Exiting a PEO:  A Checklist of Considerations

Many small to mid-size companies look for solutions to outsource certain aspects of their businesses due to a multitude of financial and staffing related concerns.  To meet this outsourcing need, professional employer organizations (PEOs) provide their clients with an entire workforce or human resources management team over an extended period.  A PEO can offer a variety of services and support for a company, including handling taxes, employee benefits, payroll processing, worker’s compensation, and administrative support, to name a few.  For a small business, a PEO can significantly ease their administrative burden and provide compliance and risk management for the absorbed or new services.

While there may be many advantages to hiring a PEO, there may come a time where the PEO is no longer meeting your company’s needs.  As your company grows and changes, there are some common reasons why exiting a PEO might be the right decision.  Several reasons for leaving may include the desire for customization of employee benefits, cost, service, and full control of employee culture, relationships, records, and technology.  Exiting a PEO may seem like a daunting task so it is important to involve the key players of your company in order to have a smooth transition.  You must also take into account time when exiting a PEO, as many changes and systems will have to be operational before the exit.  The below checklist touches on some of the most critical considerations when leaving a PEO.

Your company will need to have a payroll system in place before the transition to ensure uninterrupted service (timely and accurate paychecks).  You will have to implement a payroll system by either hiring a payroll expert or finding a payroll vendor.

There are some tax consequences when exiting a PEO mid-year.  Employees are new employees for tax purposes during a mid-year switch, and FICA and FUTA taxes paid on each employee’s wages for the year under the PEO are not transferable and the wage base will restart at the time of transfer (essentially resulting in double taxation).  However, employees can reconcile excess payroll taxes on their individual tax returns.  If you are leaving a certified-PEO, a mid-year exit will not cause the tax consequences described above because you are a successor employer in this context.

After leaving a PEO, you will have many considerations regarding HR staff, policies and procedures.  It will be necessary to update your employee handbook and any policies within the handbook that may have changed due to your transition out of the PEO.  Your company will also have the responsibility of keeping abreast of employment laws and regulations (ex. FMLA and FLSA). It may be prudent to retain a legal professional to help draft your employee handbook and implement any new policies and procedures.

The ease of this transition will depend on your company’s risk profile and the worker’s compensation carrier.  Coverage must be in place at the time of transition with no interruption.

Disengaging from the PEO may mean leaving their single source, integrated solution for technology.  You will have to decide on replacement systems for the various HR and benefit functions that the PEO previously provided (whether this is a single source solution or multiple systems).  Finding a good solution will depend on your company’s needs.

After exiting a PEO, you will have to establish a new benefit package for your employees.  Finding a good employee benefits advisor for this transition is a key element to success.  Below are a list of legal obligations and requirements that go along with the implementation of an employer-sponsored plan:

• Structuring a Health Plan. You will have to decide what kind of health plan to offer to your employees (a fully insured plan or a self-insured plan). A fully insured plan will require the evaluation of carriers and getting policies in place, whereas self-funding will require considerable work with a TPA.
• COBRA Administration. A former employee may be on COBRA during the transition away from the PEO. Usually, an employee can continue benefits through the PEO plan for the remainder of the maximum coverage period. However, be aware that a PEO may charge fees to manage these COBRA participants.  An employer may also negotiate to include the COBRA participants on their new health plan.  The most important consideration is communication to the existing COBRA participants to let them know which plan is covering COBRA continuation coverage.
• Health Care Reform Compliance. You are now responsible for tracking employees in order to determine whether they are full-time under the ACA regulations. It is necessary to find out what measurement method the PEO was using and whether or not you will use that same measurement period.  Furthermore, you will now be responsible for ACA reporting, which includes finding a vendor to file the Form 1094-C and 1095-Cs.
• Reporting and Disclosure Requirements of ERISA. Employee benefits plans that are subject to ERISA (the Employee Retirement Income Security Act of 1974) must comply with certain reporting and disclosure requirements, including but not limited to a wrap plan document, wrap SPD, Form 5500 filing, and benefit notices.
• HIPAA Compliance. As plan sponsor, it’s important for you to determine your HIPAA obligations – particularly if you decide to sponsor a self-insured group health plan. An employer has to have the proper notices, policies and procedures in place to remain compliant with HIPAA.
• Employees may not be able to access their FSA funds after the agreement between the PEO and employer terminates. Communication with your PEO is necessary so you can advise your employees if they have to spend down their FSA funds.
• Commuter Benefits.

The above list is not an exhaustive list of all of the considerations to keep in mind when exiting a PEO.  To make leaving the PEO an easier transition, it is imperative to find a PEO transition consultant who understands your organization’s needs and can plan the right exit strategy with you.