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Vol. 72, No. 9, September 1999

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

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.

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