What is a Certified PEO, and why is it not always the right solution?

If you run a small business or medium-sized company, you’ve probably heard about professional employer organizations (PEOs). But what about certified PEOs (CPEOs)?

For many businesses—especially in the age of remote work—the benefits of partnering with a PEO are clear. PEOs specialize in payroll, benefits, HR management, and labor compliance, providing a way to streamline and automate employee-related administrative duties so you can focus your time and resources on higher-value work. Not only do PEOs help ease the resource-intensive HR demands of running a business, but they also enable small businesses to offer top-tier benefits at affordable prices so they can attract and retain the best talent.

But if you’re considering partnering with a PEO, you may have run into some tricky questions: Does your PEO need to be certified? What exactly is a certified PEO (CPEO)? Does PEO certification make a difference—and what are some of the risks of using CPEOs? We’ll cover all this, plus how to know which is the best choice for your business. Read on to learn more.

What is a CPEO?

PEO certification was introduced in the Tax Increase Prevention Act of 2014, part of the Small Business Efficiency Act (SBEA). This legislation created a voluntary Internal Revenue Service (IRS) certification program for PEOs.

Certification means a PEO has satisfied particular criteria in terms of its background, expertise, finances, and reporting, as determined by the IRS. Again, this is an entirely voluntary certification program, and it’s important to note that this qualification does not represent an endorsement by the IRS but shows that the PEO has passed a series of assessments. The IRS maintains a list of all CPEOs on its website, as well as CPEOs that have been suspended or had their status revoked.

The certification process can be complicated, and PEOs need to meet a number of requirements. Per the IRS, a PEO is eligible for certification if it:

• Is a business entity with at least one physical business location within the US.
• Has a history of financial responsibility, organizational integrity, and tax compliance at the federal, state, and local levels. The PEO must be willing to provide financial information, including annual audited financial statements prepared by a certified public accountant (CPA).
• Is operated by a majority of US citizens/residents who have knowledge of federal and state employment tax compliance and business practices.
• Provides a Surety Letter when applying for CPEO status.
• Provides an assertion and CPA examination level attestation regarding federal employment tax compliance.
• Fills out the appropriate application via the IRS Online Registration System and pays a $1,000 fee.

What are the benefits of CPEOs?

CPEOs do offer some benefits for the organizations that choose to use their services, including an added layer of financial security—as part of their certification, CPEOs are required to maintain a $1 million annual bond to ensure they can pay their clients’ federal employment tax liabilities. Companies that use non-certified PEOs that don’t pay their taxes could be found liable for unpaid taxes, plus late fees, penalties, and interest.

Clients of CPEOs can also claim certain tax credits, which they might otherwise lose through co-employment, including those for increasing research activity, health insurance expenses, work opportunities, and empowerment zone employment.

However, the main benefit of using a CPEO has become obsolete. To understand why, we have to start with wage-base restarts. A wage base is the maximum amount of an employee's earnings on which a specific tax or benefit calculation is applied, often subject to an annual limit. A wage-base restart refers to when an employee's wage base is reset because they start working for a new employer in the middle of a tax year. 

In the past, there was confusion about whether this could be triggered when the employee didn’t change employers—but their employer joined, exited, or changed their PEO, causing their federal Employer Identification Number (FEIN) to change. CPEOs were initially developed to shield employers from double taxation because they weren’t required to restart employees’ taxable wage bases.

Employers who wanted to avoid double taxation thought they had two options: Either avoid switching PEOs mid-tax year or use a CPEO. However, in Paychex Business Solutions, LLC v. United States of America and Cencast Servs., L.P. v. United States, the courts determined that switching PEOs doesn’t restart employees’ wage bases. CPEO status is not needed to protect employers from double taxation. This means the main benefit that employers have sought from CPEOs for years is actually moot. Clients of PEOs can switch at any time without waiting until Jan 1.

The risks of certified PEOs

While CPEOs may have made sense in the past, certification doesn’t necessarily add value over a traditional PEO anymore. In fact, in certain contexts using a CPEO can be risky, especially for tech companies with modern compensation structures that include equity compensation.

CPEOs can be a marketing ploy

When businesses need the services a PEO offers—HR administrative support, payroll, labor compliance expertise, and large-group benefits at affordable prices—they need to think about what PEO certification actually offers them. Now that we know a CPEO isn’t required to avoid double taxation if your business needs employment flexibility during the tax year, is certification really necessary anymore? It turns out that non-certified PEOs offer almost everything CPEOs do; certification doesn’t bring much value to the table for most businesses. Certification sounds fancy, but it’s little more than a marketing ploy.

CPEOs can have their status suspended at any time

The IRS is the only agency that can suspend or revoke a CPEO’s status—there’s no accountability or oversight from any other agencies—which creates risk because businesses can (and sometimes do) have their status revoked or suspended for nonconsequential reasons. Even a clerical error can result in a CPEO losing its status.

Yet suspension—or revocation—can have major consequences for both the CPEO and their clients as the CPEO tries to regain their status. The CPEO only has to give clients 10 days’ notice regarding their suspension. This creates uncertainty, and they may face duplicate taxation for their customers and employees. What’s more, the CPEO customers, not the CPEO with suspended or revoked status, could be liable for payroll taxes on subsequent wage payments. 

Non-CPEOs can secure surety bonds that meet or exceed the bond requirements for CPEOs

Many state-based PEO licensing and registration laws require PEOs to maintain levels of surety to guarantee their tax obligations to the state—for example, payment of employment taxes, unemployment insurance, and workers’ compensation coverage. But even when it isn’t required, non-certified PEOs can still secure surety bonds that meet or exceed the bond requirements for CPEOs as a way of distinguishing themselves from competitors and creating financial peace of mind for their clients.

Take Rippling, for example. Although Rippling is not a CPEO, we have surety bonds ranging from $25,000-$250,000 as required by various state licensing agencies, as well as a CPEO bond at the same level as CPEOs: 5% of current liabilities, with a minimum of $50,000 and up to $1M.

Limited provider options

Of the approximately 900 PEOs operating in the United States, less than 10% have CPEO status. Considering the small slice of PEO providers that are certified, it may be difficult to find a CPEO that offers the services your company needs. Many excellent PEOs choose not to become certified because not only are the IRS requirements challenging to meet and maintain, but CPEO status may not even accommodate their clients’ needs. 

For example, some specialized PEOs may not pursue CPEO certification, particularly if they cater to niche industries or offer unique HR solutions. Expanding your search to non-certified PEOs gives you a broader range of industry expertise and experience.

Higher pricing

While not all CPEOs charge higher prices than non-certified PEOs, they often do. This is because there are additional costs associated with the IRS certification requirements, including bonding and compliance-related expenses—costs that may be passed on to CPEO clients.

CPEOs can be risky for tech-forward businesses 

Many tech-focused businesses grant equity-based compensation, such as stock, stock options, restricted stock units (RSUs), stock appreciation rights (SARs), and fringe benefits. But for these companies, working with a CPEO can be risky—CPEO legislation doesn’t address payroll tax restarts for equity- and property-based compensation. It’s unclear if that’s intentional or a statutory oversight, but either way, it could put tech companies (and any other business that pays employees in equity) at risk of added payroll tax liabilities.

Rippling opted out of pursuing CPEO status because many of our tech-forward clients offer equity-based compensation. We didn’t want to take the risk that they’d be double-taxed.

Rippling’s PEO is built for high-growth companies—we can take on all your HR services and IT busy work. Rippling can:

• Onboard your employees in just 90 seconds.
• Automatically create state and local tax accounts when you hire your first employee in a new state—and manage all unemployment insurance tax annual rate updates for you.
• Automatically provide employees with labor law posters electronically, and update posters when employees move to new locations.
• Automatically enroll applicable employees in state-mandated anti-harassment courses via Rippling LMS.
• Provide your team with the benefits provided by big companies at a fraction of the cost.

Rippling is also the only PEO that offers a standalone HR platform. That means when you’ve outgrown the PEO, you can seamlessly transition overnight to our all-in-one HR platform without needing to re-enter any employee data.

Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any related activities or transactions.