of any work site employee for purposes of liability for employment taxes.

 

Although the CPEO is deemed the sole employer for employment taxes purposes, the client or business will remain the employer for purposes of determining the exemptions, exclusions, definitions and other rules applicable to the employer used to compute employment tax liability.

Additionally, the business remains the employer for purposes of determining eligibility for various tax credits, such as:

  • Credit for Increasing Research Activities, IRC Section 41;
  • Indian Employment Credit, IRC Section 45A;
  • Credit for Portion of Employer Social Security Taxes Paid with Respect to Employee Cash Tips, IRC Section 45B;
  • Clinical Testing Expenses for Certain Drugs for Rare Diseases or Conditions, IRC Section 45C;
  • Employee Health Insurance Expenses for Small Employers, IRC Section 45R;
  • Work Opportunity Credit, IRC Section 51;
  • Empowerment Zone Employment Credit, IRC Section 1396.

For purposes of IRC Section 3511, a “work site employee” is someone who (a) performs services for a customer under a qualifying contract between the business and the CPEO; and (b) at least 85 percent of the individuals performing service for the business at the work site where the individual performs service are subject to one or more qualifying contracts.

IRC Section 7705(e)(2) defines a qualifying contract and provides that a CPEO must:

  • Assume responsibility for the payment of wages to such individuals, without regard to the receipt of adequacy of payment from the business for such services
  • Assume responsibility for reporting, withholding and paying any applicable employment taxes with respect to such individual’s wages, without regard to the receipt of adequacy of payment from the business for such services;
  • Assume responsibility for any employee benefits which the service contract may require the CPEO to provide, without regard to the receipt of adequacy of payment from the business for such benefit;
  • Assume responsibility for recruiting, hiring, and firing workers in addition to the business’ responsibility for recruiting, hiring and firing works;
  • Maintain employee records relating to individuals subject to the contract;
  • Agree to be treated as a CPEO for purposes of IRC Section 3511 with respect to the individuals subject to the contract.

Beginning July 1, the Internal Revenue Service will begin accepting applications for certification as a certified professional employer organization.

It is presumed that a CPEO will have various contractual provisions in place to protect it from becoming liable for a business’ employment taxes. That is fine. The benefit to be gained by using a CPEO is that if your businesses pays all the taxes and fees to the CPEO, there should be no question that the CPEO is responsible for the taxes if they do not get paid over to the IRS by the CPEO or its employees.

For this reason, if you are using a PEO, you should have a discussion with them about applying to become a CPEO and how long that process should take. If the PEO does not become certified, you should consider moving to a PEO that has become a CPEO.

This certification process is just now in its infancy, but it is something that all businesses should review.

 

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