Posted by Income Taxes and Bookkeeping LLC

What Is a CPEO? Here Is Your Easy to Understand Guide

What Is a CPEO? Here Is Your Easy to Understand Guide

There has been much talk around the Human Resources world about CPEOs (certified professional employer organizations). Here is a quick guide on understanding what CPEOs is.

 

Background

The SBEA (Small Business Efficiency Act) of 2014 set things in motion when it decided to clarify the relationship between a CPEO (certified professional employer organization) and its clients for federal payroll tax purposes. This is the federal recognition that the CPEO industry has needed since its inception over 30 years ago.

A CPEO establishes a working relationship with its clients. In it, CPEO assumes many of the responsibilities related to the employer's employees while the client continues to manage and administer the business.

Here is a brief overview of the working relationship:

The business role

  • Maintains control over the management of the employees' day-to-day activities and the basic functions of the position, as well as the maintenance of the organizational structure.

  • Your business is still an employer.

  • Your company's management team remains focused on fulfilling the essential role they have been hired for.

The role of the CPEO

  • Acting as an employer for these purposes, the CPEO can take on more responsibilities than, for example, a payroll company.

  • As a co-employer, the CPEO assumes specific obligations as an employer, as provided for in its service contract.

  • This enables the CPEO to provide benefits and manage functions such as payroll, tax remittances, and related government records.


Not everyone qualifies

It is not easy to obtain IRS certification, and not all CPEOs will qualify. Here are some of the requirements for certification companies:

  • A review of your financial statements.

  • Background report of their individuals responsible for employment tax payments.

  • Documentation confirmed by CPA, who pays payroll taxes on time.

  • Documentation that they have positive working capital.

The IRS wants to carefully review the CPEOs it certifies because they are solely responsible for paying the payroll taxes to employees at work. Previously, the IRS could have appealed to the corporate client if the CPEO had not paid federal payroll taxes. The IRS wants to make sure that taxes are paid.


Why does it matter?

The law intends to give more structure to those who are responsible for what and how eligibility for certain tax credits is defined. Key aspects of the law and its relationship to CPEOs and their clients include:

  • Double payment of taxes

  • Payroll tax liability

  • Withholding of specific tax credits


Payroll tax liability

The IRS has traditionally held that the CPEO and the client are jointly and severally liable for paying federal employment taxes. Suppose a small business hires a CPEO, pays the bill, which would have included employment taxes, and CPEO did not pay employment taxes. Before SBEA, the IRS could have gone after the client's business for taxes – money the company believed it had already paid the CPEO.

The SBEA clarifies that an IRS-certified CPEO is solely responsible for paying the federal payroll taxes that it pays to employees at work. Therefore, once the customer pays the invoice, including federal payroll taxes, to the CPEO, the IRS cannot refer the customer to collect employment taxes if the customer is under a CPEO contract or a service contract. CPEO is responsible, not the customer.


Maintaining tax credits

Since many tax credits depend on the employer, companies entering a CPEO co-employer relationship often fear losing their eligibility for these tax credits.

The SBEA clarifies the ability of a CPEO client to retain certain tax credits when in a CPEO relationship.

A record of tax credits in the SBEA clarifies that clients get to retain certain tax credits during their CPEO relationship. These include:

  • IRC. Sec 41 credits for increasing research activities

  • IRC. Sec 45R credit for health insurance costs

  • IRC. Sec 51 Work opportunity credit

  • IRC. Sec. 1396 employment zone employment credit


Wage base restart 

As an employer, federal payroll taxes must be paid for a certain amount of each employee's salary, called wage base.

When a company enters or leaves a CPEO in the middle of the year, the problem arises of paying taxes on the wage base of the company and the CPEO. This is known as a wage base restart or employment tax and occurs when a new Federal Employer Identification Number (FEIN) is used. When a CPEO starts paying wages (or a company leaves a CPEO), it changes the FEIN of the entity that pays the salaries.

For example, in June, a CPEO takes a new client who has been paying employment taxes since January. In June, the CPEO will be considered a new employer under the Internal Revenue Code. Then the payment of federal payroll taxes is resumed, resulting in the payment of double taxation.

According to the SBEA, it is clear that if you are a CPEO client subject to a CPEO contract, the wage base does not start over. CPEO begins succeeding to the salary base of employees with a client who enters into a relationship so that there is no more double payment of taxes. Although there are many other meanings for the term "successor employer," a CPEO would be the successor employer only in terms of the wage base for the payment of payroll taxes.

In addition, if a company doing business with a CPEO under a CPEO contract leaves the relationship, it would benefit from the status of the successor employer. It would not have to restart the employee's wage base for federal income tax.


Summary:

  • A CPEO has additional responsibilities related to payroll administration and the reporting and payment of federal employment taxes.

  • A CPEO is responsible for paying the social charges that it pays to employees at work.

  • Being certified means that a CPEO has applied for certification from the IRS and has received a CPEO designation from the IRS after providing financial and other information.


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