Potential impacts of working with professional employer organizations (PEOs)

Whether a small business or a large corporation, all companies with employees must fulfill their payroll tax obligations. While there are various options available for outsourcing payroll services, including professional employer organizations (PEO), it’s crucial to understand the distinctions between provider types.

PEOs can provide several advantages, but also bring potential drawbacks, particularly if your business plans to claim specific tax credits such as payroll tax credits like the employee retention credit.

Explore key consideration when engaging PEOs and other providers below.

PEO overview

A traditional payroll company manages payroll administration and taxes, while PEOs offer additional human resources (HR) services and assume shared employer responsibilities.

Potential concerns for engaging PEO

Some potential concerns that come with working with PEOs could include the following.

Hidden costs

A PEO may charge fees and commissions, which can result in a reduced benefit for companies claiming payroll tax credits.

Since the PEO would be considered the employer of record for tax purposes, companies are often left with no choice but to pay these fees. Additionally, commissions are typically calculated as a percentage of the credit.

Challenges of exiting a PEO midyear

With federal and state payroll taxes being reset at the beginning of each year for employer and employee alike, leaving your existing PEO midyear could come with some tax implications.

For example, if the employee met the wage base for Social Security tax and the existing PEO wasn’t withholding any further Social Security tax from the employee when the company changes PEOs, the following implications could apply.

• Employee implications. Withholding could end up reset for the remainder of the year or until the wage base is met on the new platform, which could leave the employee waiting until after filing their personal income tax return for a refund.
• Employer implications. If Social Security tax is withheld from the employee for the remainder of the year until the wage base is met again, getting refunded on excess withheld employer tax could be challenging.