CPEOs Can't Be Used to Transform Self-employed Individuals and Partners into Employees

(Parker Tax Publishing May 2019)

The Chief Counsel's Office advised that payments made to an individual by a CPEO for services the individual's sole proprietor business performs for a firm of which the individual is a full-time employee are not "employee" wages and must be reported as payments to a self-employed individual under Code Sec. 6041; however, payments the CPEO makes to the individual for the services performed at the firm where he works as a full-time employee are employee wage payments reportable on Form W-2. Similarly, payments made by a CPEO to a partner in a partnership are not employee payments and are not reported on Form W-2. CCA 201916004.

Background

The Stephen Beck, Jr., Achieving a Better Life Experience (ABLE) Act of 2014 added new Code Sec. 3511 and Code Sec. 7705 relating to the federal employment tax consequences and certification requirements, respectively, of a certified professional employer organization (CPEO).

Practice Tip: By hiring a CPEO rather than a professional employer organization (PEO), a taxpayer can avoid liability for unpaid federal employment taxes where paying such taxes is the responsibility of the CPEO. If the taxpayer hires a PEO to take care of payroll, the taxpayer is still ultimately responsible for ensuring that payroll taxes are paid, and paying them if they are not.

In 2016, the IRS issued final, temporary, and proposed regulations (T.D. 9768 and REG-127561-15), upon which taxpayers could rely immediately, relating to CPEOs. The proposed regulations provide general guidance regarding the federal employment tax consequences under Code Sec. 3511 for persons certified as CPEOs and their customers, as well as certain definitions under Code Sec. 7705 that are necessary to implement Code Sec. 3511. Specifically, Prop. Reg. Sec. 31.3511-1 clarifies the following terms: customer, covered employee, work site employee, work site, and self-employed individual. Prop. Reg. Sec. 31.3511-1 also provides that, in the case of a covered employee who is a work site employee, no person other than the CPEO is treated as the employer of the work site employee for purposes of federal employment taxes imposed on remuneration remitted by the CPEO to the work site employee.

Chief Counsel's Clarifications on the Self-Employed Provisions Relating to CPEOs

In CCA 201916004, the Office of Chief Counsel stated that it had received some questions concerning language in the preamble to the CPEO proposed regulations dealing with the treatment of self-employed individuals who receive remuneration from a CPEO. According to the Chief Counsel's Office, some tax practitioners asked for clarification of the language addressing how payments from CPEOs to self-employed individuals should be treated for employment tax purposes. The Chief Counsel's Office began by noting that the reporting of amounts paid to self-employed individuals is provided for in Code Sec. 6041. CPEOs must report remuneration they pay to self-employed individuals in accordance with the rules under Code Sec. 6041 and other applicable provisions. Code Sec. 3511(f), for instance, provides that a self-employed individual is not a work site employee with respect to remuneration paid by a CPEO to the self-employed individual. Code Sec. 3511(c) provides that a CPEO is not treated as an employer of a self-employed individual. Consistent with these two provisions, the Chief Counsel's Office noted, Prop. Reg. Sec. 31.3511-1(f)(2) provides that Code Sec. 3511 does not apply to any self-employed individual.

The Chief Counsel's Office then noted that Prop. Reg. 301.7705-1(b)(14) defines a "self-employed individual" as an individual with net earnings from self-employment (as defined in Code Sec. 1402(a) and without regard to the exceptions thereunder) derived from providing services covered by a CPEO contract, whether such net earnings are derived from providing services as a non-employee to a customer of a CPEO, from the individual's own trade or business as a sole proprietor customer of the CPEO, or as a partner in a partnership that is a customer of the CPEO, but only with regard to such net earnings. Accordingly, any remuneration from the CPEO to such self-employed individuals, in their capacity as a non-employee providing services to a customer of the CPEO, a sole proprietor customer of the CPEO, or a partner in a partnership that is a customer of the CPEO, is not wages and must not be treated as such for reporting purposes.

Under the Code Sec. 6041 regulations, payments to self-employed individuals are reported on information returns such as Form 1099-MISC, Miscellaneous Income, and not on Form W-2. The Chief Counsel's Office noted that the proposed regulations' preamble discussion of the definition of "work site employee" under Prop. Reg. Sec. 301.7705-1(b)(17) provides that a self-employed individual, whether an independent contractor to the customer, a sole proprietor customer of the CPEO, or a partner in a partnership customer of the CPEO, is not considered to be a work site employee under Code Sec. 3511(f) with regard to such earnings, but 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. According to the Chief Counsel's Office, this latter language addresses the very uncommon situation in which one individual is receiving payments from the CPEO in two separate capacities. For instance, a common law employee of a marketing firm receives wages from a CPEO for services the employee performed for the marketing firm under a contract between the firm and a CPEO. This employee also owns a part-time cleaning business as a sole proprietor and this cleaning business is contracted by the marketing firm to clean its offices. Payments to the cleaning business for its cleaning services are also managed by the CPEO under its contract with the marketing firm. The Chief Counsel's Office advised that payments made to the individual by the CPEO for the services the individual's sole proprietor cleaning business performs for the marketing firm are not wages and must be reported as payments to a self-employed individual under Code Sec. 6041. However, the Chief Counsel's Office also advised that the CPEO is treated as the employer of the individual for employment tax purposes with respect to the payments the CPEO makes to the individual for the services the individual performs as a common law employee of the marketing firm and these payments are reported as wages by the CPEO.

The Chief Counsel's Office contrasted the situation above with the provision in the proposed regulations which states that 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 under Code Sec. 6041. Under Rev. Rul. 69-184, the Chief Counsel's Office stated, bona fide members of a partnership are not employees of the partnership for employment tax purposes. Such a partner who devotes his time and energies in the conduct of the trade or business of the partnership, or in providing services to the partnership as an independent contractor, is, in either event, a self-employed individual rather than an individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee. Thus, the Chief Counsel's Office stated, remuneration received by a partner from the partnership is not "wages" with respect to "employment." So, the Chief Counsel's Office concluded, whether an individual partner in a partnership is receiving payments from the CPEO for services performed in the conduct of the trade or business of the partnership, or receiving payments from the CPEO for services performed as an independent contractor of the partnership, the payments are payments to a self-employed individual and should be treated as such for reporting purposes as provided by Code Sec. 6041.

Observation: The bottom line is that a CPEO can't be used to transform a self-employed individual or a partner in a partnership, who are not entitled to receive fringe benefits that are limited to employees, into an employee eligible to receive such benefits. Self-employed individuals or partners in a partnership should not be receiving Form W-2s from a CPEO since they are not employees.

For a discussion of the tax treatment of payments by CPEOs, see Parker Tax ¶218,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com