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Updated on March 8, 2024
A professional employer organization (PEO) is a third-party company that provides human resources services to small and midsize businesses, which often include payroll processing, benefits management, and talent management. The type of outsourcing that PEOs offer is known as “co-employment.”
In a PEO relationship, the PEO agrees to perform specific employment responsibilities for its clients. This arrangement is referred to as “co-employment,” in which the PEO serves as a “co-employer” of the client’s employees.
With this arrangement, the PEO becomes the client’s employer of record for business tax purposes and typically shares employment-related risks with them. As the employer of record, the PEO has the legal right to complete tasks tied to employment on behalf of the client. For example, the PEO uses its own employer identification number to file their client’s employment tax returns — even though payroll is still funded by the client. In terms of risks, the PEO helps shield the client from noncompliance with employment regulations by ensuring related tasks are done accurately and timely.
Although the PEO assists with employment responsibilities, it does not own or control the client’s business. As stated by NAPEO, “The PEO client/business owner retains ownership of the company and control over its operations.”
The terms and conditions surrounding the client’s and the PEO’s responsibilities are typically outlined in a client service agreement (CSA) that’s agreed to by both parties.
These typically include:
According to NAPEO, the PEO may retain a limited right to hire or fire employees, depending on the terms of the client service agreement. They may also offer additional talent management services to help attract, develop, engage, and retain top-performing employees.
Keep in mind, the IRS holds statutory employers, such as PEOs, responsible for employment tax purposes. Some states do as well, for state employment tax purposes. The takeaway is that PEOs have a vested interest in keeping their clients’ compliant with relevant laws.
NAPEO reports that more than 200,000 small and midsize businesses use PEOs, employing over 4.5 million people (most of these businesses have between 10 and 99 employees). Furthermore, the US PEO market has undergone major growth and is expected to grow at a CAGR of 11.15% during 2022 – 2030, according to Straits Research.
Smaller businesses account for most PEO clients because they often lack the budget and resources to maintain a full, in-house HR team like their larger counterparts. Hiring a PEO can save these smaller companies significant time and money. Research by NAPEO found that such companies see a 27.2% annual return on investment (in cost savings alone) from using a PEO.
However, employers should perform due diligence before hiring a PEO to ensure a good match.
“Our small business partnered with a PEO not only to help with administrative HR tasks but also because we were struggling to get competitive rates on our benefits packages.”
Terms related to: Professional employer organization (PEO)
Articles and resources related to: Professional employer organization (PEO)
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