A New Approach To Employment Administration
Developing a relationship with a professional employer
organization can help law firms more evenly compete for quality
employees and reallocate limited resources to focus on client
service.
By James J. Gettel & Bruce A. McIlnay
hile people are the
greatest assets of any law firm, managing human resources is one of the
most expensive and time-consuming administrative tasks in a law firm.
Wages, payroll taxes, and employee benefits are among a firm's biggest
expenses. The time spent effectively managing these costs adds more
expense. The largest law firms employ professional, full-time staff to
manage their human resources. This staff can shop for, set up, and
administer payroll, insurance, and benefit plans.
Staff also is responsible for
compliance with tax and employment regulations. In most firms, however,
these time-consuming but vital functions fall to experienced lawyers,
whose time could be more effectively spent serving clients.
Law firms can benefit from services designed to help businesses focus
on their core competencies.1 Professional
Employer Organizations (PEOs) have evolved to provide a practical,
economical, and ethical alternative for out-sourcing law firm employment
administration. This article explains how a PEO can make a law firm more
competitive in the market for quality employees and more effective in
firm administration, and offers tips on selecting a PEO. It also
describes the recent development of "coemployment" law to support PEO
arrangements, and addresses relevant ethical considerations arising from
the coemployment relationship.
The Advantages of PEOs
Increasingly, businesses are using PEOs to manage complex
employee-related matters.2 By contract, PEOs
assume a variety of responsibilities for their clients, including
payroll management, employee benefit plan design and administration, and
tax and human resources compliance.
The PEO delivers services by becoming a "coemployer" of the
customer's employees. As coemployers, the PEO and the customer become
partners in the employment of their workers. The PEO provides specific
employment administration services but the customer retains
responsibilities for employee supervision, training, evaluation,
discipline, compensation, and other essential terms of
employment.3
By using PEO services, a business redirects many noncore business
responsibilities to an outside supplier.4
PEOs help their customers focus on their primary business rather than on
the business of employment. PEOs can reduce the costs and improve the
quality of employment administration services and employee benefits.
Competing in the Labor Market. PEOs help smaller
businesses attract, retain, and support valuable employees by providing
a competitive benefit package and quality employment administration that
otherwise might be unaffordable. With unemployment rates in Wisconsin
well below 5 percent, Wisconsin businesses face difficult challenges in
attracting and retaining qualified employees.5 To compete for employees, businesses must offer
competitive pay and benefits in addition to a challenging career. Firms
also must be responsive to changing employee needs and concerns.
The largest businesses have economies of scale in payroll, benefits,
and human resource administration that permit these services to be
economically provided by professional, in-house staff. Large businesses
also enjoy a competitive advantage in the market for benefit products
like insurance.6 These economies can be
great advantages in competing for quality employees.
PEOs can level the playing field. PEOs allow small and medium-sized
businesses to offer competitive and affordable benefits such as health,
disability, dental, and life insurance, a 401(k) retirement plan, and a
flexible spending account plan. By aggregating the employees of multiple
customers to increase buying power, PEOs secure and administer superior
benefits for their customers at substantially better prices than smaller
firms could obtain for similar benefits.7
Reducing Administrative Burdens. PEOs also offer
professional administrative services. Businesses that cannot afford to
hire a professional human resource manager must rely on busy
professionals to take responsibility in areas for which they have little
or no expertise. Every issue can require study, and employees must wait
for answers. In contrast, PEOs are employment professionals. PEOs
regularly handle paperwork, such as payroll tax filings, for multiple
companies; provide efficient and responsive claims processing and
management for benefit plans, unemployment insurance, and worker's
compensation; and assist with human resources compliance, including
employee handbooks, forms, policies, procedures, communications, and
fiduciary responsibilities.
The professional skills of the PEO benefit primary employers and
employees alike. The primary employer is relieved of the time-consuming
and expensive tasks of shopping for and comparing insurance and benefit
plans, administering the plans they choose, and staying informed about
and complying with a myriad of tax- and employment-related regulations.
The employee can receive better benefits and timely advice concerning
benefits and other employment issues.
Ease in Tracking Costs. In a typical PEO
arrangement, employees submit the information necessary to calculate
periodic payroll to the PEO. The PEO, in turn, prepares the payroll
checks, makes the required withholdings for taxes and benefits, and
makes necessary deposits with taxing authorities or benefit plan
sponsors. The PEO sends the customer one invoice per pay period, which
saves the customer the time and expense of calculating the amounts of
various withholdings; and relieves the customer from the burden of
making separate deposits with the several taxing authorities. The PEO's
invoice represents a concise tally of a firm's total labor costs.
Most PEOs charge a percentage markup on gross payroll to cover
mandatory payroll taxes, benefit costs, and a margin for the PEO. Some
PEOs will estimate benefit costs, while others provide a direct pass
through of actual costs. Typically, the PEO is seeking a fixed, gross
dollar margin per employee per year. As a result, the percentage of
payroll attributable to this component may be reduced for more highly
compensated employees. This fact makes it attractive to a professional
firm to include all employees in its PEO contract. This means that
attorneys can track not just the cost of their support staff but what it
costs to pay the attorneys themselves.
The Development of "Coemployment" Laws for PEOs
PEOs Improve on Earlier Models. The PEO coemployment
arrangement should not be confused with historical "staff leasing"
arrangements. Early staff leasing arrangements involved firing employees
and then "leasing" them back from a third party. The PEO arrangement
does not involve the "leasing" practice of "fire, hire, and lease back."
Instead, the PEO becomes a coemployer, not a substitute employer.
Neither is a PEO a temporary employment agency. In a traditional
"leasing" arrangement, people are assigned to a customer on a
supplemental or temporary basis for a specific project or for a fixed,
usually short, time. The PEO arrangement is created for exactly the
opposite result assisting customers in making a long-term
investment in their employees.
Unlike present PEOs, early staff leasing arrangements were limited in
scope and produced only isolated cost savings. Staff leasing became
disfavored by regulators who considered it abusive. During the 1970s,
small business owners could receive pension benefits without providing
the same benefits to their other employees whom they leased from a staff
leasing company. Congress closed this loophole in 1982 with the
enactment of section 414(n) of the Internal Revenue Code.8
Some early employee leasing firms got into trouble as they shifted
from pension-driven programs to offering low-cost health insurance,
unemployment insurance, or worker's compensation insurance coverage.
Often the cost savings were illusory, based on underpricing self-funded
health insurance, or artificially low worker's compensation experience
modifiers, or state unemployment insurance rates. Leasing companies
began to fail and regulators took the position that the leasing
companies were not true employers. Regulators sought to hold the leasing
companies' clients liable for unpaid employment taxes and employee
benefits. Today's PEOs, based on the concept of coemployment, have
improved dramatically over staff leasing companies of the past.
Coemployment Moves Beyond Common Law Concepts. The
coemployment relationship in a PEO arrangement is different from other
multiparty employment relationships recognized at common law. This
difference permits the PEO and its customer to allocate responsibilities
and risks in the employment relationship.
Traditionally, whether an employment relationship exists is
determined by reference to the common law of agency.9 The Restatement (Second) of Agency10 is a helpful summary of the common law
approach.
The Restatement describes three types of multiparty employment
relationships recognized at common law. First, "joint employment" occurs
when a single employee, under contract with two employers, and under the
control of both, simultaneously performs services for both employers
that are the same as, or closely related to, the services performed for
the other.11 Second, "dual employment"
occurs when an employee is hired by two separate employers at the same
time (with or without knowledge of the other) to perform separate tasks
for each.12Third, and best recognized at
common law, is the "loaned servant" employment relationship that occurs
when a servant is directed or permitted by his or her master to perform
services for another and, thus, becomes the servant of the party to
which the servant was "loaned." The "loaned servant" may become
another's servant as to some acts and not as to others.13
All three traditional types of multiparty
employment arrangements contemplate an employment relationship by the
employee with both employers. In joint employment and dual employment,
both employers simultaneously employ the employee. Similarly, the loaned
servant cases concern the question of whether the borrowing person
becomes a "special employer." This analysis implicitly assumes that the
first employer must retain at least some indicia of an employer and does
not completely surrender its rights and obligations as an employer.
While the common law recognizes multiparty employment arrangements,
it generally seeks to allocate responsibility between employers
according to who controls the employee in a given instance. Depending
upon the circumstances, either employer can be held responsible for all
liabilities arising from the employment relationship. This result could
leave one of the employers responsible for aspects of the employment
relationship that it sought to allocate to the other.
The PEO arrangement is different from traditional employment
relationships because coemployment makes each employer responsible for
different aspects of the employment relationship. In this type of
relationship, it is possible that neither employer has all the
characteristics of a common law employer. This should not mean that the
employment relationship fails, leaving the employee an independent
contractor or an employee of only one company or the other.
The proper analysis should be whether the PEO has enough of the
characteristics of an employer to be considered a coemployer together
with the primary employer. In the PEO arrangement, it takes two
employers to create the full employment relationship, with each employer
assuming different responsibilities of a single employment relationship.
The law is beginning to recognize that both employers in a PEO
arrangement do not each have to meet all of the common law criteria for
establishing employment relationships. Instead, as long as the PEO and
the customer jointly satisfy the criteria, a common law employment
relationship will still exist.
Legislative and Regulatory Recognition of
Coemployment. The Internal Revenue Service acknowledges that a
PEO is the employer responsible for federal employment and unemployment
taxes and also may provide qualified plan benefits.14Many states, including Wisconsin, statutorily
recognize PEOs as the employer or coemployer of worksite employees for
purposes of worker's compensation and unemployment insurance
laws.15PEOs are legally recognized as
employers in the EEOC Contingent Worker Guidance, regulations
implementing the Family and
Medical Leave Act, new COBRA regulations, recent cases interpreting
the Fair
Labor Standards Act in coemployment situations, and the OSHA draft
"multi-employer worksite policy."
The IRS 1997 Business Plan specifically targeted additional "employee
leasing" issues for resolution, but guidance was not released in
anticipation of Congressional enactment of the Staffing Firm Worker
Benefits Act of 1997 (HR
1891). The bill would have amended the Internal Revenue Code to make
it clear that a "qualified staffing firm" is the employer of the
employees covered by staffing arrangements, both for purposes of
employment tax liability and employee benefit plan sponsorship.16 The bill also would have amended the leased
employee provisions of IRC section 414 to encourage
retirement and fringe benefit coverage of employees of qualified
staffing firms.17
Notwithstanding the failure to pass the Staffing Firm Worker Benefits
Act, state and federal legislators and regulatory agencies continue to
show interest in, and support for, PEO arrangements. A new bill limited
to clarifying PEO arrangements will be introduced soon in Congress with
apparently strong bipartisan support.18
Selecting a PEO
![Gettel](/SiteCollectionImages/WisconsinLawyer/1999/09/gettel.jpg)
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![Mcilnay](/SiteCollectionImages/WisconsinLawyer/1999/09/mcilnay.jpg)
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James J. Gettel (left), Illinois 1984, is executive vice president
and general counsel of the Waterstone Group Employment Administration
Services LLC, a professional employer organization with offices in
Mequon, Plymouth, and Green Bay. Prior to starting the Waterstone Group
in 1994, Gettel was a partner in the Milwaukee office of Michael, Best
& Friedrich.
Bruce A. Mcilnay (right), U.W. 1984, is a shareholder in Maier,
Mcilnay & Kerkman Ltd., Milwaukee and Grafton. He practices in
business planning and dispute resolution. His firm has used Peo Services
since 1996.
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A good place to start a search for a PEO is with the National
Association of Professional Employer Organizations (NAPEO), which has a
Web site.
As with selecting any major vendor, firms should perform a credit
check on PEOs under consideration. Firms also should search public
records for incidents involving noncompliance with tax requirements and
ask for customer referrals. When speaking to the customer, talk to staff
employees who have experience in asking the PEO for benefit information
or assistance with claim processing. How responsive was the PEO to
requests for information?
Given the relative infancy of the industry, many participants are
adding to existing, more limited, services to create PEOs. For example,
more traditional payroll service or staffing firms are creating PEOs.
The firm's history can offer some clues as to its strengths and
weaknesses in offering a full-service PEO.
The quality, cost, and variety of benefits offered are important
factors to consider. A strong PEO should have sufficient knowledge of,
and bargaining power in, the benefits market to offer attractive
benefits at costs less than a firm's smaller group could obtain on its
own.
In the final analysis, the PEO should in all respects be an
outstanding business partner to the law firm.
Conclusion
PEO arrangements can be an effective strategy to combat the spiraling
costs of having a professional and clerical support staff perform
employment administration. PEOs can offer financial and administrative
benefits to legal practices, and employees can receive better benefits,
which in turn can increase staff loyalty and reduce turnover.
As lawyers decide whether to enter a PEO arrangement, they should
especially review their health insurance and retirement plan costs, and
the time and costs associated with employee administration and
government compliance. Many lawyers will discover that they spend a lot
of time on employment administration (usually in relatively small,
disruptive increments) and that PEO services will give them more time to
address the quality of services they provide clients.
Chosen wisely, and properly structured, a relationship with a PEO can
be an ethical, economic, and efficient means of unburdening attorneys
from the "business of law," and free more time to devote to the
"practice of law."
Endnotes
1"An important reengineering principle is
that companies should focus on their core competencies and outsource
everything else. ... Our core competencies at Microsoft are creating
high-volume software products, working with other software companies,
and providing customer service and support. We outsource a number of
functions that don't fall into those categories, from help-desk
technical support for our employees to the physical production of our
software packages." Gates, W. H., Business @ The Speed of
Thought, pp. 133-34, Warner Books (1999).
2The PEO industry is among the fastest
growing industries in the United States. The National Association of
Professional Employer Organizations conservatively estimates that more
than 3 million employees are in PEO arrangements and that the industry
growth rate is 20-30 percent per year. In 1983 only about 4,000
employees were covered by PEO arrangements. The average client customer
of a PEO is a small business with 16 employees, though businesses of up
to 300 employees find value in PEO arrangements. PEO customers include
all types of businesses and professions, including accountants, doctors,
and lawyers.
3In some cases, the PEO relationship
places greater responsibilities on the law firm as an employer.
Generally, the determination of whether an employer is subject to a
particular statute is based on the number of workers employed during the
year. Workers employed by a PEO are protected by more laws because they
are included in the larger workforce of the PEO. Examples of statutes
that apply because of the PEO arrangement are COBRA, the Family and
Medical Leave Act, Title
VII of the 1964 Civil Rights Act, the Age Discrimination
in Employment Act, and the Americans with
Disabilities Act.
4The PEO business is a comprehensive form
of outsourcing. A recent American Management
Association survey revealed that 94 percent of the responding
companies had outsourced at least one activity. The primary reason for
outsourcing was to reduce costs, followed by saving time and improving
quality. Good PEO services offer all of these benefits.
5Retaining employees is especially
critical. A recent U.S. Department of
Labor study put the direct cost of hiring a new employee at 33
percent of the employee's first year salary. Direct costs include the
time involved in recruiting, selecting, and training new personnel.
Indirect costs include the decreased productivity of coworkers and the
negative impact on customer relationships that turnover creates. For
professional positions, turnover costs are even higher because it can
take up to three years for a new employee to reach his or her productive
capacity.
6Smaller law firms' cost disadvantages are
most evident in purchasing power for benefits such as health, life, and
disability insurance, and retirement plans. In addition, a study by
Thomas Hopkins of Diversified Research found that smaller businesses pay
about $5,400 per employee to manage regulatory compliance compared to
$3,000 for larger firms a cost difference of 80 percent.
Staffing Industry Reports, January 1999.
7According to a 1996 Bankers Trust Co.
study, small business owners generally save 3 to 5 percent of their
payroll expenses by outsourcing to PEOs.
8Use of leasing as a means to avoid
pensions created some animosity in Congress toward the employee leasing
industry, and this use of leasing as a "tax shelter" was short lived.
See Professional & Exec. Leasing Inc. v. Comm'r,
862 F. 2d 751 (9th Cir. 1988). Under current regulations, businesses
that lease their employees either must include the leased employees in
their retirement plan or show that the leasing company provides the
employees with a plan that is comparable or better.
9Courts consider many factors in
determining the existence of the employer-employee relationship. Among
those factors are: 1) the right to control the details of the work; 2)
the furnishing of tools and the work place; 3) withholding of taxes,
worker's compensation and unemployment insurance funds; 4) right to
discharge; and 5) permanency of the relationship. See United States
v. Silk, 331 U.S. 704, 714-16 (1947), and the IRS 20-factor test in
Revenue Ruling 87-41, 1987-1 C.B. 296. See also, Siev, Jordan
W. and Kirsten M. Eriksson, Are Your
Independent Contractors Truly Independent?, 72 Wis. Law. 10
(July 1999); Beightol, Scott C., In Wisconsin, Most Workers
Are "Employees," 72 Wis. Law. 13 (July 1999).
10American Law Institute, 1958-1992.
11The Restatement defines "joint
employment" as: "Two persons may agree to employ a servant together or
to share the services of a servant. If there is one agreement with both
of them, the actor is the servant of both at such times as the servant
is subject to joint control. Restatement (Second) of Agency, § 226,
comment b. See also, Larson, The Law of Workman's
Compensation, § 48.41 (Matthew Bender 1991).
12Restatement (Second) of Agency, §
226, "Servant Acting for Two Masters."
13Restatement (Second) of Agency, §
227, "Servant Lent to Another Master."
14PEOs are contractually (and in some
states, statutorily) obligated to pay worksite employees without regard
to the receipt or sufficiency of payment by customers. Internal Revenue
Code section 3402(a) requires every employer making payment of wages to
deduct and withhold from such wages federal income taxes in accordance
with the tables or procedures prescribed by the Secretary of the
Treasury. For the purposes of both sections 3401 and 3402 the term
"employer" means the person having control of the payment of wages to an
individual (employee) who performs or performed services. Statutes, case
law, revenue rulings, and private letter rulings substantiate the
responsibility of the PEO for payroll taxes and other withholding
liabilities. See, e.g., Revenue Ruling 75-41, 1975-1 C.B. 323;
Packard v. Comm'r, 63 T.C. 621 (1975); Private Letter Ruling
7748037, Aug. 31, 1977; Private Letter Ruling 8250042, Sept. 13, 1982
(citing Otte v. U.S., 419 U.S. 43, 51 (1974); In re
Armadillo Corp., 561 F. 2d 1382 (10th Cir., 1977); In re
Southwest Restaurant Sys. Inc., 607 F. 2d 1237, 1240 (9th Cir.
1979). Internal Revenue Code section 414(n) permits a PEO or the
recipient of the PEO's services, or both, to provide qualified plan
benefits to employees. The legislative history of section 414 makes
clear that the provision does not override traditional common law
employee rules and that an employee does not cease to be a common law
employee of the recipient by virtue of section 414. See General
Explanation of the Revenue Provisions of the Deficit Reduction Act of
1984 (DEFRA Blue Book), 827-28. Section 414(n) also applies to cafeteria
plans, group term life insurance plans, dependent care assistance
programs, group legal service plans, qualified tuition reduction
programs, and employer sponsored health plans. See I.R.C.
§ 414(n)(3)(C).
15For unemployment insurance, Wis. Stat.
section 108.02(12m) defines an "employee service company" to include a
"leasing company" that performs specified services for its customer,
including paying, hiring, and terminating employees. For worker's
compensation, Wis. Stat. section 102.01(f) defines a "temporary help
agency" to include "an employer who places its employee with or leases
its employees to another employer who controls the employee's work
activities and compensates the first employer for the employee's
services, regardless of the duration of the services," and section
102.04(2m) makes "a temporary help agency the employer of an employee
whom the temporary help agency has placed with or leased to another
employer that compensates the temporary help agency for the employee's
services." Seventeen other states provide some form of licensing,
registration, or regulation of PEOs.
16In mid-1997, Congress nearly passed a
tax law with the same effect as The Staffing Firm Worker Benefits Act.
Early provisions in the Taxpayer Relief Act of 1997 (HR 2014)
recognizing coemployer status (and eliminating the 20-factor common law
test applied by the IRS to determine employer status in Revenue Ruling
87-41) passed the House and survived the House-Senate Budget conference
committee in July 1997, but were dropped at the last minute to avoid
vulnerability to a parliamentary point of order.
17The Staffing Firm Worker Benefits Act
did not pass in 1998 for two reasons. First, the Act was attached to HR
3788, legislation focused on comprehensive pension reform which will
require further study. Second, the Act defined temporary staffing firms
and PEOs as employers, making the bill controversial because it would
remove clients of temporary employment agencies from worker
classification disputes such as Vizcaino v. Microsoft Corp.
(CA-9, 96-2 USTC ¶50,533; 96 FTG ¶3933A and ¶8356). In
Microsoft, the federal court found that Microsoft had an
obligation under the terms of certain employee benefit plans to cover
temporary workers as well as direct employees.
18Information regarding the status of
these legislative initiatives can be obtained from the National Association of Professional
Employer Organizations (NAPEO), 901 N. Pitt St., Alexandria, VA
22314.