IRS: Self-employed individuals and partners not employees of CPEOs

Tax Hot Topics newsletterThe IRS provided clarification in CCA 201916004 that self-employed individuals are not work site employees with respect to remuneration paid to them by a Certified Professional Employer Organization (CPEO), and therefore, a CPEO is not treated as an employer of a self-employed individual for employment tax purposes. 

Any remuneration paid by a CPEO to such self-employed individuals, whether in their capacity as a non-employee providing services to a customer of the CPEO, a sole proprietor customer of the CPEO, or a partner in a partnership that is a customer of the CPEO, is not wages and must be reported on information returns such as Form 1099-MISC instead of on Forms W-2. 

Professional employer organizations (PEOs) handle various payroll administration and tax reporting responsibilities for their business clients, and 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 employment taxes. 

Legislation enacted in late 2014 required the IRS to establish a voluntary certification program for PEOs. 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 individuals (covered employees) performing services for a customer of the CPEO. Covered employees include work site employees but generally exclude self-employed individuals. Thus, if the PEO is a CPEO, the PEO’s customers are relieved of ultimate responsibility for employment taxes. 

The IRS explained that it has received questions regarding language in the preamble to proposed regulations issued in May 2016 to address the new CPEO rules (Prop. Treas. Reg. Sec. 301.7705-1). The specific preamble discussion provides that, although a self-employed individual generally is not considered to be a work site employee under Section 3511(f) with respect to net earnings from self-employment, “in the limited case in which such individual also is paid wages by a CPEO under a CPEO contract with the customer, the individual may nevertheless be a work site employee with respect to such wages.”  The IRS noted that this language addresses the very uncommon situation in which one individual is receiving payments from the CPEO in two separate capacities. 

The IRS explained further that, in contrast to the two-capacity situation, under the proposed regulations any payment made by a CPEO to a partner in a partnership under a contract between the partnership and the CPEO must always be treated as a payment to a self-employed individual and reported as such under Section 6041. The IRS noted that under Rev. Rul. 69-184, “bona fide members of a partnership are not employees of the partnership” for employment tax purposes.
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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