Katherine Sanford Goodner (Lewis Thomason, Knoxville, TN) & Ursula Ramsey (North Carolina, Cameron School of Business), Certified Professional Employer Organizations and Tax Liability Shifting: Assessing the First Two Years of the IRS Certification Program, 16 Berkeley Bus. L.J. 571 (2019):
The growing popularity of Professional Employer Organizations ("PEOs") over the past several decades has led to an increasing number of small businesses using third-party organizations to provide everything from payroll services to benefits management to human resource services. Recent data suggests that between 780 to 980 PEOs exist industry-wide and provide services for 156,000 to 180,000 clients. Even more staggering is the $136 billion to $156 billion in client payroll and PEO fees that make up the gross revenues of these PEOs. These PEOs, often referred to as "co-employers," are generally responsible for the remittance of the taxpayer's employment taxes as a part of the PEO's payroll services.
Unfortunately, the increase in the number of PEOs and the use of such organizations by small (and large) businesses (hereinafter referred to as "customers" and sometimes referred to as "recipients" in cited authority) created a landscape primed for abuse by PEOs that failed to remit the customers' employment tax payments to the federal government. In such situations, the familiar story is that although the customer provided the funds to the PEO to cover the employment taxes, the PEO failed to pay the taxes owed and instead, as seen in many cases, used the money for the PEO owners' personal use and expenditures. Once these cases made their way into the courtroom, the central issue became whether the customer or the PEO bore responsibility for the employment taxes owed. Historically, the answer has depended upon a variety of situationally specific variables and changing laws regarding co-employment. Significantly, the IRS often found, and courts agreed, that the customer was the common law employer for purposes of tax liability and generally remained liable for the employment taxes, regardless of an arrangement between the customer and a PEO.
In December 2014, President Barack Obama signed into law the Tax Increase Prevention Act of 2014 ("TIPA") which, among many other things, added §§ 3511 and 7705 to the Internal Revenue Code, created a new category of PEOs referred to as "Certified Professional Employer Organizations" ("CPEOs"), and required the IRS to establish a program to certify such PEOs by July 1, 2015. This new certification process definitively places the liability for employment taxes squarely on the shoulders of the CPEO, while allowing the customer to remain the employer for purposes of claiming certain employment-related tax credits. The certification process also provides for "successor employer" status when utilizing a CPEO to protect the customer from the potential double-taxation upon retention or termination of CPEO services. While PEOs are not required to go through the new certification process, this shifting of liability from the customer to the CPEO marks a significant opportunity for businesses who employ the use of PEOs to limit exposure for employment tax liability by making sure that their PEO is appropriately certified.
With the first round of PEOs achieving certification effective January 1, 2017, this article explores the certification effort's effectiveness. Part I of this article provides an overview of the history and evolution of PEOs, the uncertainty surrounding employment tax liability and the increasing fraud stemming from co-employment arrangements. Part II explains the recent TIPA legislation that aims to bring clarity and efficacy to the PEO landscape, both for PEOs and their customers. Next, Part III explores the unknown implications of TIPA. Finally, Part IV addresses the initial effectiveness of TIPA, including an analysis of current CPEO data from the IRS's public listings.