For this purpose, a service agreement means a written or oral agreement in which the payor asserts it is the employer (or “co-employer”) of individuals performing services for the client; pays wages to such individuals; and assumes responsibility to collect, report, and pay, or assumes liability for, any employment taxes with respect to the wages paid.
These regulations address arrangements with a professional employer organization (PEO) and certain other third-party payors.
Today’s final regulations [PDF 33 KB] provide that a payor may implicitly or explicitly assert it is the employer—which would include agreeing to: (1) recruit and hire employees for the client; (2) hire the client’s employees as its own and then provide them back to the client to perform services for the client; and (3) file employment tax returns using its own EIN that includes wages paid to the individuals performing services for the client.
These final regulations generally adopt rules that were proposed in January 2013, and address the designation of a payor to perform the acts of an employer when the formal IRS administrative procedures to designate an agent (i.e., filing Form 2678) are not followed. These rules address all federal employment taxes (FICA, FUTA, and income tax withholding).
The final regulations also clarify that:
- A third-party payor of sick pay that is treated as an employer will not be designated under these regulations to perform the acts of an employer with regard to sick pay, with an additional exception at Reg. section 31.3504-2(d)(4) for payors treated as employers under section 3121(a)(2)(A) and
- There is an exception for a section 3401(d)(1) employer (commonly referred to as a “statutory employer,” as discussed in the preamble to the proposed regulations)
Examples are provided illustrating the application, or non-application, of the rules to various fact patterns.
A designation of a payor required to perform acts of an employer is provided solely for purposes of determining liability for employment taxes under section 3504 (i.e., there is no inference that the same rules would apply for any other Code provision).
The regulations do not change the underlying common law employment rules. An entity that is a PEO or other third party acting under a service agreement does not automatically become the common law employer for non-payroll purposes. For example, a PEO cannot be treated as the common law employer of its client’s employees for purposes of retirement plan discrimination testing.
If a payor is designated to perform the acts of an employer, all provisions of law (including penalties) applicable with respect to an employer are applicable to that payor, and each employer for whom the payor is designated to act remains subject to all provisions of law (including penalties) applicable to an employer.
Consistent with the IRS's position on administering the section 6672 trust fund recovery penalty, the employment tax liability of an employer will be collected only once—whether from the payor or the employer.