The Internal Revenue Service wants employers to understand their options when it comes to choosing payroll service providers.
Employers are responsible for withholding and paying employment taxes and filing required returns. Many employers outsource some or all of their payroll and related tax duties to third parties. These third-party organizations can help employers meet filing deadlines and deposit requirements and greatly streamline business operations.
Employers should know that depending upon what type of third-party they hire, they may or may not remain responsible for the payment of income tax withheld and the employer and employee portions of Social Security, Medicare, and additional Medicare taxes.
Here are some types of third-party providers:
Payroll Service Provider
Reporting Agent
Section 3504 Agent
Professional Employer Organization
Certified Professional Employer Organization
Payroll Service Providers
A payroll service provider (PSP) is a third-party that can help an employer administer payroll and employment tax obligations. An employer may enter into an agreement with a PSP where the employer authorizes the PSP to perform one or more of the following acts on the employer's behalf:
Prepare the paychecks for the employees of the employer.
Prepare Forms 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, and 941, Employer's QUARTERLY Federal Tax Return using the employer's EIN for signature by the employer.
File Forms 940 and 941 using the employer's EIN.
Make federal tax deposits and federal tax payments for the taxes reported on Forms 940 and 941 using the employer's EIN.
Prepare Form W-3, Transmittal of Wage and Tax Statements, and file and furnish Forms W-2, Wage, and Tax Statement, for the employees of the employer using the employer's EIN.
An employer's use of a PSP does not relieve the employer of its employment tax obligations or liability for employment taxes. This type of third-party does not assume any of the employer's employment tax liability.
Reporting Agent
A reporting agent (RA) is a PSP that has informed the IRS of its relationship with its client (via Form 8655, Reporting Agent Authorization, which is signed by the client). An employer may enter into an agreement with a RA where the employer authorizes the RA to perform any or all of the acts that a PSP can perform. Differences between a RA and a PSP include that the RA is generally required to electronically submit any returns it files on behalf of its client and to electronically deposit its client's taxes. In addition, a RA is authorized to exchange information with IRS on behalf of its client, such as to resolve an issue.
As is the case with PSPs, an employer's use of a reporting agency does not relieve it of its employment tax obligations nor its liability for employment taxes. A reporting agent does not assume any of the employer's employment tax liability.
Section 3504 Agents
A Section 3504 agent is a type of third-party payer authorized under Internal Revenue Code Section 3504. An employer may appoint a Section 3504 agent to perform acts such as the withholding, reporting, and paying of federal employment taxes with regard to wages paid by the agent for the employer, as well as the agent's own employees. A significant difference between PSPs or reporting agents and Section 3504 agents is that the latter agrees to assume liability along with the employer for the employer's Social Security, Medicare, and federal income tax withholding responsibilities. An agent appointed under Form 2678 files aggregate returns (e-file or paper) using the agent's EIN. The IRS can seek to collect any unpaid employment taxes from both the employer and the Section 3504 agent who was designated and authorized to pay such taxes.
Professional Employer Organization
A professional employer organization (PEO) is a business entity that will contract with clients to perform some or all of the federal employment tax withholding, reporting, and payment functions related to workers performing services for the client. The PEO charges the client a percentage of payroll or other fees for the services it provides.
A PEO may represent itself to be the employer or co-employer of individuals performing services for clients. However, the rules established in the Internal Revenue Code and applicable regulations determine which party is liable for employment taxes, and the Service is not bound by any agreement between an employer and a third-party.
Certified Professional Employer Organization
A certified professional employer organization (CPEO) is an entity certified by the IRS to perform federal employment tax withholding, reporting, and payment functions related to the wages it pays to workers performing services for its customers. Under a contract between a customer and a CPEO, the CPEO pays wages to the customer's workers and is responsible for the withholding, reporting, and paying of federal employment taxes.
A CPEO uses Form 8973, Certified Professional Employer Organization/Customer Reporting Agreement, to notify the IRS that a contract between a CPEO and a customer has started or ended. A CPEO files aggregate returns using the CPEO's EIN. Generally, the CPEO is solely liable for paying the customers' employment taxes, filing returns, and making deposits and payments for the taxes reported with regard to remuneration it pays to worksite employees. A CPEO and its customer may both be liable for taxes on remuneration the CPEO pays to non-worksite employees.
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