When reviewing payroll tax systems, the terms PEO, employee leasing, and common paymaster, among others, are often used interchangeably. However, employers often do not understand the differences between these systems. Each is very different and can impact the operations of a single company or a group of related companies. It’s important to compare and contrast the different systems when determining which is the best option for your company. Some of the most common include the following:
A common paymaster system is used by related corporations to avoid payroll tax duplication. For related corporations, one entity withholds and pays the applicable taxes, including FICA and FUTA. In a common paymaster system, only the common paymaster pays payroll taxes for concurrently employed individuals across related companies. Concurrent employment is a requirement for common paymaster eligibility.
It is important to note that the common paymaster system rules only apply to qualified-related corporations (i.e., S and C corporations). It is also important to note that the rules regarding common paymaster systems vary by state, as some states do not allow using a common paymaster.
A pay agent files an aggregate employment tax return on behalf of multiple employers using its own federal identification number and address. To do so, a pay agent obtains authorization to file any applicable returns by filing Form 2678, Employer/Payer Appointment of Agent. While it is common for a third party to serve as the pay agent, related businesses can designate one of the businesses as the agent for all of them.
The significant difference between using a payroll agent versus a payroll provider is that a payroll provider still files returns under the employer’s ID number. A payroll agent uses its own ID number, so the employer should remain cognizant of what the agent is filing. Further, a pay agent cannot file aggregate FUTA and SUTA returns, so each employer must continue to file and remit those taxes separately.
Professional Employer Organization (PEO)
Professional employer organizations (PEOs) allow companies to outsource payroll, benefits, training and other key human resource functions. This type of system is a co-employment relationship, as the business and the PEO share certain employer responsibilities. However, the business retains full authority over its workforce, including the responsibility for hiring and managing employees.
Utilizing a PEO is different than utilizing a payroll company to process payroll. A payroll company assists in running payroll, filing payroll tax returns and remitting payroll taxes. In a PEO relationship, the PEO processes payroll and offers support in many other areas such as benefits, human resources administration and workplace safety.
An employee leasing organization furnishes workers to another business. By leasing employees from another company, businesses can reduce their administrative burden and may, in some cases, have better access to qualified candidates. Under an employee leasing arrangement, it is essential to confirm which company is the employer under common law rules. In a pure employee leasing scenario, the leasing company remains the sole employer of the employees. It is also imperative to carefully review the terms and conditions of the applicable employee lease agreements.
Which payroll system is best for your company?
When evaluating the above payroll tax systems, employers must ask themselves some of the following questions before making a decision:
- Do we want to use a third party or retain all payroll processing and related functions in-house?
- If we use a third party, do we want to outsource only payroll processing or other HR-related functions?
- Who is the employer under common law rules?
- Do we have employees working concurrently for multiple companies?
- What is the cost to implement and maintain each system?
Each company is different, so there is no one-size-fits-all answer to which payroll system best fits. If you have questions, please contact your GBQ tax professional for more information.
Article written by:
Sara Goldhardt, CPA
Director, State & Local Tax Services