Many businesses enter contractual arrangements with third-party companies, known as professional employer organizations (PEOs), to fulfill staffing needs and outsource other administrative functions. In the typical PEO arrangement, the PEO contractually assumes the responsibility for paying and providing benefits to workers (“PEO workers”) who perform services for the PEO’s client (the “client employer”).

Obtaining workers through this arrangement may raise certain employee benefit compliance concerns for the client employer. Before entering such arrangements, client employers should seek the advice of their legal counsel to ensure that the arrangement is structured properly to comply with applicable federal and state laws.

This article identifies some key issues companies that use or plan to engage the services of a PEO should review with their legal counsel, including:

1. Is there an obligation under the Affordable Care Act’s (ACA) employer-shared responsibility rules to offer the PEO workers coverage? Who is responsible for the ACA reporting obligations related to offers of coverage and/or the provision of coverage?
2. Does the provision of coverage to the PEO workers create a MEWA, and if so, what, if any, ERISA obligations does this create for the client employer?
3. Are PEO workers able to make pre-tax salary reduction contributions for health and welfare benefits?
4. Who is responsible for complying with the various COBRA notice obligations?
5. What compliance-related issues arise when the client employer terminates its contract with the PEO?

EMPLOYER SHARED RESPONSIBILITY PENALTIES/ACA REPORTING

Under the ACA, Applicable Large Employers (ALEs) that do not offer certain health coverage to their full-time, common-law employees face potential penalties under Internal Revenue Code (IRC) Section 4980H (“employer shared responsibility penalties” or “ESRPs”). ALEs are employers who employed an average of 50 or more full-time employees and full-time equivalent employees in the prior calendar year. Under the ESRP regulations, the common-law employer is the entity subject to ESRP liability. In the context of a business contracting with a PEO, the question is whether the PEO or the client employer is the common-law employer of the PEO workers.

The IRS has provided guidance on this issue. The preamble to the employer-shared responsibility final regulations notes in regard to PEO workers, “in the typical case . . . the professional employer organization or staffing firm is not the common law employer.”¹ Accordingly, in the typical case, the common law employer of PEO workers will likely be the client employer rather than the PEO itself, meaning that potential ESRP liability will typically fall on the client employer rather than the PEO (assuming the client employer is an ALE).

Note: While the IRS suggests that PEOs are typically not considered the common law employer of PEO workers for ESRP purposes, determining whether such employees are the client employer’s common law employees is fact-specific and should be determined with the assistance of employment law counsel.

For client employers that are ALEs and are the common law employers of the PEO workers, the final regulations provide that an ALE can take credit for coverage offered by a staffing firm or PEO. However, it can only do so if the client employer pays an extra fee to the PEO:

[I]n cases in which the staffing firm is not the common law employer of the individual and the staffing firm makes an offer of coverage to the employee on behalf of the client employer under a plan established or maintained by the staffing firm, the offer is treated as made by the client employer for purposes of section 4980H only if the fee the client employer would pay to the staffing firm for an employee enrolled in health coverage under the plan is higher than the fee the client employer would pay the staffing firm for the same employee if that employee did not enroll in health coverage under the plan.²

This rule provides relief to client employers who are ALEs that contract with either a staffing agency or PEO and wish to avoid potential penalties under the ACA’s employer-shared responsibility provisions. The rule does not, however, specify the amount of the required extra fee, nor is there specific guidance on how the extra fee is calculated or how a client employer can account for paying it. As a result, a client employer that is an ALE should discuss these issues with qualified legal counsel when entering into a contract with a PEO.

¹ 79 Fed. Reg. 8543, 8566.
² 79 Fed. Reg. 8543, 8566.

Regulatory and Legislative Strategy Group