In its Action on Decision, the IRS took issue with the TriNet decision on two fronts. First, the IRS objected to the Eleventh Circuit’s legal interpretation. The IRS has maintained a consistent position that section 3401(d)(1) provides only a narrow exception. The IRS considered the Eleventh Circuit’s statement of what is essentially a new test for determining which party has control of the payment of wages in the PEO context as going far beyond the intended narrow reach of the exception and compromising a key principle—that “an employer may not simply delegate or contract away its taxing responsibilities.”
Second, the IRS objected to both the Eleventh Circuit’s analysis and its interpretation of key facts that supported its analysis. An important fact in determining who had control of wage payments for the Eleventh Circuit was that the PEO generally issued payroll payments prior to receiving a payment from the client company: that was considered a strong indicator that the PEO, not the PEO’s client, had control of the payment of wages. The IRS, however, characterized the arrangement as a flow-through transaction for the PEO for which it bore no financial risk and supported that view by noting that the PEO did not include these payments on its SEC financial statements as revenue because of SEC flow-through rules. To the IRS, a delay in one day in receiving a payment from the client company was not sufficient to make the PEO the statutory employer in control of wage payments.
Moreover, the IRS noted that the Eleventh Circuit failed to apply properly its own test. In the TriNet opinion, the Eleventh Circuit explained that approximately seventy-five percent of PEO clients pay via an automated clearing house (ACH). The IRS’s non-acquiescence questioned the logic of applying this interpretation evenly to all PEO clients, as the remaining twenty-five percent of clients use wire transfers or certified checks that, unlike an ACH transfer, have no lag time. At the least, the IRS claimed, the Eleventh Circuit should have differentiated these two scenarios.
In recommending nonacquiescence, the IRS held firm to its interpretation. “The IRS will continue to take the position that an entity is not in control of the payment of wages if the payment of wages is contingent upon, or proximately related to, the entity having received funds from the common law employer.” The practical impact of the IRS’s nonacquiescence is that the IRS will only follow this case in the Eleventh Circuit and only in cases with the same facts.
III. Implications
Perhaps the biggest takeaway from the IRS’s TriNet nonacquiescence is the IRS’s firm insistence on its understanding of the section 3401(d) statutory employer. Going forward, parties should anticipate that the IRS will continue to maintain this position. Interested parties should follow developments in other circuits to see if they adopt the Eleventh Circuit’s looser test or follow the IRS’s interpretation.
It is worth reviewing the reason for the IRS position on who qualifies as the statutory employer. The IRS viewed the TriNet court’s expansion of the section 3401(d) exception as compromising the key principle that “an employer may not simply delegate or contract away its taxing responsibilities.” For support, the IRS noted, among other cases, the decision in the 1995 Garami case that illustrates the nearly inescapable nature of an employer’s taxing responsibilities. In Garami, a cleaning company used the services of a PEO (Sunset Staffing Services, referred to in the case as an employee leasing company) to issue payroll and to withhold and remit employment taxes. The PEO remitted employment taxes under its own EIN without differentiating on which client company’s behalf a payment was made. When the United States filed a claim for unpaid FICA taxes in a bankruptcy case involving the cleaning company’s owner, that owner asserted that it had made the appropriate payments to the PEO. The IRS’s position was that the cleaning company’s owner/debtor remained responsible for the unpaid FICA taxes, unless the PEO could provide specific proof that it had remitted taxes on behalf of the cleaning company’s employees. The court explained that “although [the PEO] contractually agreed to pay the employment taxes of Tidy Maid’s cleaners, such an agreement does not relieve the actual employer, Tidy Maid, of the obligation to pay those taxes.” The district court noted the apparent unfairness to the owner of the cleaning company and suggested that the owner try to obtain proof of payment from the PEO. Still, “until payment is actually made to the government, the responsibility for such payment rests on the shoulders of the [employer].” Given the strong stand that the IRS has taken in such prior case law, it is understandable that the IRS would be resistant to an erosion of the non-delegable nature of this duty in future cases.
Furthermore, it is worth noting that Florida, included in the Eleventh Circuit’s jurisdiction, was the cradle of the PEO industry in the 1970s-80s: today, Florida PEOs process approximately $25 billion per year in payroll. In addition, both Florida and Georgia in the Eleventh Circuit have a high relative PEO presence when controlled for size. The fact that PEOs are highly active in the area means the Eleventh Circuit’s looser test could have a major impact within the industry.
Finally, an important first step for attorneys who counsel businesses that are PEO clients is to determine whether the PEO with whom your client works is an IRS-certified PEO (CPEO). A CPEO is a PEO that has applied for and achieved voluntary certification by the IRS as having met the requirements of section 7705—including requirements related to bonding, background checks, reporting, service contracts with clients, and independent financial review. PEO certification status can be verified at the CPEO public listings on the IRS website. That website includes certified PEOs as well as PEOs whose certification the IRS has suspended or revoked. Because section 3511(c) definitively provides that the CPEO is the employer of its client companies’ work site employees, clients who work with a CPEO can escape the uncertainty discussed here regarding employer status. Clients of a noncertified PEO need to track court discussions of the test for control of the payment of wages, as any changes adopted broadly by appellate courts would dictate whether the PEO qualifies as the statutory employer for employment tax purposes.
While the IRS will follow TriNet within the Eleventh Circuit in cases with the same facts, the IRS has clearly stated its nonacquiescence. It appears likely that the battle of statutory employer interpretations in the PEO context will continue.