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A Guide to PEOs and Employee Leasing

Looking for a professional employer organization (PEO)? Here's everything you need to know about what a PEO is, what it offers and how to choose one. If you already know what you're looking for, visit our best picks page to see which ones we recommend.

Before you can start choosing a PEO, you should know exactly what one is and how it works.

  • A PEO provides small and midsize businesses with a wide range of human-resources-related services, including the following:

1. HR management

2. Benefits administration

3. Insurance plans

4. Section 125 plans

5. Payroll administration and processing

6. State unemployment insurance (SUI) administration

7. 401(k) retirement plans

8. COBRA

9. Workers' compensation

10. Safety programs (OSHA)

11. Training and development

12. Recruiting and outplacement support

13. Government compliance

  • Instead of simply outsourcing the HR-related services, a PEO operates with a co-employment arrangement. Under this format, businesses maintain control over their employees, but the PEO shares in the risk and liability issues.
  • The PEO's job is to pay employees and handle all of the administration of payroll and benefits.
  • The cost of a PEO varies greatly depending on the services you want provided, the number of employees you have and the type of business you operate. The cost structure also varies by PEO provider. Some PEO services charge on a per-employee basis. Under this structure, employers pay a set amount for each employee. Other providers base pricing on a percentage of gross payroll.

What the experts say: "A PEO is a partnership that creates a co-employment relationship between a small to midsize business and a provider," Lonny Ostrander, vice president of human resources services for Paychex, told Business News Daily. "This relationship results in the business’s ability to gain access to benefits normally available only to Fortune 500 companies."

Editor's note: Looking for information on PEOs? Use the questionnaire below, and our vendor partners will contact you to provide you with the information you need:

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1. Fewer administrative tasks: Companies don't have to spend time working on tasks such as payroll and benefits administration because the PEO handles them.

"A PEO can take some of the critical work of managing a company off of a businesses owner's plate so that they can focus on building and maintaining their core business," said Sarah Grimstead, a regional sales manager for PEO provider Insperity.

2. Better benefits: PEOs allow small businesses to offer a robust benefits package.

"Providing HR services through a PEO often gives companies access to better health, retirement and workers' compensation benefits for their employees," Grimstead said.

3. Cost savings: PEOs can negotiate lower insurance costs because they negotiate rates on behalf of all of the businesses they work with.

"Companies that partner with a PEO usually experience lower group insurance costs, workers' compensation discounts and, in most cases, a lower state unemployment insurance (SUI) rate because their employees are listed under the PEO's federal ID number for payroll purposes," Ostrander said.

However, keep in mind that you are paying the PEO a fee for this benefit. To make sure you're coming out ahead, it's important for you to weigh the service fees against the added benefit costs savings.

4. Legal compliance: PEOs remove the burden of having to keep up with the constantly changing human resources regulatory laws.

"It can be difficult for a business owner or an HR practitioner to keep up with the changes, develop policies in light of those changes, and train managers and employees on those changes," said Jaqueline Breslin, director of human capital services for PEO provider TriNet. "A PEO helps their clients remain HR compliant. From producing employee handbooks to helping a business understand the Affordable Care Act (ACA), a PEO is a strong partner to help with these complexities."

5. Talent acquisition: Being able to offer better benefits helps small businesses not only hold on to their more valuable employees, but also bring in other top workers.

"Because they're able to offer competitive benefits through the PEO, companies are able to reduce turnover while attracting and retaining a higher-caliber workforce," Ostrander said.

6. Legal protections. Most PEOs provide civil defense and employment liability insurance in case a former employee sues the company for discrimination or wrongful termination.

1. Surrendering responsibilities. For small business owners who are used to having their hands in every aspect of the business, relinquishing control of human resources can be a tough adjustment.

"Some businesses might view a loss of control — whether it's significant or not — as being a drawback of joining a PEO," Ostrander said. "The truth, though, is if you find the right PEO partner, it becomes an extension of your business."

2. Health insurance changes. PEOs are always looking for the best deal on health care, so they may change insurance providers on a regular basis.

"While a PEO offers the ability to provide the most cost-effective and competitive health benefits, it also means the provider reserves the right to switch health providers," Ostrander said. "That can be frustrating for the business and its employees if an impending change is not fully communicated."

3. Impersonal. Companies that use a PEO can't always provide the same level of personalized HR service to their employees as businesses whose HR department is located down the hall can. The hope is that the PEO treats your employees like its own when they need information or need to file a claim, but that is not always the case. It's important to find a PEO that will provide the type of hands-on support that both you and your employees need.

Because of the abundance of PEO providers, it can be hard for small business owners to know what they should be looking for when searching for one. We asked our experts to weigh in on the most important factors small business owners should consider when hiring a PEO.

  • As your business grows, will the PEO be able to grow with you? For example, will the offerings be a one-size-fits-all package, or will the provider tailor a program to your needs?
  • Does the PEO provide all of the services you currently want and may want in the future?
  • Will the PEO team administering services for you be trained to know federal, state and local labor laws that could impact you and your business? Given today's ever-changing regulatory environment, it's more essential than ever that businesses ensure compliance.
  • What kind of user access does the PEO offer? Will your employees have online access to payroll and benefits administration? Do they have mobile apps to make it easier to see payroll stubs and other HR information?
  • What does the cost structure look like? Each PEO has its own method of billing and pricing. Be sure you have a good handle on exactly what that entails so you can budget accordingly.
  • Is the PEO financially stable and secure? You don't want to partner with a PEO that is in danger of going out of business.
  • What kind of commitment does the PEO make to customer service? Will you have your own dedicated team of support members, or will you have to call a 1-800 number every time you need help?
  • The PEO should be accredited so you can be assured that you are working with a secure provider. 
  • Is the PEO properly licensed?  Some states require PEOs to be licensed, others require registration and others have no requirements. Find out what the rules are in your state, and if applicable, verify that the PEO is compliant.
  • Does the PEO have positive referrals? Referrals help you look past a PEO's marketing and sales lingo to get the real story. Ask fellow business owners who have used PEOs whether they would recommend the service and why.

Now that you've got the basics, you might be ready to make some decisions on which PEO is right for you. If you're interested in a PEO, check out our best picks for PEOs.

Still have more questions about PEOs? No problem. Here are a number of questions and answers that may help you come to a decision.

Q. Are PEOs typically used by small businesses?

A. Yes, PEO services are geared toward smaller organizations that don't have a dedicated human resources staff.

According to the National Association of Professional Employer Organizations (NAPEO), the average NAPEO member company has 19 employees.

There are also a wide variety of business types using PEO services. The NAPEO reports that businesses ranging from accounting firms to high-tech companies and small manufacturers use PEO services. In addition, an extensive number of professions — including doctors, retailers, mechanics, engineers and plumbers — use PEO services.

Q. How does the co-employment arrangement work?

A. Co-employment, also referred to as employee leasing, allows small businesses to maintain the day-to-day control of employees. However, the PEO becomes the employer of record for tax purposes and is responsible for all of the HR-related tasks, such as paying the employees and providing the benefits.

"The biggest aspect of the arrangement is that the business maintains ownership of the employees when it comes to functions like wages and hours, but from a benefits sense, the PEO provider assumes all responsibility," Ostrander said.

Q. What is the difference between using a PEO service and simply outsourcing your HR services?

A. The biggest difference is the co-employment model. When you outsource human resources services, there is no co-employment arrangement. So, although you are hiring a service to handle some or all of your HR needs, you are still responsible and liable for all of the outsourcing company's work.

"A key difference between using PEO services and simply outsourcing HR services is that the PEO model allows the PEO to be joint stewards with companies, helping them navigate all of their HR needs, versus outsourcing models that leave it entirely to the employer to manage the risk," Breslin said.

Q. What type of liability does the PEO provider incur on behalf of its small business customers?

A. PEO services take on all of the liability as it relates to payroll and taxes.

"Submitting payroll taxes timely and distributing W-2s by the required due date are the PEO's responsibility," Breslin said. "These activities are taken away from the client, and the PEO is responsible and bears the burden of making sure they are compliant with important payroll-associated activities."

In addition, PEOs share in a businesses' employment-related risk. For example, coverage under an employer practices liability insurance (EPLI) is frequently a part of the PEO services, Breslin said.

Q. Do you lose control of your business by using PEO services?

A. No. Even though you will be operating as a partner with your PEO provider, you are still in charge of your business and how it is run.

"The business still has the option to make the ultimate decisions regarding hiring, performance management, discipline and terminations," Breslin said. "The PEO is there to point out the risks the client may be taking by the employment decisions they are making, but the business can choose to follow or disregard that advice."

Q. What does it mean if a PEO is accredited?

A. The Employer Services Assurance Corp. (ESAC) is an independent nonprofit organization that is the official accrediting agency of the PEO industry.

A board of directors that includes PEO industry attorneys, CPAs and independent directors representing more than 100 years of combined PEO industry regulatory experience manages the ESAC.

The accreditation process verifies a PEO's ongoing financial solvency and compliance with government regulations and industry standards. Earning accreditation demonstrates a PEO's financial stability, ethical business conduct and adherence to operational standards and regulatory requirements.

You can see which PEOs have earned accreditation by visiting the ESAC website.

Q. Do I have any options for the health insurance plans I offer to employees? Or does a PEO offer only one plan?

A. The majority of PEOs offer customers a variety of plans that they can then, in turn, offer their employees, including PPO and high-deductible options.

While you do have your choice of plans, you likely won't have a choice for the provider. Most PEOs typically use one health insurance provider and require all customers using its health care to use that specific carrier.

If you think a PEO is right for you, we encourage you to check out our roundup of our best picks for various business types, our reasoning for picking each and our comprehensive list of PEO services. 

Additional reporting by Ashley Smith

Editor's note: Looking for information on PEOs? Use the questionnaire below, and our vendor partners will contact you to provide you with the information you need:

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Chad  Brooks
Chad Brooks

Chad Brooks is a Chicago-based freelance writer who has nearly 15 years experience in the media business. A graduate of Indiana University, he spent nearly a decade as a staff reporter for the Daily Herald in suburban Chicago, covering a wide array of topics including, local and state government, crime, the legal system and education. Following his years at the newspaper Chad worked in public relations, helping promote small businesses throughout the U.S. Follow him on Twitter.