CPEOs for Self-Employed Persons
After proposed regulations for Certified Professional Employer Organizations (“CPEOs”) were released, some thought that the use of a CPEOs would enable partners or other self-employed individuals to be treated as CPEO employees. The IRS has now clarified the language in the proposed regulations preamble stating that such an interpretation is not correct. The use of a CPEO does not convert a partner in a partnership, a sole proprietor or an independent contractor to a CPEO employee.
Sometimes partnerships try to use a CPEO to enable their partners to be treated as employees of the CPEO, rather than partners, subject to the Self-Employment Contributions Act (“SECA”), for employment tax purposes. This position is based on a sentence in the preamble to the proposed regulations highlighting the fact that partners cannot be treated as employees. The sentence also provides that “in the limited case in which such an individual also is paid wages by a CPEO under a CPEO contract with the customer, the individual may nevertheless be a work site employee with respect to such wages.” Chief Council Advice memorandum (“CCA”) 201916004 clarifies that this sentence refers to a situation in which the same individual is both an employee and a nonemployee for a CPEO client. The CCA explains that where an individual has two roles, that individual can be a CPEO employee for work as an employee of the CPEO client, but cannot be a CPEO employee for work as a nonemployee of the CPEO client. The CCA continues, “any payment made by a CPEO to a partner in a partnership under a contract between the partnership and the CPEO must always be treated as a payment to a self-employed individual and reported as such.”
Partnerships and sole proprietors contracting with CPEOs and treating partners, sole proprietors or independent contractors as CPEO employees need to work with the CPEO to correct any improper employment tax filings. Earnings will need to be reported on a Schedule K-1 or Form 1099-MISC, and not subjected to income or employment tax withholdings. The partner or sole proprietor will be responsible for paying income and SECA tax as a self-employed person.