What Is a PEO?

Wondering if you should join the 175,000 small to medium-sized businesses who already use Professional Employer Organizations, or PEOs, for payroll and HR help?1 We break down what a PEO is and examine the pros and cons to help you decide if a PEO can meet your payroll needs.

If doing payroll in house has you at your wit’s end, you have more options than hiring an accountant or outsourcing to a payroll company. You can also work with a PEO, or Professional Employer Organization.

PEOs are companies that handle Human Resources (HR) tasks like payroll, workers’ compensation coverage, employee benefits like insurance, and ensuring compliance with all payroll-related taxes, laws, and regulations. Unlike outsourced payroll and HR companies, a PEO company becomes a joint owner of your small business—which can be confusing and off-putting to some small-business owners but hugely reassuring to others.

If a PEO company doesn’t work for you, no sweat; there’s another payroll solution out there for you somewhere, whether in the form of payroll software or a full-service accountant. But for employers who could use another set of hands on one of the most expensive, complicated parts of running a business, a PEO company can be an affordable, stress-relieving solution.

How PEO companies work

PEO services differ from other types of HR and payroll processing in a few key ways, but the biggest is that when you sign a contract with a Professional Employer Organization, they become co-owners of your company—principally for tax reasons.

When you established your business and hired your first employees, you had to request an Employer Identification Number, or EIN, from the federal government. Like a Social Security number, an EIN identifies you to the government so you can file taxes correctly.

But when you use a PEO, it becomes responsible for issues like payroll taxes (federal income, Medicare, and Social Security taxes deducted from your employees’ paychecks). Since a PEO is its own company, it has its own federal tax ID that it uses to file your taxes.

Here’s the other slightly confusing concept. Since PEOs are external companies that deal with HR, they must be listed as your employees’ primary employer. That sentence isn’t quite as scary as it sounds.

All it means is that you transfer your employees’ information and hiring status over to the PEO, which then “leases” your employees back to you. You retain your employees, and the PEO retains responsibility for most employee-related issues: employee benefits, payroll services, health insurance, workers comp, retirement funds, wage garnishments, and any other payroll, tax, and HR tasks.

What does business co-ownership really mean?

PEO companies are co-owners in your business. That means they file your taxes under their own tax identification number. It also means you transfer your employees’ information and hiring status over to the PEO, which then “leases” your employees back to you.

Worried about what co-ownership looks like on the ground? If we’re talking day-to-day operations, the answer is . . . nothing. It’s invisible. None of your law firm’s clients or your wholesale bakery’s customers will be able to tell that you’re sharing ownership with another company. Where PEOs make a real difference is with your employees’ experience with your business.

What PEO companies do

PEO companies tackle everything from onboarding to employee handbooks. They can prep W-2 forms to ensure your employees receive them on time, print pay slips when employees request them (or if your state requires them), and handle workers compensation claims, among other things:

  • Distribute wages and salaries
  • Deduct payroll taxes from employees’ gross pay
  • Ensure compliance with local, state, and federal laws
  • Ensure tax compliance
  • Provide unemployment insurance (COBRA)
  • Provide Employment Practices Liability Insurance (EPLI)
  • Set up 401k plans for employees
  • Explain benefit plans and dealing with benefit paperwork
  • Perform training, recruiting, and employee development tasks
  • Deal with complicated new-hire procedures like work visa tracking
  • Set up employee feedback systems

If you’re looking for only payroll help, you don’t need to go all in with a PEO company. The right payroll software can make tax deductions, withholdings, and filing forms simple. Software companies like Zoho even offer human resources and project management software alongside payroll if you need a little more oomph.

What PEO companies don’t do

PEO companies take on HR and payroll responsibilities, but even though they co-own your business and work through employee leasing, you’ll still be in charge of these important decisions:

  • Deciding who to hire or fire
  • Creating and implementing your own company culture
  • Setting work schedules, wages, and business practices
  • Running daily operations
  • Keeping your work environment safe and professional
  • Giving your PEO company the information they need to process payroll
  • Paying your PEO company on time
  • Tracking your employees’ hours worked

PEO pros and cons

Some PEO pros include the following:

  • Saved time and resources. When you don’t have to dedicate any time or employee resources to payroll and human resources, you should get a few hours a week back (or more) to focus on growing profits.
  • Lower liability. Employers can be liable for failing to file paperwork on time, deducting the wrong amount of taxes, or failing to resolve employee complaints or workers compensation claims. A PEO assumes most of the traditional risks and employee liabilities an employer usually takes on.
  • Employee benefits. PEOs can simplify the process of offering benefits and streamline costs—some companies can’t afford health insurance without a boost from a PEO.

Some PEO cons include the following:

  • Potentially high costs. PEOs can save time and resources, but they don’t always save money. They usually cost more than payroll software and their costs aren’t always transparent.
  • Less control. Even though you have more control over your company culture and rules than your co-owner does, you do still give up the possibility of complete control. For instance, the PEO could have some HR department practices you disagree with—but you still have to comply with them.
  • Limited options. While a PEO might make it possible for you to offer a health plan, your employees will be locked into the PEO’s insurance plans, and they may not love the options.

How much PEOs cost

Best Payroll Software & Services
Gusto
Quickbooks
Square
Xero
Better Accounting

And now for the moment of truth. Regardless of Professional Employer Organizations’ pros and cons, are they at all affordable for a small business?

The answer obviously differs between businesses, and for some owners, the saved time and effort might be worth the extra cost. But you should plan to pay more for a PEO than you would for payroll software or even internal HR and payroll departments.

Most PEOs charge you two main fees:

  • A percentage of your payroll (usually no more than 15%)
  • A per-employee per-month fee

Other PEOs charge you a flat rate instead of taking a percentage of payroll.

Unfortunately, PEOs for small businesses can also require a range of hidden fees, a lot of them hidden in the fine print that next to no one reads. But if your small business opts for a PEO, you’ll have to be the “next to” in that sentence; you might discover high one-time setup fees and extra fees for common payroll and HR activities like processing new hires, doing interviews, or distributing paychecks.

The takeaway

If you have a complicated HR situation—for instance, you frequently hire employees around the globe for your domestic business—and spend way too much time on payroll, the right Professional Employer Organization could reduce costs and stress associated with payroll and human resources.

Just make sure to read the fine print: PEO providers charge more than other HR and payroll companies, and even without the hidden fees, they’re slightly more expensive than payroll software.

Do you need more accounting services than just payroll, like bookkeeping and invoicing? Our piece on the best accounting software for small businesses can get you started on an accounting solution.

Disclaimer

At Business.org, our research is meant to offer general product and service recommendations. We don’t guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.

Sources

1. National Association of Professional Employer Organizations, “Industry Statistics