Controlling employee benefits and payroll is among the most difficult aspects of managing a mid-sized or small company. With rising costs for insurance as well as compliance regulations and payroll tax, even experienced business owners are often left wondering:
Is there a more efficient, smarter, and cost-effective way to manage all of this?
Then there’s the Professional Employer Organization (PEO) which is a model that combines payroll, HR, and benefits all under one roof. How does it compare to traditional methods of managing everything, especially when it comes to saving on payroll taxes?
Let’s explore the distinctions among traditional insurance and PEO plans and examine how each impacts the tax burden of your business and decide which will give your business the most benefit in terms of financial advantage.
What Is a PEO (Professional Employer Organization)?
The PEO is an external third-party HR and payroll service which works with your business via co-employment arrangement. In this type of arrangement, your employees have the benefit of being technically employed by both your company and the PEO.
The PEO has key responsibilities in the administration including:
- Processing of payroll and tax filings
- Administration of employee benefits
- Workers’ compensation insurance
- Human resource compliance as well as risk management
In the meantime, you have complete control over your daily operations and management of employees.
It allows for small to mid-sized companies to gain access to benefits of enterprise-level and payroll systems typically at a lower cost.
Traditional Insurance and Payroll Administration
In the traditional system, your business handles the payroll tax as well as insurance policies and HR functions on its own. You buy workers compensation insurance or health insurance directly from insurance companies while your company’s payroll provider, whether outsourced or internal, is responsible for filing employment tax using your company’s tax identification number.
This setup provides full control but it also means that your business has to shoulder the full financial and administrative burden for tax filings, compliance, and the management of premiums.
Payroll Tax Savings: The PEO Advantage
One of the major reasons that businesses decide to switch to a PEO is the possibility of lower payroll tax expenses. Here’s how:
1. Federal and State Unemployment Tax (FUTA & SUTA) Efficiencies
PEOs combine employees from a variety of small-sized businesses under one umbrella and often qualify as a part of less state unemployment insurance (SUTA) rates.
For example:
- Small-sized businesses with no experience in payroll may begin with an SUTA rate of 4 to 6%.
- A PEO with a strong track record and a solid claim management, could offer rates as low as 1-2%.
When you join the PEO’s group, your business will gain these lower rates of unemployment tax which can result in direct savings.
2. Streamlined Payroll Tax Filings
PEOs manage every federal, state and local tax filings for payroll on your behalf, ensuring timely and accurate submissions. This reduces the chance that comes with penalties and interests, which could quickly accumulate if the tax filings are not completed or calculated correctly.
3. Workers’ Compensation Optimization
Premiums for workers’ compensation are yet another sector where PEOs can earn savings. Because PEOs are part of group coverage plans. They offer better rates than individuals small-sized businesses could get by themselves.
This is often the result of:
- Lower costs because of group purchasing power
- Less claims due to proactive risk-management programs
- Correct job classifications to ensure that there is no overpay
The traditional insurance plans, in their nature, have a price based on the specific risk factors of your business and history of claims and can be considerably higher if you’ve had previous claims.
4. Reduced Administrative Overhead
While they’re not a “tax” savings in the traditional sense, PEOs are also able to reduce expenses associated with HR staff as well as payroll processing software and the management of compliance. Small businesses often find these indirect savings when combined with tax reductions are more than enough to make up for the PEO service charges.
How Traditional Insurance and Payroll Models Compare
The traditional model works great for companies that desire total financial independence as well as having robust internal HR systems. When compared to the PEO, the traditional payroll management typically has:
- Higher SUTA charges for small or new employers
- Different insurance companies each with their own compliance and billing methods
- Higher risk of being penalized when the payroll tax is not properly filed
- Limited benefit options that could make it difficult to retain and attract the best talent
In essence, although traditional insurance offers you greater control, it is at the expense of greater rates as well as higher unemployment taxes and more administrative burdens.
Additional Financial Benefits of Using a PEO
Access to Large-Group Health Plans
Since PEOs have employees from a number of small businesses, they are able to provide corporate-level health, dental as well as vision insurance plans at prices that individual firms cannot make their own deals. This doesn’t just save the company money, but also improves employee satisfaction and retention.
Improved Tax Compliance
PEOs remain current with all state and federal tax laws, assisting your company avoid the risk of compliance, particularly when you have operations in multiple states.
Simplified Year-End Reporting
All W-2s, benefits reports, tax summaries are consolidated by the PEO streamlining year-end reports and financial reports for your CPA.
Potential Drawbacks to Consider
Although PEOs have many advantages, they do not work for all businesses. The potential challenges are:
- Limited autonomy in the selection of insurance carriers
- Service charges that could reduce savings for very little pay-rolls
- Complexity of transition because onboarding involves employees to move within the PEO’s system.
- The risk of a bad reputation because your tax returns are linked to the EIN of your PEO.
It’s crucial to do a Cost-benefit assessment together with your CPA prior to making the switch. A professional audit can assist in determining whether the savings on payroll taxes and insurance exceed the service cost.
Which Option Saves More Overall?
Most of the time, PEOs deliver greater pay tax and insurance savings for smaller and mid-sized enterprises particularly businesses with fewer than 100 employees, or with high SUTA rates. The ability to gain access to benefits for groups, cut down on unemployment tax expenses and avoid mistakes in payroll compliance can bring the potential for both short-term and long-term financial advantages.
For established businesses which have decreased unemployment rates, internal HR expertise, and customized insurance requirements, the conventional model is still viable.
The most important thing is to evaluate the total costs of employment administration that includes more than insurance costs.
Final Thoughts
Making the choice between PEO and traditional insurance isn’t a matter of convenience. It’s an important decision that will affect your financial burdens, tax liability and the risk of compliance.
By understanding the impact of each model on the cost of insurance, payroll taxes and overall financial management, it is possible to make an informed decision that will help your business grow and its stability.
At Parr & Ibarra CPA, we are experts in helping small business owners review their HR and insurance structure to ensure the highest efficiency on taxes. Our experts will analyze the payroll data you provide, SUTA rates, and the cost of benefits to determine which arrangement will save more in the long-run and also keeps you in compliance.
Are you ready to discover the ways you and a PEO can help you reduce the tax burden on your employees?
Contact Parr & Ibarra CPA now to arrange an appointment with our team of tax advisors and consultants.
