As construction backlogs continue stacking up while the labor pool tightens, some contractors are looking to "employee leasing" options to meet their staffing needs.

The practice of employee leasing, which is conducted through professional employer organizations, can offer several perks to companies, such as reducing the risk and the burden of administrative responsibilities relating to payroll and insurance. Before considering this option, though, it’s imperative to understand where the line is drawn between PEO and contractor.

PEO 101

But first, what is a professional employee leasing organization? When small- and medium-sized businesses want to outsource human resources burdens involving payroll, benefits, tax administration and regulatory compliance, many turn to PEOs, which offer the full gamut of HR solutions, according to the National Association of Professional Employer Organizations.

Simply put, a PEO is "all about outsourcing employment-related work that doesn't make money and takes time away from things that do," said Mike Burgelin, president at national PEO called Employee Leasing Quotes. "That can include administrative work like payroll, tax reporting, workers' compensation audits, compliance issues and unemployment claims, to name a few. The PEO model streamlines these services to one point of contact, thereby reducing paperwork, costs and most importantly, time." PEOs are designed to partner with their clients on a more one-on-one, full-time basis, as opposed to a staffing agency, which is more commonly used when temporary labor is needed, said Burgelin.

Many companies, and contractors in particular, are becoming more comfortable with contracting third parties to handle responsibilities that are outside of their core business and are realizing the benefits of working with PEOs. NAPEO’s research shows that small businesses that work with PEOs grow 7% to 9% faster, have lower employee turnover and are 50% less likely to go out of business.

As such, the trend is inching toward a tipping point. As more small businesses start to use PEOs, the corresponding awareness of the companies grows, enabling even further growth. In recent years, the PEO industry has grown by up to 15% a year. "The biggest impediment to growth is awareness," said Pat Cleary, NAPEO's CEO. "At some point that awareness becomes exponential." 

Construction and trades are among the most prominent industries that use PEOs, Burgelin said, largely because workers' compensation insurance can be the most expensive part of doing business. “A PEO's master workers' comp policy can allow for immediate discounts on insurance rates, even for those who have had claims issues," he said. "Plus, because the PEO is managing payroll, a direct audit is created each pay period, saving the employer time compared to traditional policy audits."

On average, a PEO's administrative costs range from 2% to 4% of its annual payroll, but pricing varies based on the specific contract.

PEO selection

Once a contractor determines whether using a PEO is a viable option, it then must evaluate the PEOs based on its services. Clients also seek PEOs that do business in their professional space and understand the industry.

Attorney Quinlan S. Tom, co-chair of the Wendel Rosen Construction Practice Group in Oakland, California, said a proven track record of reliability is the biggest factor when selecting a reputable PEO. His colleague, Margaret J. Grover, partner in Wendel Rosen's Employment Practice Group, agrees. " A lot of PEOs are focused on one industry or another. You want somebody that's in your industry and understands what skills you need, what kind of experience you’re looking for and that has those people in their stable of workers.

"The other thing to look at is what kind of contract they're willing to provide," she continued. "Contracts between general contractors and PEOs can vary dramatically. Some of them will say, for example, that any mistake in payroll is the GC's problem. The PEO will issue the paycheck, but the GC is liable if the hours aren't recorded correctly. Other PEOs will say that if the GC gives them the hours, they'll figure out what overtime is owed and any other premiums per the contract." 

Grover also recommends contractors ask a potential PEO about how it handles legal documentation. "One of the risks becoming more apparent is whether your workers are properly qualified to work in the U.S.," she said. "One question I'd ask the PEO is what screening they're doing in terms of the I-9 form and supporting documentation."

Attorney Jennifer Monrose Moore, co-chair of the staffing/PEO Group of Ogletree, Deakins, Nash, Smoak & Stewart, P.C. in Tampa, Florida, recommends finding out whether the PEO is well-funded and could handle a catastrophic incident.

"If I was a [contractor] and I had a death on the job, I'd want to make sure the PEO wasn't a mom-and-pop [operation] with a small workers' comp coverage," she said. "The last thing you'd want is to have an issue as to who was responsible from an under-coverage situation." But, she added, most national and regional PEOs ensure they comply with individual state laws.

Moore also recommends the client have a detailed conversation with the PEO about issues such as ensuring necessary inspections are complete and determining who is responsible for workplace safety and who will take financial responsibility if a claim arises. "You’re really talking about how you want your relationship to be with the PEO [and] what services are part of it and creating a contract based on how you want that relationship to look and play out. But the most important thing is to look at where you are from a geographic standpoint in terms of what the law requires."

NAPEO's website also provides 10 guidelines for selecting a PEO, including determining HR and risk management needs, procuring professional references and understanding how employee benefits are tailored.

State, federal regulation

Contractors also need to consider a PEO's legitimacy and its regulatory compliance, even though the lines aren't as clear-cut in that regard, Clearly continued. The IRS recognized PEOs in the internal tax code in section 3511 in early 2015, which he said was a "huge watershed moment" for the industry. Other federal regulation is scarce, though. Rather, it's up to individual states to propose and enforce legislation around PEOs, and Cleary said 42 states have some form of licensing or recognition statutes.

"Regulation protects clients and the PEOs in that they have requirements in place for a PEO to operate," he said. "It also gives a certain level of legitimacy and certainty with the PEOs you’re dealing with."

Moore added the most important thing is look at the statute for the state you are doing business in. "Some [statutes] are very lean, dealing simply with how it factors into a workers’ comp or unemployment compensation situation, whereas some are more hardy statutes that deal with specific requirements the PEO and client need to take on to ensure that relationship falls within a particular state’s purview and regulation."

Determination of which parties are responsible for associated taxes also varies by state. Moore said though some states require the client to pay state unemployment taxes directly to the state, others allow the PEO to take on that responsibility. "Most nationwide PEOs I deal with have addendums and amendments in their client services agreement to talk about those particular state-specific issues."

In some states, PEOs are provided immunity in personal injury cases based on a leased employee’s conduct. In Florida, for example, a PEO "is not going to be held liable for the actions of a leased employee against a third party in a personal injury lawsuit," Moore said, in scenarios in which it's not acting as a joint employer.

California has statutes that protect a worker whether that person is an employee or not, said Tom. He also referenced a statute the state made effective Jan. 1 that makes the general contractor liable for unpaid wages for all workers on a project whether they’re an employee or not. Another California-specific statute mandates that an employer who hires through an agency will be liable for workers’ compensation if the agency is not providing it, said Grover.

Moore sums it up as, "Each state has a different way of looking at PEOs."

Finding, leasing workers

Could a construction company that wants to use a PEO find a good candidate and then ask the PEO to hire that individual? Attorney Tom references a case in which his contractor client asked an unrelated company to put a worker on its payroll to cover union dues and workers' compensation premiums. The worker was hurt on the job and alleged the general contractor was his employer and, therefore, liable for his injuries, in addition to the other company, where his paycheck came from.

"Even though we were paying the second company for putting him on its payroll ... we were found to be an employer for workers' comp purposes and liable for all of the work injuries," he said. "It was a very unfortunate and expensive lesson."

The PEO is responsible for finding and hiring employees, then leasing those employees to clients. Grover and Tom caution against a construction company finding a worker and then asking the PEO to hire him. "Once you do that," said Tom, "it's going to be easily found to be a sham."

It's one thing for a company to suggest a potential employee apply to a PEO, Grover said, but if that company is advertising positions then sends applicants to the PEO, it would "cross the line. I don't think it's actually as clear in either direction as it could be."

Joint employment challenges

If a worker is injured on the job and files a claim, the issue of joint employment could come up and essentially come down to who he is receiving his work instructions from. In PEO arrangements, Grover said, the worker often gets instructions from the general contractor although wages come from the PEO. In that case, "both of them are on the hook as employers because the wage payer is the technical employer, but the day-to-day control comes from the general contractor," she explained.

Moore added that, "The issue of whether a PEO becomes a joint employer with a client in a subsequent claim by an employee is going to be somewhat federally regulated because that’s where a lot of the case law comes from — from the joint employment test the IRS created, as well as the National Labor Relations Board.

"The more one has control over the employee, the more likely they will be found to be a joint employer," she continued. "The client is always going to be deemed the employer. The question is whether or not the PEO will be deemed a joint employer in a given context."

Human resources, for example, is one function that is looked at as to whether or not a PEO would share a joint employment liability or could be argued as such in a lawsuit, Moore said.

Defining the burden

Joint employment is a hot issue in Congress as some representatives continue to push for legislation that would define and clarify much of the gray area around the topic.

Grover thinks the use of PEOs will continue, and general contractors need to thoroughly review contracts to make sure that "if they think they're shifting the burden to the PEO then the contract allows them to do that."  "Whatever burden they think — whether it is properly classifying the employee, properly calculating wages, or making sure they have workers’ comp — all of that needs to be in the engagement between the two organizations," she said.