Understanding Co-Employment and Its Risks

Co-employment can be a practical and cost-effective solution for smaller businesses struggling with HR operations. However, it doesn’t come without a risk or two. Find out what a co-employment arrangement is and what potential pitfalls to avoid. 

What is a PEO? 

Before we discuss co-employment risks, it’s important to understand what a PEO is and what it does. PEOs — Professional Employer Organizations — are mainly involved in HR compliance and outsourcing, benefit outsourcing, and payroll.

PEOs can also offer additional services. For instance, managing worker compensation insurance, recruiting, consulting, tracking performance, or training. By partnering with an organization like that, a client company can offer better rates on insurance or retirement accounts — something only a larger company is usually able to offer to employees. 

What is a co-employment arrangement? 

A co-employment relationship is basically a partnership between a PEO and a business where they share employer responsibilities for employees. They sign a Client Service Agreement (CSA) to lay out who handles what. 

In this setup, you still choose and manage your employees. The PEO takes care of the boring admin tasks like payroll, employee benefits, and legal compliance. This saves small businesses tons of money and time since they don’t have to deal with paperwork. Instead, you can focus on running and growing your business. 

As a small business owner, your job is to provide a safe workspace, assign tasks, track progress, manage performance, and follow local labor laws. Keep in mind that the exact responsibilities depend on your contract. If you want a better idea of how it works, check out the simplified diagram from Bridgely Key that breaks it down.

Co-employment can give you flexibility and free time to focus on what matters the most. But there are some risks associated with it we need to address (and debunk). 

Co-employment-associated risks 

Some mistakes made on the PEO side might lead to unpleasant consequences for your business — these are mainly tax-related issues. For example, failure to pay taxes such as Social Security and unemployment insurance or improper tax withholding. If any of these things happen, the IRS is coming for you with penalties. 

Another major risk is worker misclassification, particularly misclassifying employees as independent contractors. Here is an IRS brochure that can help you distinguish the two. The distinction should be clear because it affects how much taxes you pay and what benefits you’re eligible for. 

I asked today’s expert, Nate Baber, a Partner and Lawyer at InjuredCT, to share his opinion on the biggest issues with co-employment arrangements. In his experience, a major challenge is getting anyone to admit who is actually calling the shots. He shared that when two entities control supervision, pay, and work conditions but neither wants to be held accountable for wage theft or retaliation, the result is confusion by design. 

I have handled wage cases where a worker's paycheck came from Entity A, the job site was controlled by Entity B, and both pointed fingers when unpaid overtime came into question. The solution was aggressive pretrial subpoenas — bank records, contracts, email chains — that took the guesswork out of it. No policy solves that. Only paper trails do. 

{{Nate Baber}}

These risks and challenges sound super scary, right? Luckily, they are quite simple to avoid. Let’s find out how in the next chapter. 

How to avoid co-employment risks 

First and foremost, make sure the PEO you partner with is certified by the IRS. This will protect your business from liability for incorrect federal employment tax payments. You can find a list of certified PEOs (CPEOs) on the official IRS website. Working with CPEOs comes with benefits. For example, they can pay federal taxes on your behalf and prevent double taxation. 

Secondly, don’t be naughty and classify your workers correctly. Misclassification can lead to massive fines and loss of benefits for workers — invest your time to get it right. 

It’s important to note that while a PEO can provide guidance on worker classification, the client company is ultimately responsible for compliance with federal and state regulations. 

My advice is simple. If you are a business owner and co-employ anyone, write down exactly what your obligations are. Who pays payroll taxes? Who disciplines? Who tracks hours? Spell it out before litigation forces you to backfill that answer with guesswork. If you cannot say in 10 seconds who is responsible for each core employment duty, you are already exposed.

{{Nate Baber}}

A co-employment arrangement won’t cause an issue if you voice and document your expectations from the get go in the CSA. And, it is always a good idea to regularly audit tax filings and records.

How is co-employment different from similar arrangements?

Co-employment is a business arrangement that often gets confused with joint employment, employee leasing, and employer of record (EOR). Let’s see what the major differences are between them:

Wrapping up 

Co-employment can be a smart move for smaller businesses but it’s important to manage it correctly. Stay on track by: 

• Partnering with CPEOs.
• Outlining parties’ tasks and responsibilities clearly.
• Making sure you work in compliance with employment regulations and classifying your workers right. 
• Maintaining a solid paper trail and auditing regularly. 

Stay on top of co-employment management to minimize risks and boost your business growth. Good luck!  

FAQ

What are the advantages of using a PEO?

It saves a client company time and money. If you’re a small business, you probably don’t want to create an entire Human Resources department. Instead, you can outsource it to a PEO and have access to industry experts. On top of that, a partnership like this comes with a range of benefits as we discussed in the article. 

Can a PEO hire global talents? 

Most U.S.-based PEOs are not legally authorized to hire international workers. If you need to hire employees outside the U.S., an Employer of Record should work better for you.

What companies benefit most from co-employment? 

It is small and mid-sized companies that usually enter a co-employment. 

How much does a PEO cost? 

It depends on the services provided. According to Rippling, costs may vary from $500-$1500 a year per employee, which is between 2% to 12% of wages. 

‍What are the best PEO services? 

It depends on your business needs. Forbes did a compilation on the 10 best PEO services last September — you can check out the full list here.

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