Regulations finalized on CPEO certification and reporting obligations

Tax Hot Topics newsletterThe IRS issued final regulations (84 FR 24367) detailing the certification requirements, federal employment tax liabilities and other obligations for certified professional employer organizations (CPEOs). The final regulations adopt proposed regulations issued in May 2016, with certain changes, and are effective as of May 28, 2019.

Professional employer organizations (PEOs) handle various payroll administration and tax reporting responsibilities for their business clients, and generally consider themselves to be a co-employer of their clients’ employees. Forms W-2 are typically issued to the employees in the name of the PEO, and the PEO takes responsibility for remitting federal employment taxes. However, under federal employment tax rules, the PEO’s clients remain ultimately responsible for the employment taxes.

Under the final regulations and pursuant to the IRS’s voluntary certification program, a CPEO is treated as the employer of any individuals (covered employees) performing services for a CPEO’s customer, but only with respect to the remuneration the CPEO pays to such covered employees. Therefore, a CPEO’s customers are relieved of ultimate responsibility for employment taxes. However, independent contractors, sole proprietors, partners in a partnership, and other self-employed individuals are not considered covered employees of CPEOs. Any remuneration paid by a CPEO to such individuals is not wages and must be reported on information returns such as Form 1099-MISC instead of on Forms W-2.

In addition, a CPEO may also take certain tax credits related to wages or employment taxes that a common-law employer would otherwise be able to take. However, the final regulations clarify that the Section 45S credit for paid family and medical leave is included in the list of specified credits that apply to the CPEO customer, and not the CPEO. The regulations also contain provisions that may allow PEOs to reapply for certification after a denial of certification or withdrawal, with applicable procedural requirements to be addressed in future guidance. Domestic disregarded entities are allowed to apply for certification as CPEOs but are required to be domestically organized and wholly owned directly by a U.S. person. Sole proprietorships may also apply for certification as CPEOs. The final regulations further provide various definitional and administrative changes related to the qualification requirements for certification as a CPEO.

Jeff Martin
Washington National Tax Office
T +1 202 521 1526

Keith Mong
Managing Director
Washington National Tax Office
T +1 202 521 1554

James Sanchez
Senior Associate
Washington National Tax Office
T +1 202 861 4107

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