BILL ANALYSIS
Senate Committee on Labor and Industrial Relations
Mark DeSaulnier, Chair
Date of Hearing: June 23, 2010 2009-2010 Regular
Session
Consultant: Gideon L. Baum Fiscal:Yes
Urgency: No
Bill No: AB 2570
Author: Ma
Version: As Amended June 21, 2010
SUBJECT
Unemployment insurance: professional employer organizations.
KEY ISSUE
Should the Legislature allow Professional Employer Organizations
(PEOs) to be the sole employing unit for the purposes of
unemployment insurance laws?
PURPOSE
To create a unique co-employment statutory structure to allow
Professional Employer Organizations to contract with employers
and provide specific employment services.
ANALYSIS
Existing law defines "leasing employers", also known as
Professional Employer Organizations (PEOs), as employing units
that supply workers to perform services for the client, as well
as to perform the following functions:
a) Negotiate with clients or customers for such matters as
time, place, type of work, working conditions, quality, and
price of the services;
b) Determine assignments or reassignments of workers, even
though workers retain the right to refuse specific
assignments;
c) Retain the authority to assign or reassign a worker to
other clients or customers when a worker is determined
unacceptable by a specific client or customer;
d) Assign or reassign the worker to perform services for a
client or customer;
e) Set the rate of pay of the worker, whether or not
through negotiation;
f) Pay the worker from their own account or accounts;
g) Retain the right to hire and terminate workers.
Existing law requires that when questions arise on if a PEO is
an employer or not, those questions must determined under common
law rules applicable in determining the employer-employee
relationship unless the entity performs all of the above
functions. If the PEO does not perform all of the above
functions, the client is the employer .
This bill creates a regulatory structure for Professional
Employer Organizations (PEOs) and removes PEOs from the
traditional framework of employer-employee common law.
Specifically, this bill :
1) Defines a "Professional Employer Organization (PEO)" as
a person or entity that enters into an agreement with one
or more client employers to provide professional employer
services.
2) Defines a "professional employer agreement" (agreement)
as a written contract between a client employer and a PEO
for professional employer services. In the agreement,
except for newly established client employers, hire initial
covered employees from among the employees of the client
employer at the time of the execution of the agreement.
3) Defines "professional employer services" as service
provided by the PEO to the client and covered employee
which may include human resources functions, risk
management services, payroll services, and employee benefit
services, such as sponsoring health benefit plans, workers'
compensation plans, and retirement plans.
4) Requires that, for the purposes of Unemployment
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Insurance Code only , a PEO must be considered the employing
unit for employees covered under an agreement for the
remitting and reporting of tax obligations.
5) Requires that no more than 14 days after the effective
date of a PEO agreement with a client, the PEO must notify
EDD of the name and Employer Identification Number (EIN) of
the client and social security numbers of each covered
employee. EDD must then create a new sub-account under the
PEO's UI account and transfer the existing experience rate
and reserve balance to this sub-account.
6) Requires that, no more than 14 days after the
termination of an agreement with a client, a PEO must
notify EDD of the name and Employer Identification Number
(EIN) of the client and social security numbers of each
covered employee. EDD must then transfer the existing
experience rate and reserve balance to the former client's
sub-account.
7) As of January 1, 2012, EDD must create special
sub-accounts for each PEO's clients Unemployment Insurance
(UI) tax and Employment Training Tax (ETT) payments. The
experience rating for the employees covered under the
agreement will transfer to this new sub-account.
8) As of January 1, 2012, a PEO must remit Disability
Insurance (DI) and Personal Income Tax (PIT) payments for
both the PEO's direct employee and the PEO's indirect or
client-placed employees. The aggregate PIT deposits for
both groups of employees shall be combined.
9) As of January 1, 2012, the PEO is solely liable for
transmitting the appropriate funds to the sub-accounts
until the agreement is terminated by the PEO or the PEO's
registration is terminated by EDD. Upon termination of an
agreement, the PEO must provide a notice to EDD of the
effective date the PEO is canceling the agreement with the
client.
10) Requires that for a PEO to be registered, the PEO must
annually send information required by EDD to administer the
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Senate Committee on Labor and Industrial Relations
act. This includes a $2,000 annual assessment and evidence
of a surety bond, irrevocable letter of credit, certificate
of deposit, or other security in an amount equivalent to:
i) 25% of unemployment insurance and disability
insurance tax contributions for which the PEO was
liable the previous calendar year if the PEO has more
than 2,500 covered employees;
ii) 20% of unemployment insurance and disability
insurance tax contributions for which the PEO was
liable the previous calendar year if the PEO has fewer
than 2,500 covered employees and more than 1,500
covered employees;
iii) 15% of unemployment insurance and disability
insurance tax contributions for which the PEO was
liable the previous calendar year if the PEO has fewer
than 1,500 covered employees;
iv) For a newly registered PEO, $100,000 or an
estimate of 25% of the unemployment insurance and
disability insurance tax contributions the PEO
estimates it will be liable for in California,
whichever is greater;
11) Provides that, on or after June 1, 2012, any PEO
operating without a registration shall result in a civil
penalty of $100 per day, not to exceed $10,000.
12) Provides that, if a PEO fails to remit any of the taxes
due with respect to the wages of covered employees, EDD may
begin an enforcement action against the PEO. If the PEO
fails to appeal the reassessment or pay the amount
assessed, EDD may treat all client companies as separate
entities. The clients will be liable for all unpaid tax
liability .
13) Provides that EDD may promulgate all rules and
regulations necessary for the administration of this
section, including provisions for the revocation of the
registration of a PEO provided that the regulations allow a
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PEO to cure noncompliance within 30 days of notice from
EDD .
COMMENTS
1. What are Professional Employer Organizations?:
The concept of the leasing employer, or Professional Employer
Organization (PEO), first developed in the 1970s. As
originally developed, the PEO business model involved a client
terminating its entire workforce, a leasing company employing
that workforce, and then the leasing company providing that
same workforce back to the client as leased employees. With
AB 2570, the PEOs would establish a 'co-employer' relationship
with the client (formerly the sole employer) for the purposes
of tax payments, which is currently prohibited under current
law. This would allow PEOs to sell insurance packages to
California's employers.
The idea behind the PEO model is that the client is freed from
the day-today responsibilities of running a business, while
the PEO is able to provide services to the client and the
covered employee through economies of scale. Unlike
traditional temporary service employers, the use of a PEO and
covered employees was not temporary or seasonal, but rather
the PEO would be a permanent third party in the operation of
the business.
This model has historically been problematic. As the 2002
National Association of Insurance Administrators (NAIA) -
International Association of Industrial Accident Boards and
Commissions (IAIABC) report stated:
There are many reasons for entering into employment
services outsourcing agreements. Many businesses become
employment services outsourcing clients because they find
it to be an efficient way to obtain high quality
administrative services?. However, other employment
services outsourcing arrangements have been motivated by
factors ranging from exploitation of loopholes in rating
rules to outright fraud.
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According to the Employment Development Department (EDD),
there are currently 1,200 to 1,800 PEOs operating in
California.
2. How Does California Currently Define the Employer-Employee
Relationship?
Generally, California utilizes a common law definition for
enforcement issues surrounding employer-employee
relationships, which defines someone as an employer if he or
she can control what will be done and how it will be done.
This includes wages, hours, and working conditions. The
individual who is under the employer's control is the
employee. While for the purposes of leasing employer
enforcement common law was explicitly applied in 1986, the use
of common law in employment in American goes back to the
colonial era. Both federally and in California, the common
law employer-employee relationship is the norm.
In creating a co-employer relationship outside of common law,
the Committee may wish to consider some of the challenges
enforcement staff may face. In the event of a work injury,
who is the employer of record? In the event of wage disputes,
are both co-employers liable? If there is an error in the
processing or payment of employment taxes, who is liable?
3. Clarification on Cost of Implementation:
While fiscal concerns are traditionally outside the purview of
this Committee, a discrepancy between Assembly analyses on the
costs of the implementation of the measure requires
clarification. In the Assembly Appropriations analysis on a
prior version of the bill, the costs were estimated at "in
excess of $200,000" without further explanation. In a later
Assembly floor analysis on the same version of the bill, the
costs were estimated at a one-time cost of $6.7 million and
annual on-going costs of $4.5 million for the manual
processing.
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The Committee requested the Employment Development Department
(EDD) to clarify its cost estimates, and the Department
reiterated the Assembly floor analysis estimates.
Specifically, EDD estimates 1,400 PEOs registering statewide,
averaging 19 clients. However, the reporting assumptions for
this cost estimate do not reflect the current version's
requirements, which may increase costs further.
Unlike other states, California collects payroll taxes and
Disability Insurance taxes along with Unemployment Insurance
taxes. EDD then bills the appropriate fund based on ratio of
funds collected. As such, about a third of all costs are
currently billed to the General Fund for the collection of
Personal Income Taxes (PIT). Assuming the EDD's cost
estimates are correct, at least a third of the funds must come
from the General Fund, resulting in an on-going annual cost of
at least $1.44 million .
These high costs are the product of the need for manually
processing the UI-ETT Sub-accounts, as the upcoming Automated
Collection and Enhancement System (ACES) is currently not
equipped to handle sub-account reporting. As the funding of
the ACES system is dependent on increased collections through
the automation of existing collections system, it is an
unknown and key question as to if the addition of PEO
sub-accounting would be something a vendor would be able to
address at a later date.
4. Workers' Compensation Plans and "Sponsorship":
Currently, under the list of services a Professional Employer
Organization (PEO), the "sponsorship" of health benefit plans,
workers' compensation plans, cafeteria plans, and retirement
plans. However, this bill does not define what "sponsorship"
entails. For the purposes of workers' compensation, does
"sponsorship" entail self-insuring? If so, with the diverse
groups of employees under agreement, would a PEO need to take
on the responsibilities of an insurance company? As written,
this bill is silent on this issue. The Committee may wish to
consider if clarification is appropriate.
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Senate Committee on Labor and Industrial Relations
On a related note, AB 2570 requires that the sponsorship of
the workers' compensation plans should occur as laid out in
the California Workers' Compensation Rating Plan (WCRP),
Section 5, Rule 4. That rule carefully defines under what
circumstances a policy can be purchased for leasing employers,
as well as who can be covered by those plans. The Rule 4 was
a product of careful deliberation and discussion by the
Department of Insurance (DOI) and stakeholders, and provides
detailed and clear guidance. Therefore, the committee and the
author may wish to continue the requirement of workers'
compensation plans being bound to WCRP Section 5, Rule 4 if
the sponsorship language is clarified.
5. The Challenge of PEO Fraud:
As was mentioned earlier in the analysis, historically PEOs
have been utilized by unscrupulous actors for significant
fraud. In a 2005 New York Times article by Ellen Rosen titled
"The Perils of Hiring Out", the author detailed several people
were victimized by tax fraud. One individual detailed in the
story, Dan McCoy, was defrauded by what was then the fourth
largest PEO in the country. After that experience, he signed
up with another PEO, and was promptly defrauded again.
Currently, by not allowing a co-employer relationship in
California, small businesses are protected. Payroll companies
or accountants can be hired; third party experts can be sought
out. But because none of these individuals form the
co-employer relationship, the small businesses in California
face cannot face the circumstance Mr. McCoy faced of a PEO
disappearing in thin air and facing a multi-million dollar tax
bill for what he thought was paid employment taxes.
As currently written, AB 2570 creates a path for a PEO to
register with the EDD and consummate a co-employer
relationship with the client. But the bill does not currently
contain protections from, or additional penalties for, tax
fraud. Beyond the hurdle of establishing a bond, this bill
would allow virtually anyone to form a PEO. This potential
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Senate Committee on Labor and Industrial Relations
for fraud is particularly distressing in light of the
insolvency of California's Unemployment Insurance Fund. The
committee may wish to consider if allowing for the creation of
a co-employer relationship and its theoretical benefits
out-weigh the serious and significant impact of potential
fraud.
6. Committee Amendments:
Proposed Unemployment Insurance Code 606.6, part (b)(6) in AB
2570 addresses the "professional employer agreement" between a
client and a PEO. In order to clarify which employees are
being covered by the agreement, as well as limit the potential
for abuse, the committee may wish to include the word
"exclusively" after the word "complement" on page 3, line 23.
The Committee may also wish to check some of the potential
issues with the unemployment insurance remittance by ensuring
the employer is still responsible for the remittance of
unemployment insurance taxes by striking out "Upon the
effective date of the" on line 21 and lines 22 and 23 and
insert "Upon the effective date of the professional employer
agreement, the PEO and the client-employer shall be jointly
and severally liable for reporting and remitting taxes to the
PEO UI-EIT". Similarly, the Committee may wish to strike "an"
on page 2, line 4, and insert "a co-" after "be" on the same
line, as well as insert "Under a professional services
agreement, the PEO and client shall be jointly and severally
liable for reporting and remitting taxes under this part and
all related provisions."
7. Proponent Arguments :
The National Association of Professional Employer
Organizations (NAPEO) believes that AB 2570 provides a clear
and transparent guideline for the PEO industry in terms of
registration and employment tax compliance. NAPEO argues that
PEOs enable clients to cost-effectively outsource the
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Senate Committee on Labor and Industrial Relations
management of human resources, employee benefits, payroll, and
workers' compensation. By creating a specific statutory basis
for Professional Employer Organizations, NAPEO believes that
the state and small businesses that engage PEOs will benefit
from the clear responsibilities and certainty for various tax
reporting obligations.
8. Opponent Arguments :
None on file.
9. Prior Legislation :
AB 1560 (Committee on Labor and Employment) from last year
provided that an entity providing or advertising professional
employer services be registered with EDD. The bill was moved
forward as a vehicle for discussion but was held in the
Assembly Appropriations Committee.
AB 2975 (Keene) from 2008 stated the intent of the Legislature
that professional employer organizations (PEOs) be regulated
with respect to unemployment insurance obligations, as
specified. The bill was moved forward as a vehicle for
discussion but was held in the Assembly Appropriations
Committee.
AB 2891 (Frommer) from 2004 stated the intent of the
Legislature that professional employer organizations (PEOs) be
properly recognized and regulated. The bill was moved forward
as a vehicle for discussions to take place with
representatives of organized labor and the Department of
Industrial Relations, but these provisions were subsequently
amended out of the bill.
SUPPORT
Administaff, Inc.
ADP TotalSource
National Association of Professional Employer Organizations
Hearing Date: June 23, 2010 AB 2570
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Senate Committee on Labor and Industrial Relations
(NAPEO)
Trinet Group, Inc.
OPPOSITION
None on file.
* * *
Hearing Date: June 23, 2010 AB 2570
Consultant: Gideon L. Baum Page 11
Senate Committee on Labor and Industrial Relations