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Updated: May 3, 2024

Employee leasing lessons and how professional employer organizations (PEOs) work

Published By:

David Kindness, CPA

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Employee leasing — also known as professional employer organization (PEO) services — is when a business borrows, or “leases,” an employee from a third-party company (usually a staffing agency). In fact, many businesses rely on the expertise of PEOs, and the American Staffing Association found that these agencies place over 10 million employees each year.

 

Fast facts about leased employees

  • Leased employees are hired by a staffing agency, but are then leased to a client business for a period of time
  • Employee leasing is often known as professional employer organization (PEO) services
  • Employee leasing removes much of the risk associated with hiring an employee long-term by reducing the legal and HR aspects of hiring and offering a lower level of financial commitment
  • Employee leasing is different from contracting because the leased employee is technically employed by the staffing agency and is not a separate business entity

However, how do you know when it is best to lease employees and if there are any tax considerations to be aware of?

 

In this employer’s guide, we’ll explore why companies consider employee leasing, some key differences between these types of workers and independent contractors, and things to remember during tax time.

Why do employers use employee leasing?

Simply put, leasing employees gives businesses access to specialized skills without the long-term commitment of hiring a full-time employee. In this scenario, the business only “borrows” the employee and is not considered their legal employer. When the lease ends, the business can decide to hire the leased employee as a contractor or full-time employee if they choose to.

 

How does this work? Professional employer organizations (also known as PEOs) contract with a company to take many time-consuming hiring and human resourcing responsibilities off their plates. In many cases, PEOs are staffing agencies and it’s basically like outsourcing your human resources department to a team of external experts.

 

Among the responsibilities a PEO generally helps employers with are:

 

Many recruit and hire employees

Many offer assistance with job descriptions, interviewing candidates and help employers with hiring decisions.

 

Training and development

once an employee joins the company, PEOs assist with onboarding, employee training, retaining employees and making sure new hires complete paperwork such as I-9 forms so there’s no issues with compliance.

 

Manage HR

They can also help with other HR-related heavy lifting, from creating an employee handbook and mediating employee conflicts to managing employee benefits administration if a business offers perks.

 

There’s many other back office to-dos these agencies can help with depending on what the client needs as well. In fact, there are over 5,000 in the US and it can be a good idea to contact multiple PEOs to understand their rates, markups, which services they offer, and the availability of their leased employees.

 

The National Association of Professional Employer Organizations (NAPEO) offers a comprehensive search of hundreds of PEOs here.

 

Some important questions to ask potential PEOs can include:

  • What is your markup on leased employees over market salaries?
  • What HR, payroll, and benefits services do you offer?
  • Do you have employee lease terms or time limits?
  • Do you offer co-employment services for non-leased employees?

 

For employers taking a closer look at how these types of workers can fit with their organizational needs, it’s important to point out that leased employees are not the same as independent contractors, even if the work they perform is similar. Leased employees are just that — employees — and the HR responsibilities are managed by the PEO. Contractors, on the other hand, are generally contracted to work directly with the hiring business, and do not go through a PEO to do so.

 

Understanding the differences can be a little tricky, so let’s go over each in more detail.

Learning about how leased employees and independent contractors differ

On the surface, these workers may appear to be identical. But even though they can perform similar tasks and work for the same period of time, there are several key differences between leased employees and independent contractors to be aware of. What you want to look for is the relationship they have with their employers or clients and how they are managed (or how they manage themselves).

 

Employment relationship

  • As we mentioned earlier, leased employees are just that – employees. That means they are employed by a PEO and “loaned” to a client business. As a result, the PEO is the legal employer and handles all employer responsibilities, including HR, payroll, benefits, and more.
  • Contractors are independent business entities, usually made up of a single individual, or sometimes a group of individuals. They are not employees of a PEO or a client business – instead, they are contracted by businesses on an as-needed basis.

 

Management and supervision

  • While leased employees are legally employed by a PEO, they work under the day-to-day management and supervision of the leasing business — much like any other employee. This generally gives the leasing business control over how they spend their time, which tools they use to perform their work, their deadlines, and more.
  • Similarly, independent contractors perform tasks for their client, but they generally have more freedom and flexibility than leased employees. They can set their own schedules, manage their work processes, are able to with multiple clients at the same time

 

It is worth considering these differences when choosing which type of worker you’d like to collaborate with in your business. It’s also possible to work with both leased employees and independent contractors at the same time.

 

Now that we better understand how leased employees and independent contractors differ, let’s discuss how taxes come into play.

Related reading

Get more guidance in our in-depth article on the difference between employees and independent contractors.

How tax reporting works with leased employees

Because Uncle Sam expects his due, filing taxes is something that every individual and business has to take care of (whether we want to or not). So how do you report taxes when you hire a leased employee?

 

When the client business files its corporate taxes, the leased employee’s pay would be included in salaries or payroll expenses on their income statement, just like any other employee the business hires. This expense reduces the business’s taxable income and lowers its tax liability for the year by increasing its expenses. The takeaway is that if a business hires a leased employee, they should always include that employee’s pay on their income statement.

 

On the employee side, the payroll taxes for a leased employee are handled by the PEO — not the leasing business. The PEO will manage this process at the same time as they manage the payroll and benefits for the leased employee. They’ll withhold income taxes, Medicare taxes, and social security taxes for the employee, just like any company would do for a W-2 employee.

 

For more information, take a look at the IRS website and the IRS’s employee benefit plans guide to employee leasing.

 

Moving on, let’s take a closer look at some possible advantages and disadvantages for employers trying to decide how employee leasing aligns with their operational goals.

Pros and cons of hiring leased employees

There are various pros and cons associated with hiring a leased employee instead of a regular part- or full-time employee, or an independent contractor.

 

Outsourced human resources support

Instead of managing the HR responsibilities of another part- or full-time employee, the PEO manages these tasks, which can reduce the administrative burden on the business.

 

Lower short-term payroll costs

PEOs often allow businesses to hire leased employees on an “as-needed” basis, so there’s less time being invested compared to hiring and training full-time employees. Some PEOs can also offer health, retirement, and workers comp benefits at lower prices than some small businesses could access.

 

Access to a larger talent pool

Using leased employees can offer businesses access to a wide range skilled employees that they may not otherwise come across. For example, employers who can’t afford to hire specialized employees full-time could lease employees with specialized skills to assist with specific projects. This reduces costs and gives the business more access to talent.

 

Potential cons of hiring a leased employee can include

 

Relationship complexity

Because the leased employee is effectively employed by both the PEO and the leasing company, the business-employee relationship can feel more complicated. As a result, the leasing business and the PEO should take steps to maintain a clear division of responsibilities as well as clear communication with the employee so all parties are on the same page.

 

Potentially increased long-term payroll costs 

Leased employees are typically cheaper to use on short or mid-term projects because of the flexibility of their employment. But for longer-term projects, leased employees could pose additional costs. Because the PEO is the middleman and must make a profit, paying the PEO, who then pays the employee, may result in higher long-term costs than paying the employee directly. Additionally, leasing employees may create additional costs in the form of training for the job.

 

Maintaining corporate culture

If the leasing business has a healthy corporate culture with tight-knit teams who work together well, then it can be difficult to integrate short-term employees smoothly, which could potentially affect team dynamics. It can be a good idea to confirm the PEO has a process in place for vetting talent so you know they’ll be a good fit before bringing them onboard.

 

We have covered a lot of ground, but let’s touch on one more topic that’s likely to come up when getting familiar with employee leasing.

 

Differences between leasing employees vs PEO co-employment

While doing research to determine whether employee leasing is right for you, you might come across something called PEO co-employment. PEO co-employment is an interesting workforce management option for many businesses because it allows them to share employer responsibilities for their normal workforce with a PEO.

 

Essentially, PEO co-employment allows businesses to outsource some of their HR, payroll, benefits, employment laws, worker’s comp, and more for their full-time workforce. Instead of the business managing those tasks, the PEO does it for them. This removes much of the administrative burden from the business and allows them to focus on their core competencies without worrying too much about the administrative aspects of recruiting, hiring and managing HR tasks for employees.

OnPay is great because it saves me time on administrative tasks so I can plan ahead, help customers, and keep the focus on my business. Processing payroll is easy and their customer service is phenomenal and always responds in a timely manner via email.


— Chris Theis, Theis Management, LLC

Employee leasing can be worth a closer look

Hiring and managing employees is an important aspect of every growing business, and who you choose to hire can impact your company culture, level of available expertise, and even your bottom line. Employee leasing can allow businesses to manage payroll expenses, outsource some HR tasks to a PEO, and access expertise that might otherwise have been unavailable to them.

 

This article is for informational purposes only and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors for formal consultation.

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David Kindness is a CPA, experienced financial writer and editor, and a tax and accounting expert with 7+ years of experience. David lives and works in San Diego, California.