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The IRS Action on Decision in TriNet: An Updated View on the Test for the Statutory Employer

Katherine Sanford Goodner and Ursula Lynn Ramsey


  • The provision of employment tax services by PEOs inevitably has led to interpretation disputes between PEOs and the IRS.
  • In June 2021, the IRS issued an Action on Decision in which it noted its nonacquiescence in the TriNet case.
  • The central issue in the IRS’s Action on Decision in TriNet is whether the PEO qualifies as the section 3401(d)(1) statutory employer.
The IRS Action on Decision in TriNet: An Updated View on the Test for the Statutory Employer
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In the United States today, there are 487 professional employer organizations (PEOs) that provide human resources, payroll, and employment tax services to approximately 173,000 small and mid-sized businesses employing nearly four million worksite employees. PEOs are attractive to small and mid-sized businesses, in part, because a PEO-client relationship allows each party to focus on its area of expertise: business owners focus on running their businesses, while PEOs handle the administrative side of things. In addition to the time gained by outsourcing the administrative burdens of payroll processing, human resources administration, and employment tax compliance, PEOs tout cost savings on benefits, workers’ compensation, and unemployment insurance as an additional benefit of PEO use. Beyond that, the typical PEO client also gains access to employee benefits that may have been unavailable otherwise based on the client’s size. Offering better benefits, in turn, helps PEOs’ client companies attract and retain talent, something that is especially important in today’s business environment.

The provision of employment tax services by PEOs inevitably has led to interpretation disputes between PEOs and the IRS. One question that continually arises is whether the PEO or the client company is the employer of the client company’s employees for federal employment tax purposes. Recently, courts in the Eleventh Circuit, including the Eleventh Circuit appellate court itself, have faced this issue. In November 2020, the Eleventh Circuit issued its opinion in TriNet Group, in which it established a new test for determining whether the PEO or the PEO’s client had control over the payment of wages and, consequently, qualified as the statutory employer under section 3401(d)(1). In June 2021, the IRS issued an Action on Decision in which it noted its nonacquiescence in the TriNet case. This article provides an update on the status of the current test for the statutory employer in the PEO context after the IRS’s issuance of that Action on Decision. It also discusses implications of which attorneys should be aware when advising clients who work with PEOs.

I. The Statutory Employer Under Section 3401(d)(1): A Brief Overview

Because the central issue in the IRS’s Action on Decision in TriNet is whether the PEO qualifies as the section 3401(d)(1) statutory employer, it is helpful to review those requirements. Responsibility for withholding and paying employment taxes rests with the employer, rendering the determination of the employer of considerable importance. Typically, determining the employer involves identifying the common-law employer by assessing that employer’s right to control the employee (the right to control both the methods and the results of their work). Section 3401(d)(1) provides an exception to this rule, as follows: “if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services, the term ‘employer’ … means the person having control of the payment of such wage.” The regulations caution, however, that this definition of a statutory employer “is designed solely to meet special or unusual situations. [The definition is] not intended as a departure from the basic purpose.”

Whether a PEO satisfies this special definition of statutory employer is a point of tension between PEOs and the IRS. Using the right-to-control test, the typical PEO client clearly would qualify as the common-law employer of the client company’s employees because the PEO client maintains control over their day-to-day work. Nonetheless, an avenue for the PEO to qualify as the employer would be for the PEO to qualify under the exception for having legal control of the payment of wages based on the payroll and employment tax services it provides. Whether the statutory employer exception applies thus depends on what it means to control the payment of wages. On this point, the IRS and PEOs disagree.

II. The IRS’s Action on Decision in TriNet

In the TriNet decision, a PEO called Gevity and its client companies entered into contracts that specified that Gevity, on behalf of each client company, would issue paychecks, process payroll, and file employment taxes. To that end, Gevity filed Forms 941 on behalf of client company employees using its own name and Employer Identification Number and without identifying itself as a PEO. Because Gevity had clients in the food and beverage industry whose employees earned tips, Gevity claimed FICA tip credits under section 45B. From 2004 to 2009, Gevity claimed these FICA tip credits on a fairly large scale on behalf of “274 to 477 client companies per year, totaling more than 1,170 clients over the period at issue.” Having determined that Gevity was not the employer of these client company employees, the IRS found that Gevity was not eligible for the credits and issued notices of deficiency covering those years. As successor-in interest to Gevity, TriNet paid more than $10.5 million, was subsequently denied a refund, and filed suit. Both parties moved for summary judgment, which the district court granted in favor of TriNet as the statutory employer under section 3401(d). The IRS appealed that decision to the Eleventh Circuit.

The central issue in TriNet was, of course, whether the PEO was the section 3401(d)(1) statutory employer. The Eleventh Circuit held it was because it controlled the payment of wages and that it was therefore entitled to claim the tax credits. The Eleventh Circuit noted at the outset that either the employer is the common-law employer or the employer is the statutory employer. If the common-law employer does not control the payment of wages, then the statutory employer is deemed the employer and becomes responsible for employment taxes. To determine who has control over the payment of wages, the Eleventh Circuit found illustrative the contract in place between the parties, explaining that determining control meant determining “who is actually responsible for the payment of wages, as informed by the parties’ understandings of their arrangement.” As is highlighted in the Action on Decision, “[t]he Eleventh Circuit looked to both the language in the PSAs and how the relationship between the parties functioned, ‘most importantly the fact that Gevity generally issued wage payments before receiving cleared payment from its clients.’”

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.