Professional employer organizations (PEOs) are more popular among small companies and startups than ever, and if you’re considering switching to a PEO, you should also think about what time during the year is best to make the transition. At Kruze Consulting, we’ve seen the market share for PEOs among our client base go from about 15 percent to about 30 percent. The growth is probably fueled by the pandemic and the increase in remote employees. PEOs like TriNet, Justworks, Sequoia, and Rippling will help you with state and local taxes for employees, which is very helpful, since having employees in different states triggers tax nexus and increases your administrative burden.   

Risks your company may see

When you move from a regular payroll provider to a PEO, you and your employees will see some changes: 

  • IRS Form W-2. Your PEO will now be the employer of record for your employees, and will issue payroll and do tax filings under the PEO’s Employer Identification Number (EIN). When your employees get their W-2s, the PEO’s name will be on them, not your company. If you switch to a PEO at any point during the year, your employees will get two W-2s, one from your company and the other from the PEO. So if this transition doesn’t go smoothly, your employees’ taxes could get complicated.  
  • Medical plans. Many employees, especially younger people, are on high deductible health insurance plans, and those deductibles are annual. If your company switches to a PEO midway through the year, there is the chance that the deductibles may reset. For example, if one of your employees has a $5,000 deductible, but has experienced significant medical expenses, that employee may have satisfied the $5,000 deductible. In this case the medical insurance is paying for all medical expenses except for co-pays. If your company switches plans and that deductible is reset during the year, the employee may have to satisfy the deductible again, which could be very expensive for the employee. The same could apply to Healthcare Savings Accounts (HSAs) or Flexible Spending Accounts (FSAs).
  • Social Security and Medicare taxes. Similarly, if you switch to a PEO during the year, it’s possible that the Social Security or Medicare tax contributions could be reset. 

Certified PEOs can smooth the process

A certified PEO can help your company make the switch. A certified PEO has gone through a rigorous process with the IRS that reviews the company’s background, financial reporting, and other requirements. The certified PEO agrees to take over some or all of the client company’s federal income tax withholding, reporting, and payment responsibilities. Certification means that a PEO has established a relationship with the IRS and state tax agencies, and they should be more effective at helping your company through the transition process. Tax laws are extremely complex, but a certified PEO can help make this a seamless transition for your company.

Choose your transition date

Because of the tax and benefits issues, most companies choose to switch to a PEO at the beginning of a quarter or the year. However, there’s a lot of details that need to be addressed prior to the date of the switch. One of the biggest mistakes we see with startups is a lack of planning for a PEO transition. You should allow at least two months to plan the switch, review all your tax accounts and benefit plans, get your employees enrolled in new benefit plans, and execute the switch. Two months allows your PEO enough time to make an efficient transition. 

The most conservative option is to switch over on January 1, but switching at the beginning of a quarter is also an option. The most important factor is the effectiveness of your PEO onboarding team and how much time you allow them to plan a seamless and successful transition. Your accounting team at Kruze Consulting can help you make sure you’ve covered all the details and you’re ready to switch. And if you are still trying to find the best payroll system for your startup, or if you have questions or need more information, contact us.