The Risks of Co-Employment: How Employers Can Protect Themselves When Using a PEO

The use of professional employer organizations (PEOs) has grown rapidly in recent years, with over 150,000 U.S. businesses now relying on PEOs for payroll, benefits, workers’ compensation, and HR services. However, many companies don’t fully understand the risks of partnering with a PEO. Without taking proper precautions, employers can end up facing major liability issues, financial losses, damages to their brand and culture, and more. In this post, we’ll break down the key hazards of PEO co-employment and provide best practices for mitigating risks when working with a PEO.

PEO parachute representing Co-Employment benefits.

The Co-Employment Risk

PEOs assume certain employer responsibilities through a contractual relationship, and this co-employment creates shared liabilities between the PEO and its clients. If the PEO fails to responsibly manage payroll taxes, employee safety protocols, or discrimination issues (to name a few), the client company also faces legal and financial accountability.

For example, a report by Bloomberg Law cited AccuPay, a PEO that went bankrupt in 2013. AccuPay had failed to remit payroll taxes for over 2,000 businesses under their payroll services. Many client companies then owed back taxes and penalties exceeding $100,000 per organization — some even owed over $1 million!

A 2019 Department of Labor investigation found that Washington-based Professional Employment Resources (PER Solutions) had mishandled $57 million in healthcare contributions. Because PER Solutions failed to transmit deducted participant contributions into employee health plans, they were ordered to restore millions in losses, impacting hundreds of client companies.

PEO negligence can even jeopardize basic employer tax credits and incentives. For instance, New Jersey manufacturer Airflow Catalyst Systems suffered over $100,000 in lost tax credits and workforce training funds that the PEO, Premier Payroll, failed to properly file for. Without the PEO upholding key employer support programs, significant value was left on the table.

In April 2022, Delaware-based Payroll 365 vanished overnight, with losses estimated at over $30 million. This PEO neglected to remit payroll taxes for months, and as a result, local construction contractors owed significant IRS penalties and back payments in addition to unpaid wages.

And just this past June of 2023, Wells Fargo business analysts reported on the abrupt failure of Frontline Source Group, estimating over $100 million in client losses. Frontline folded with no warning, leaving up to 67,000 worksite employees without pay and exposing client companies to major financial and legal troubles.

These examples highlight how lack of financial controls, missed filings, benefits mismanagement, and other PEO compliance failures can rapidly escalate the damage to client companies in not only dollars, but also reputation. Brands can suffer significant culture and PR damage if a PEO poorly manages HR services, diversity initiatives, harassment issues, and day-to-day personnel relations.

Best Practices for Mitigating Co-Employment Risks

When partnering with a PEO, implementing these risk management strategies can help safeguard your interests:

  • Conduct extensive due diligence on potential PEO partners, examining financials, policies, histories, and client reviews. Obtain third party validation through audits, certifications like ESAC accreditation, or SOC reports on internal controls.
  • Require substantial insurance coverage for employee practices liability, professional liability, errors and omissions, fiduciary liability, and cyber liability. Set minimum thresholds appropriate for your company’s size and risk profile.
  • Secure strong indemnity terms that hold the PEO accountable for failures in areas like payroll, benefits, safety, discrimination issues, and improper employment actions.
  • Institute regular reviews of service performance metrics, risk exposures, and policy/procedural changes. Measure PEO services against defined KPIs and SLAs.
  • Maintain internal HR/personnel oversight for cultural initiatives, training, employee relations issues, diversity programs, and strategic planning. Don’t fully outsource your people priorities.
  • Join relevant groups like the National Association of Professional Employer Organizations (NAPEO) that advocate for client protections within state and federal regulations.

Avoiding Co-Employment Pitfalls

While PEOs can provide invaluable services, the legal and financial risks of co-employment should not be taken lightly. Without vigilant vendor selection, contractual protections, and ongoing oversight, employers can end up accountable for substantial liabilities. However, by making informed PEO decisions and proactively managing relationships, businesses can securely leverage talent management support.

Carefully weigh the considerations covered here when evaluating a PEO partnership for your business. Don’t hesitate to acquire legal counsel to craft contractual safeguards tailored to your unique needs and risk exposures. With proper diligence, you can make PEO co-employment work effectively without all the worries.

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