IRS Notice 2014-55 and the Certified PEO Program
Understand how IRS Notice 2014-55 provides tax certainty for businesses by establishing the Certified PEO program and defining employer responsibilities.
The Small Business Efficiency Act (SBEA) created a voluntary certification program for Professional Employer Organizations (PEOs) through the Internal Revenue Service (IRS). This program established the Certified PEO (CPEO) designation for PEOs that meet specific financial and reporting standards. In a co-employment relationship, a PEO handles many payroll administration and tax reporting duties for its client’s employees. The CPEO program provides clear federal tax rules and a layer of security for businesses that use these services.
The Pre-CPEO Employment Tax Problem
Before the CPEO program, a significant issue for businesses using a PEO mid-year was the “wage base restart.” This problem impacted federal employment taxes like Social Security (FICA) and Federal Unemployment (FUTA), which are calculated on wages up to an annual limit, or wage base. When a company hired a PEO, the IRS often viewed the PEO as a new employer, which meant the wage base for each employee would reset.
This reset created a duplication of tax payments. For example, if an employee met the Social Security wage base with their original employer, the PEO would have to start paying Social Security taxes on that same employee’s wages again. This duplication, which also applied to FUTA taxes, placed a financial strain on the client company and the PEO.
Key Provisions of the CPEO Program
The CPEO program introduced several provisions that changed the employment tax landscape. A central feature is wage base succession, where a CPEO is not required to restart the FICA and FUTA wage bases when a client joins or leaves mid-year. This allows the CPEO to continue tracking wages against the annual limits as if no change in employer occurred, eliminating the tax duplication problem.
A defining element of the program is the shift in tax liability. The CPEO is treated as the sole employer for the federal employment taxes on wages it pays to worksite employees and is solely responsible for remitting them. Once the client pays the CPEO for these taxes, the client is relieved of the federal employment tax liability for those wages.
The program also clarifies that the client company remains eligible for certain federal tax credits related to its worksite employees, such as the R&D tax credit. This ensures businesses do not forfeit tax incentives by partnering with a CPEO.
Requirements for PEO Certification
A PEO seeking to become a CPEO must meet rigorous IRS requirements to demonstrate its financial stability and integrity. A primary requirement is posting an annual bond of up to $1 million to cover federal employment tax liabilities. The organization must also submit annual audited financial statements prepared by an independent Certified Public Accountant (CPA) to the IRS.
The application process requires detailed disclosures on Form 14737, Application for Voluntary Certification. This application requires information about the business entity, its tax compliance history, and its organizational structure. Furthermore, the individuals who manage the PEO must undergo background checks to verify their knowledge and integrity.
Formalizing the CPEO Agreement
The CPEO is responsible for reporting the start and end of its service contracts with clients to the IRS. This is done by filing Form 8973, Certified Professional Employer Organization/Customer Reporting Agreement. This form officially notifies the IRS of the agreement dates, documenting when the CPEO is responsible for the client’s federal employment tax duties.