Definition of Professional Employer Organization (PEO)

what is a peo?

What is a PEO?

PEO is a term that first arrived on the HR scene in the form of “employee leasing,” as made popular in the 1960s by Marvin Setler. Over the next 20 years, the term morphed into the current Professional Employer Organization (PEO) model. This type of company:

  • Becomes a co-employer with your SMB
  • Is contracted to conduct specific HR services on your company’s behalf
  • Reduces an SMB’s potential employment tax liabilities

A PEO should not be confused with a SaaS (Software as a Service) company. PEO services help small businesses with various human resource activities, including:

  • Payroll and payroll taxes
  • Employee benefits and benefits administration
  • Recruiting and employee leasing, among other services

Why does an SMB owner need to know about PEOs?

As the owner of a small to medium-sized business, you are juggling a multitude of different responsibilities. The many tasks associated with key HR services involve:

  • Accurate payroll processing
  • Precise employee tax withholding, recording, and filing
  • Stringent compliance expectations, including reporting
  • Maintain correct recruiting practices and recordkeeping
  • Appropriate employee HR file management
  • Complete training recordkeeping
  • Meticulous employee benefits management, among other functions

Although there are SaaS companies that will allow you to host their software services on your company’s servers, they are a different arrangement than you would have with a PEO. You are still entirely responsible for your employees’ information input, completion, and processing when you contract with a SaaS company.

How does this work?

When you enter an agreement with a PEO, that company becomes your staff’s hiring and payment entity. Said differently, your company doesn’t directly employ the team members working for your company, but your PEO partner company does. Your company is responsible for the day-to-day management and oversight of the employees.

As the actual employer of the team members, the PEO is responsible for complying with all HR-related compliance requirements and tax deadlines. That can free up a lot of time, allowing you to focus on other business-related functions and responsibilities.

A PEO essentially takes on the majority of the HR-related back-office functions that can sneak up on a busy business owner. To do this, they typically charge a percentage of your overall payroll expense or a flat fee that is applied to your company’s total head count.

When you are in the process of deciding between hiring your own internal HR department and partnering with a PEO, some of the pros and cons come down to the difference in the required budgets for both. Similar to your finance department, your HR department is not an area where you want to cut corners, as the resulting regulatory fines brought by the DOL or BOLI could be astronomical.

What is the history of PEOs?

Professional employer organizations first started meeting employer needs in the middle of the 20th century. In the 1960s, Marvin Setler hired and then leased employees to a Californian physician’s office. His model was different than a temporary agency in that the employees were intended to be long-term solutions for the company rather than stop-gap problem solvers.

The model continued to change over the next 20 years so that by the 1980s, payroll management processes were also part of the overall solutions. Unfortunately, appropriate infrastructures and checks and balances were not in place at the time, so compliance with employment laws became problematic.

As a result, congress enacted more stringent and specific legislation to ensure businesses took employment processes seriously. To ensure compliance with these tighter regulations, PEOs began contracting with companies to become co-employers with them.

The PEO files the employment taxes under the PEO’s employer ID number (EIN). Even so, your business is on record as being in partnership with the PEO for specific services. Therefore, your business is still accountable for how the PEO treats and manages your staff members. This includes ensuring their positions are correctly classified under the Fair Labor Standards Act (FLSA).

Other references and similar terms to PEO that can assist you

We’ve discussed what a PEO is, but there are other related terms that would be helpful for you to understand as you move forward.

  • Software as a Service (SaaS): A process by which a vendor develops, manages, and makes software available to customers allowing them to complete specific electronic functions.
  • Fair Labor Standards Act (FLSA): This regulation is managed by the DoL at the federal level. It defines exempt (not entitled to overtime) vs. non-exempt (entitled to overtime and scheduled breaks) and places the onus on employers to correctly classify and pay their employees. This law also governs child labor standards.
  • Department of Labor/Bureau of Labor and Industries (DOL/BOLI): The DOL is the government entity responsible for overseeing regulations related to employment. BOLI refers to a state-level organization with similar functions to the federal-level DoL.
  • Article: PEO vs. HR Tools: How both can help your business as it grows
  • Guide: Small Business Owners Guide to choosing HR Software

People also ask

What is a PEO? Is it different than a HR Advisor?

The bottom line about PEOs

A PEO is responsible for taking on the full HR functions you and your company contract with them to complete. As part of that agreement, your company signs a co-management agreement giving the PEO the authority to conduct those services on behalf of your company.

Studies have indicated that a PEO can free up nearly 25% of management’s time and reduce turnover by 10%-14% by taking over specific HR functions.

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