IRS issues CPEO final regulations

The tax consequences under Sec. 3511 are spelled out for employee leasing and similar arrangements.
By Sally P. Schreiber, J.D.

The IRS finalized regulations governing certified professional employer organizations (CPEOs), which allow employee leasing companies and other professional employer organizations to be solely liable for payroll taxes on wages they pay to their customers' employees (T.D. 9860). The rules allow a CPEO to, in effect, be the employer for employment tax and payroll obligations, while the customer provides direction to and control over the employees and remains the common law employer for other purposes.

The Tax Increase Prevention Act of 2014, P.L. 113-295, created CPEOs by adding new Sec. 3511, which provides the rules and consequences of being a CPEO, and Sec. 7705, which provides the definition of a CPEO and sets forth the certification requirements. Sec. 7705(a) defines a CPEO as a person who applies to be treated as a CPEO for Sec. 3511 purposes and whom the IRS has certified as meeting the Sec. 7705(b) requirements, which include tax status and background requirements; certain bond, financial review, and quarterly reporting requirements; and the requirement to notify the IRS of any change that materially affects the continuing accuracy of information the CPEO provides.

Under Secs. 3511(a)(1) and (c)(1), for purposes of federal employment taxes and other obligations under the federal employment tax rules, a CPEO is generally treated as the employer of any individual performing services for a customer of the CPEO and covered by a contract meeting the requirements of Sec. 7705(e)(2) (the CPEO contract) between the CPEO and the customer, but only with respect to remuneration remitted to the employee by the CPEO.

With respect to an individual covered by a CPEO contract who performs services for a customer at a work site that meets the coverage requirements of Sec. 7705(e)(3) (a work site employee), Sec. 3511(a)(1) specifies that no person other than the CPEO is treated as the employer for federal employment tax purposes with respect to remuneration remitted by the CPEO to that individual.

On May 6, 2016, the IRS issued final and temporary regulations governing the process of applying for and remaining a CPEO under Sec. 7705 (T.D. 9768, as corrected July 12, 2016, at 81 Fed. Reg. 45012) and also issued proposed regulations (REG-127561-15) under Sec. 3511 that explain the federal employment tax consequences for CPEOs and their customers. In addition, the IRS has issued two revenue procedures and a notice providing interim guidance on the CPEO program.

The latest regulations finalize the proposed Sec. 3511 regulations. The IRS received seven written comments on the proposed regulations. The only comment that was adopted was a suggestion that the Sec. 45S credit for paid family and medical leave be added to the list of specified credits in the regulations for which the CPEO's customer, not the CPEO, is permitted to take into account wages paid to qualifying employees and to claim the credit. (The preamble to the final regulations notes, however, that this credit is currently scheduled to expire on Dec. 31, 2019.)

Several other comments address how to apply the maximum wage base for Federal Insurance Contributions Act taxes when an employee is paid wages by a CPEO. The IRS explained that because Sec. 3511 treats a CPEO as an employer separate and apart from the CPEO's customer for whom the employees are performing services, employees receiving remuneration from both the CPEO and the CPEO's customer in a calendar year must be treated as receiving remuneration from two different employers, and the annual wage base therefore applies separately, unless the Sec. 3511(b) successor and predecessor rules apply. If an employee performs services for multiple customers of a CPEO, the annual wage base is applied on a customer-by-customer basis.

The rules also address how to apply Federal Unemployment Tax Act taxes in the CPEO context.

The rules went into effect May 28, 2019.

  • T.D. 9860

— By Sally P. Schreiber, J.D., a JofA senior editor.

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