Partner Relationships

PEOs and ASOs, oh my!

Author: Gordon M. Berger, Partner

Outsourcing is big business. Millions of U.S. workers are serviced by a professional employer organization (PEO) or through an administrative service organization (ASO). According to the National Association of Professional Employer Organizations (NAPEO), more than 15% of all employers with 10 to 99 employees (referred to as “small businesses” herein) use a PEO.

What’s a PEO?

According to NAPEO, a PEOs “provide human resource services for their small business clients—paying wages and taxes and often assisting with compliance with myriad state and federal rules and regulations.  In addition, many PEOs also provide workers with access to 401(k) plans, health, dental and life insurance, dependent care, and other benefits not typically provided by small businesses. In doing so, they enable clients to cost-effectively outsource the management of human resources, employee benefits, payroll and workers’ compensation. PEO clients can thus focus on their core competencies to maintain and grow their bottom line.”

How does the PEO relationship work?

A PEO contracts with a company (typically referred to as the “worksite employer” because it direct and controls the locations where the employees work) to provide the services described above. The contract is typically known as a “client service agreement” and is normally for a one-year duration but can be extended. The CSA sets up a co-employer arrangement (vs. a joint employer) because the PEO assumes certain rights and responsibilities, the client assumes certain ones and the parties share certain ones. For example, the client sets the rate of pay, sets work schedules and reports wages and hours worked to the PEO, while the PEO is responsible for properly calculating and remitting payroll taxes. Naturally, a PEO is not in a position to confirm hours worked, duties performed, etc., so it cannot verify the information and therefore must rely upon the client’s reporting.

The PEO becomes the employer of record for wage reporting purposes, meaning that the PEO issues the W-2 to the client employees (usually referred to as “worksite employees” or “covered employees”) under its federal tax identification number (FEIN). However, many PEOs consider themselves to be an administrative employer since they do not direct and control the day-to-day operations and are not at the client’s worksite to manage the worksite employees.

As alluded to above, the PEO can aggregate all worksite employees in obtaining group buying power, which usually allows the PEO to offer Fortune 500-type benefits that a small business cannot obtain on its own. And, PEOs provide human resources (HR) advice, which can be valuable to small businesses that do not have the internal HR resources.

PEOs contract for a year or longer for several reasons. First, if the client begins the year paying employees under its FEIN and then contracts with a PEO, certain taxes, such as FUTA or SUTA, may restart since the PEO is not a successor employer (unless the PEO is a certified PEO under the IRS certification program, in which case federal employment taxes will not restart). Second, in many jurisdictions (PEOs are regulated in approximately 42 states), a PEO must co-employ “on a permanent basis”, meaning that the relationship under the CSA cannot be temporary – which some states (such as Ohio) define as being for twelve months or less or which is considered to be a temporary staffing arrangement.

In addition, in many of the states that regulate PEOs, the PEO is required to obtain a license or registration, which may include obtaining a surety bond, having audited financials (which show positive working capital, for instance), scrutiny of officers and/or owners (typically referred to as “controlling persons”) and/or other requirements.

In short, a PEO is an outsourcing arrangement, but as a co-employment model, it is like having a partner in business that does not interfere with business or strategic decisions.

What’s an ASO?

An ASO is a bit more amorphous, as there are many derivations. However, an ASO arrangement is clearly not a co-employment arrangement. The ASO provider is a vendor and not an employer. An ASO agreement can cover HR, benefits administration (the provider may collect and/or remit premiums for benefits), payroll and safety/risk management. Some ASOs provide all of these services, while others offer these service on an ala carte basis.

How does the ASO relationship work?

An ASO provider is paid a fee to provide all or some of the services outlined above. However, in contrast to a PEO, it does not assume any employer functions or employer liability. So, for example, if the provider runs payroll, it does so on the client’s behalf and all wages are paid by the client under its FEIN (and therefore the client issues the W-2, although like a payroll company, the provide typically prepares the W-2s). In a PEO relationship, a PEO may be required under state law to pay wages out of its bank accounts, but an ASO does not have to pay wages from its own accounts.

Since ASO contracts are not tied to employer status, the length of the contract can vary anywhere from 30 days to a longer period of time (such as a year). However, if a company uses multiple ASO providers in a calendar year, it does complicate the preparation of W-2s.

Since the provider is not an employer of the client employees, it does not sponsor and provide benefits to client employees. However, many PEOs also offer an ASO model, as well as having ownership in, or an affiliation with, a license insurance agency, so the provider may offer benefits to a client in that manner.

And, sometimes an ASO is used either as a “filler” or as a means for a PEO to assist a client in states where the PEO is not licensed or registered. The PEO can run payroll on client employees (they are not worksite employees under the CSA in an ASO offering) as a service provider where the client is the sole employer and is paying the wages under its FEIN. Some PEOs will then apply for a PEO license or registration and after the PEO obtains the license or registration, it will convert the client employees over to worksite employees. A PEO is able to offer ASO services in this manner because ASOs are not regulated like PEOs and therefore are not required to obtain a license or registration. Note, however, that in some states, an ASO provider may be required to register as a third-party administrator (TPA) if it collects and remits insurance premiums.

Some companies prefer using ASO providers over PEOs because they feel that they have complete control over their operations, as the ASO does not pose employer liability and therefore the provider does not have any involvement in such matters unless requested by the client (In a PEO arrangement, the worksite employees may be directed to lodge complaints to the PEO as the outsourced HR department and as the PEO may face liability for an employment decision involving worksite employees, it will likely have a say in the decision process).

The downside to using an ASO versus a PEO may be that the client does not get the benefit of the group buying power of a PEO and therefore it may be unable to provide robust benefits as a small employer.

Gordon M. Berger, Partner
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