The Internal Revenue Service (IRS) released temporary regulations that describe the application process and certification requirements necessary for businesses to become and remain a certified professional employer organization (CPEO). The IRS also released proposed regulations explaining the federal employment tax liabilities and other obligations of a CPEO.

In the future, the IRS intends to release another revenue procedure that provides for the ongoing requirements that CPEOs must meet to maintain certification and describes the consequences of the failure to meet the ongoing requirements.

These temporary regulations, along with a forthcoming revenue procedure, application forms and instructions, expected to be released before July 1, 2016, will assist those desiring the CPEO designation to prepare and submit the required applications.

Certified PEO program will allow PEOs to be recognized as the employer for federal payroll tax purposes

As we previously reported, professional employer organizations (PEOs) will be able to register with the IRS under the voluntary certification program and be recognized as the employing unit for federal employment tax purposes.

The potential benefit of registration is employment tax savings by considering year-to-date Social Security (FICA) and federal unemployment (FUTA) taxable wage bases when a client enters into or ends a co-employment relationship with a certified PEO during the calendar year. Clients benefit as well, since they are not liable for the federal employment taxes a certified PEO fails to remit. (Public Law No: 113-295; H.R.5771)

As part of the certification program, the act requires the IRS to:

— complete background, credit and tax compliance checks of the PEO
— verify the PEO has an active and approved surety bond
— verify the PEO satisfies the service agreement and financial review requirements;
— collect a user fee
— provide public disclosure of certified PEOs and any whose certification has been suspended or revoked

As we previously reported, the IRS announced that it will begin accepting applications from PEOs on July 1, 2016 for voluntary certification, one year later than required under the Tax Increase Prevention Act of 2014. The IRS requested information regarding certain PEO practices in order to streamline the implementation of the program, including financial audits by CPAs; how PEOs comply with state and federal payroll tax obligations; how PEOs monitor the number of covered employees who are providing services to a client (or to a division or work unit of the client) who are not covered by a service agreement between the PEO and client; and working capital and net worth requirements.

Temporary regulations concerning application for certification

To become and remain certified as a CPEO, a person, as well as any owner, officer, or other person (which, as described in the temporary regulations, is any responsible individual, related entity, or precursor entity), must meet such requirements as the IRS shall establish in order for the person to be certified, including requirements with respect to tax status, background, experience, business location, and annual financial audits. The temporary regulations elaborate on the requirements that a CPEO applicant and CPEO must meet in each of these categories to become and remain certified. The temporary regulations also specify the circumstances under which a PEO's application for certification may be denied.

A CPEO must provide at the time of its application for certification ( and on a quarterly basis beginning with the first calendar quarter that ends after the CPEO's effective date of certification), an assertion signed by a responsible individual under penalties of perjury stating that the CPEO has withheld and made deposits of all federal employment taxes as required for the quarter In addition, the CPEO must provide an examination level attestation from a Certified Public Accountant (CPA) stating that this assertion is fairly stated.

The CPEO must also submit other certain financial information and CPA reviews to the IRS on a quarterly and annual basis.

The CPEO must also annually post a bond for the payment of federal employment taxes in an amount that is at least equal to the greater of: (1) 5% of the CPEO's liability during the calendar year preceding the bond period, but not more than $1 million; or (2) $50,000.

The CPEO is required to agree to file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, and Form 941, Employer's QUARTERLY Federal Tax Return, electronically as a condition of certification.

The temporary regulations provide that the IRS may suspend or revoke the certification of any CPEO as a result of a failure to meet any of the requirements for CPEOs. If a CPEO's certification is revoked, the organization may not re-apply to be certified as a CPEO for one year after the effective date of its revocation. The IRS will make public, and the PEO is required to notify its customers of, the suspension or revocation.

The temporary regulations apply on and after July 1, 2016, the date the IRS plans to begin accepting certification application, and will expire on or before May 3, 2019.

Federal employment tax obligations of a CPEO

The proposed regulations indicate that the IRS will amend Schedules R of Forms 940 and 941 and develop the following new forms to provide for the application and client/tax reporting requirements of a CPEO:

— Form 14737, Request for Voluntary IRS Certification of a Professional Employer Organization
— Form 14737-A, Responsible Individual Personal Attestation
— Form 14751, Certified Professional Employer Organization Surety Bond
— Form 8973, Certified Professional Employer Organization/Customer Reporting Agreement

Upon entering into a CPEO contract with a client with respect to a work site employee, the CPEO is treated as a successor employer and the client as a predecessor employer during the term of the CPEO contract. On termination of a CPEO contract, the client is treated as a successor employer and the CPEO is treated as a predecessor employer.

A work site meets the CPEO requirements with respect to an individual if at least 85% of the individuals performing services for the client at the work site where the individual performs services are subject to one or more CPEO contracts with the CPEO.

The CPEO is treated as the employer for the purposes of federal employment taxes, taxable wage bases, and withholding thresholds, and other obligations under the federal employment tax rules, with respect to remuneration remitted by the CPEO to the work site employee. For FUTA tax purposes, a CPEO is eligible for the FUTA credit based on state unemployment insurance contributions made to a state agency by the CPEO or its client.

The proposed regulations require that CPEOs file Forms 940 and 941 and their schedules electronically unless a waiver is requested and approved by the IRS. So that the IRS can better reconcile the total wages and taxes reported on Forms 940 and 941 with the amounts of wages and taxes reported on the attached Schedule R, the proposed regulations provide that, in addition to filing information about each customer under a CPEO contract, a CPEO must also include such information as the IRS may require about each of its clients under a service agreement (described in Section 31.3504-2(b)(2)) that is not a CPEO contract.

To assist the IRS in verifying which entities reported on the amended Schedules R are customers under a CPEO contract, and which are clients under a service agreement that is not a CPEO contract, the proposed regulations require that a CPEO must also report information relating to the commencement or termination of a service agreement with a client, and the name and EIN of each such client.

The proposed regulations lay out the information a CPEO must supply to its clients within the contract and during the contract's time period, and periodically to the IRS.

The proposed regulations also detail the penalties that can be imposed on CPEOs for failure to meet reporting requirements.

Comment period is open until August 4, 2016

Comments on the temporary and proposed regulations may be made by August 4, 2016: CC:PA:LPD:PR (REG-127561-15), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044, and may be sent electronically, via the Federal Rulemaking Portal.

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