What is a professional employer organization (PEO)?

Professional employer organization (PEO) definition and meaning

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.”

Learning more about the purpose of a PEO

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.

What are common PEO services?

These typically include:

• Payroll administration: Some can help the entire payroll management process, such as calculating wages, withholding employee taxes, making mandatory and voluntary deductions, remitting employee and employer taxes, issuing Form W-2s, filing client payroll tax returns, and maintaining payroll records.
• Benefits provision: Securing affordable and quality benefits for their clients’ workforce. By pooling employees from different client employers into one larger collective workforce, the PEO increases its bargaining power with benefits vendors. This allows them to access lower rates for benefits like health insurance, dental insurance, vision insurance, and more, which a small employer might struggle to secure on their own.
• Benefits administration: Along with obtaining benefits for client employers, PEOs administer these and other benefits. These benefits include mandatory ones like workers’ compensation and FMLA leave, as well as voluntary ones like cafeteria plans, 401(k), and commuter benefits. The PEO conducts employee enrollment, deducts benefits contributions from employees’ wages, remits benefits payments to third parties, handles the claims process, performs governmental reporting, and more.
• Talent management: To allow the client to retain control over its workforce, PEOs do not independently make decisions about the client’s business, including in talent management. PEOs typically do not hire or fire client employees, or dictate pay rates, work schedules, and the like.

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.

• Risk management and compliance: PEO services are designed to help employers minimize risks that can lead to government audits, employee lawsuits, fines, and penalties. It’s challenging for employers to keep up with employment laws, which may be applicable at not only the federal but also state and local levels. PEOs offer assistance in this regard, helping employers remain compliant with HR, payroll, and benefits laws.

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.

PEOs: Usage and growth outlook

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.