Employee Outsourcing Firms Get Tax Break

A politically connected group of businesses will soon be getting a tax break, but all the other employers in Texas will have to pay for it through slightly higher unemployment insurance tax rates. This story is part of our 31 Days, 31 Ways series.

 Ken Teegardin

Throughout August, The Texas Tribune will feature 31 ways Texans' lives will change because of new laws that take effect Sept. 1. Check out our story calendar for more.

A politically connected group of businesses will soon be getting a tax break, but all other Texas employers will have to pay for it through slightly higher unemployment insurance tax rates.

Thanks to a bill pushed by the fast-growing employee outsourcing services industry — recently signed into law by Gov. Greg Abbott — companies can get a new break on their state unemployment taxes through a partnership with so-called professional employer organizations, or PEOs.

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The measure, House Bill 3150, takes effect Sept. 1, and businesses can apply under the new rules starting in January.

The legislation, which provides tax-lowering credits to outsourcing companies, makes it more attractive for businesses in Texas to change their structure and outsource human resources operations to a PEO. There are about 150 such companies licensed by the state. Proponents said that under current law, companies using PEOs were being penalized by not getting credit for taxes already paid.

The law will cost the Unemployment Compensation Fund $84 million, state figures show. The Texas Workforce Commission has estimated that bill would force unemployment tax rates up by 0.01 percent, which amounts to about $1 per Texas employee over five years. The rates have to increase to make up for the negative hit to the fund. 

The commission is spreading word about the change by providing information to the National Association of Professional Employer Organizations, the trade group that represents the industry and helped push the bill through the Legislature. Part of the change requires a new filing system for wage reporting.

“Because employer [unemployment insurance] tax rates are calculated as of Oct. 1 each year and announced in December, there will not be any immediate change on Sept. 1, 2015,” workforce commission spokeswoman Lisa Givens said. “Any changes resulting from this legislation would not be seen until [the] 2016 [unemployment insurance] tax rate year.”

The one-page bill allows PEOs to claim credit for unemployment taxes already paid by a company that hires a PEO to perform outsourcing services.

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When a company hires a PEO, it generally enters into a co-employment agreement and transfers its employees to the firm, which then processes payroll and handles health benefits, retirement plans and the like. In state and federal tax records, the PEO becomes the employer of record, and it’s the PEO’s name on employees’ paychecks instead of the “client company.”

As part of that arrangement, the PEO also becomes responsible for the client’s unemployment taxes, which support the Unemployment Compensation Fund, a trust fund that pays out unemployment compensation to employees who lose their jobs.

The new law will allow a PEO to get credit for any taxes already paid on behalf of the employee by the client company. Under current law, employers pay unemployment taxes on the first $9,000 of an employee’s wages, but the clock is restarted when they enter a co-employment relationship with a PEO. So if the business marriage happens mid-year, the PEO has to start paying unemployment taxes for employees again as if they were new hires, up to $9,000 of wages.

Typically, PEOs already save client companies on their unemployment taxes because the law allows them to use the PEO’s unemployment tax rate. And that rate is typically lower because the PEO doesn’t have to absorb the past unemployment history of the companies to which it provides outsourcing services. They get to wipe the slate clean.

Critics of HB 3150 say the law will allow PEOs to take a second tax break. It also provides an incentive to stay with the PEO — something detractors call a “golden handcuffs” deal — because the tax break doesn’t work in reverse: if the client company leaves the PEO, it doesn’t get credit for unemployment taxes already paid by the PEO.

But backers of the idea say it recognizes the unique relationship between a company and its outsourcing partner, and will end what they describe as a “double taxation” for companies that join up with a PEO to save money and headaches on human resources operations.

The bill was heavily promoted and pushed by the National Association of Professional Employer Organizations and Kingwood-based Insperity, a large and prominent PEO firm in Texas, both of which hired several lobbyists to push the bill through the Legislature.

Paul Sarvadi, the founder of Insperity (previously known as Administaff), sits on Lt. Gov. Dan Patrick’s citizen advisory council and he and other executives at his company have contributed more than $80,000 combined to the Republican leader since 2013, records show.

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Abbott’s office did not comment on the bill after he signed it, but a spokesman for Patrick, who at one point intervened to get the bill moving at the committee level, said he supported it because it made sense and would prevent companies from paying unemployment taxes twice for one employee.