By: Mike Erstling
North Carolina is home to the country’s best fall foliage, hiking, mountains, and dare I say it, one of the county’s largest unemployment tax rates. With a per-employee payroll cutoff of $20,900 and a maximum tax rate of 6.84%, NC is the 13th highest taxed state in the country for unemployment insurance. Hospitality clients and seasonal business owners often complain about the burden of needing to pay over $1,400 per employee just in SUI tax alone and that’s before turnover. Recently PEO solutions have been coming to the rescue, but is this a viable solution or simply disguising the truth with a fancy shell game?
Referring clients to a PEO for tax savings is a tough decision for many CPA firms. As financial professionals we take our fiduciary responsibility seriously, and as such, must be prudent with our recommendations, especially on strategic tax savings. Therefore, what exactly is a PEO and how does leveraging one lower a client’s tax rate? A PEO (Professional Employer Organization) built their way into the small business world as an outsourced partner for administrative burdens often faced by business owners on the human resource side such as payroll, tax administration, and compliance. As the industry expanded they catapulted in popularity with blue-collar business owners by playing an arbitrage game between the PEO’s master workers’ compensation policy rates and the client’s earned premium rates. By leveraging economies of scale, business owners were able to escape the sins of their past by seeking refuge under the umbrella of the larger PEO. As the years progressed and healthcare began to outpace inflation, PEOs shifted their arbitrage to the healthcare industry. Just as they have done on the property and casualty side, PEOs offered companies with increased health premiums a safe haven under their master policy. Now with the transformation of healthcare reform, the PEO industry has made a noticeable shift in a new direction—unemployment tax.
The logistics are quite simple. When a company contracts with a PEO, the owner and all of their employees become “co-employed” with that PEO together with all of the other clients and client employees that PEO has under their governing FEIN. The owners of the client companies contractually retain their hiring rights, firing rights and everyday control of the business and their employees. The PEO handles the payroll, tax administration, HR best practices, and provides access to the PEO’s low rates on state unemployment taxes. The reason why PEOs have such low rates is they employ entire departments to manage their claims and number of corporate entities available throughout the country. By micromanaging these areas, all of a sudden a lower SUI tax has become a commodity which can be bought on the open market. DecisionHR, a prominent PEO leader in the area of managing an array of low SUI rates, represents how clients are using their strategy to improve much needed cash flow. In their CPA Partnership Program literature, a restaurant having an earned NC SUI rate of 6.84% is showed being reduced to DecisionHR’s 2012 NC SUI rate of 1.2%, saving the restaurant $1,179 per employee in reduced unemployment taxes. In this example an 80-employee restaurant with a 30% turnover would save over $120,000 on SUI taxes alone. The PEO also provides the payroll services, tax administration, and HR deliverables the client requires all for one consolidated fee. At the end of the day the savings typically far outweigh the PEO’s fees, creating a scenario in where the PEO often literally pays companies in reduced taxation to become their clients. It is the pinnacle of a win/win scenario.
However, the above begs the question of just how sustainable is this business model? When the industry began as a straight service deliverable without arbitrage, there’s no doubt the model was sustainable. Once the PEO’s value began being diminished and associated to leveraging their economies of scale for reduced insurance premiums or taxes to their clients; many say that was the beginning of the end for the PEO industry. The industry continued to fight back though coming up with new areas of value for their clients to focus. From workers’ comp to health insurance to taxes, the arbitrage never ended. We now see PEOs spending many millions into their technology resources allowing clients to leverage a robust HRIS platform for a fraction of the cost of owning one. It has become obvious whether it is taxes, insurance, technology, or something not yet thought of, the PEO industry has continued to leverage economies of scale in new ways to keep up with the small business owner and the struggling economy. Wall Street seems to agree as well. With PEOs outpacing the S&P considerably over the last 10 years, the industry is fast approaching a $100 billion market cap with ongoing double-digit growth per annum. Whether short-term or long-term, one thing is for certain, small and mid-size business clients are leveraging the industry to reduce their overhead.
To learn more about the PEO industry or their benefit in lowering your clients’ SUI tax rates, DecisionHR’s CPA Liaison Michael Erstling can be reached at (813) 469-5326.
Michael Erstling has been a leader in the PEO/HRO/ASO industry since 2001. On average, Michael transfers over $100 million of payroll each year from the payroll’s governing state taxation to a tax reduction under the umbrella of a PEO SUI tax. Michael has accomplished this task by working as a consultant to the CPA industry and educating them on new strategies available on a per-state basis. By partnering with CPAs in specific states with the largest SUI deltas, he is able to assure a positive experience for his partners by accepting their most challenging clients. In his spare time Michael enjoys outdoor activities with his wife Leah and their 6-year-old daughter and 4-year-old twins.