What Is a PEO? Definition & How It Works

Human Resources
Article
6 min. Read
Last Updated: 03/04/2024

A business owner works with a PEO to outsource HR administrative tasks

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What is a PEO? Use this guide to learn about what a PEO is, how PEOs work, why companies may use them, and the different types of PEOs.

As a business owner, you may think that comprehensive HR solutions and impressive benefits packages seem beyond your grasp, mainly when other areas of the business require your time and attention. That's why it's essential to understand what a professional employer organization (PEO) can offer your business and the potential benefits you can expect when you outsource HR administrative tasks.

What Is a PEO and What Does It Stand For?

Businesses looking for HR help can outsource certain HR administrative tasks like payroll, benefits, workers' compensation, and employee training to a PEO to help save time and money. You can also gain guidance to help maintain your compliance with federal and state employment laws and other specialized and support for time-consuming tasks such as 401(k) plan administration and health, dental and life insurance so you and your management team can stay focused on the business and your customers.

A chart showing what services are included in a PEO

Are There Different Types of PEOs?

PEOs do not supply labor to worksites or other staffing services, nor do they take over the hiring and management of your employees. There is only one type of PEO: the organization provides HR and employee relations support services for a business's existing workforce. In short, PEOs offer outsourced HR services.

Read more about the HR services offered by PEOs.

How Does a PEO Work?

The client company signs a service agreement with the PEO, which generally includes the following:

The PEO performs certain HR administrative services while the client remains the worksite employer. The PEO can provide support to a client's in-house HR staff and teams.
The client company is responsible for hiring and managing their employees and handling non-employee-related business operations (e.g., sales, marketing, customer service).
The PEO is responsible for processing employee wages, benefits, and withholdings and for remitting and reporting taxes to any applicable state and federal authorities for the duration of the service agreement.
The PEO helps the client company maintain compliance by keeping track of complex employment laws and offering risk management strategies. This may include payroll tax laws and reporting requirements, workers' compensation, and employee relations issues.
An HR professional may work with the client company to help the organization proactively address critical areas of risk, helping ease concerns around employee relations and accommodations, terminations, and other employee-workplace issues.
Specific tasks, such as developing an employee handbook, may be shared between the client company and the PEO as outlined in the service agreement.
PEOs can assist with many HR functions, allowing businesses and internal HR teams to focus on company culture, client satisfaction, and employee engagement.
The client company obtains access to the PEO's pool of benefits options and support for administering them.

What Doesn't a PEO Do?

In contrast to leasing or staffing companies, which typically supply new workers on a temporary or project-specific basis, a PEO takes a different approach. A PEO doesn't engage in such practices, where temporary staffing services generally recruit and hire employees for short-term assignments like during employee absences, temporary skill shortages, or seasonal workloads. PEOs do not supply labor to worksites. PEOs provide services and benefits to both the worksite employer and the client’s employees.

PEOs, also known as a professional employment or employer organizations, are sometimes mistaken for other outsourcing service organizations that include similar or related services, such as:

Staff leasing company
Employee leasing company
Managed payroll
Human resources outsourcing organization (HRO)
Administrative services organization (ASO)

PEOs are not responsible for controlling your business or your employees; they provide access to HR advice and guidance to lean on when you need assistance. PEOs will also not replace your internal HR staff if you already have resources in place. A PEO can provide specialized and supplementary HR guidance from a team of subject matter experts for regulatory compliance, safety, benefits, risk management, and other HR and employee-related topics.

Why Do Companies Use a PEO?

While it may be challenging to trust certain aspects of your business operations to an external organization, business owners across the country are realizing the benefits of a PEO. So why use a PEO? For time- and energy-strapped employers, working with a PEO can free up a considerable amount of company resources that would otherwise be spent on administering payroll and other required, time-consuming tasks.

Paychex client and HR business partner Jillienne Allgäuer, SPHR, SHRM-SCP, outlines some of the most critical PEO benefits for business owners: "A PEO can offer support with administrative services spanning the entire employment life cycle. From assisting with recruiting and hiring, employee handbook development, cultivating an attractive benefits package, and ongoing management training, to consulting on employee coaching and dismissal processes and handling unemployment claims, a PEO can provide businesses both substantial administrative relief and valuable resources."

Businesses can expect many valuable PEO advantages, including:

Time savings: Clients may find that having the PEO absorb most of the time commitment associated with general HR tasks allows them to focus on other core business operations.
Cost savings: A PEO's buying power regarding workers' compensation and health insurance is generally greater, which helps to make these purchases more affordable than what's available to small businesses.
Peace of mind: Business owners may feel at ease knowing they are not alone at any point throughout the employment life cycle.
Better benefit offerings for employees: Companies looking to offer competitive benefits packages gain access to Fortune 500-level benefits and professional administrative services.
Improved tracking and administrative functions: The PEO typically conducts an in-depth HR assessment to help minimize risk and maximize growth and development opportunities.
Business growth: According to the National Associated of Professional Employer Organizations (NAPEO,) "Businesses in a PEO arrangement grow 7-9 percent faster, have 10-14 percent lower turnover, and are 50 percent less likely to go out of business."
Help with recruiting and retention: Recruiting, engaging, and retaining staff can be time-consuming and expensive. A PEO can help you maximize the investment in your people by assisting in the recruiting and hiring process, helping communicate policies via an employee handbook, providing training programs, and offering guidance throughout the employee life cycle.
Employment-related compliance help: Having support and guidance from a PEO can assist business owners with their compliance efforts as they navigate increasingly complex regulations and demanding business processes.

What Types of Companies Use and Benefit From PEOs?

Any business can find value in a PEO relationship. According to Paychex research, 59 percent of organizations with 5 to 500 employees currently use a PEO, and 16 percent have used a PEO in the past but are not currently working with one.¹ The PEO industry’s 173,000 clients represent 15.3 percent of all employers with 10 to 99 employees.²

Increasingly larger businesses are also finding benefits with a PEO arrangement because PEOs offer robust web-based HR technologies and expertise in HR management. PEOs can work with companies with large employers in conjunction with their existing HR department.

PEO clients include different types of businesses ranging from various industries, including professional services firms, skilled trades companies and high-tech organizations.

Differences Between PEO and Other Services

A PEO is one type of HR outsourcing. Other options are available, which can also help you manage your business more effectively. When evaluating your options or familiarizing yourself with PEO terminology, knowing the differences between a PEO vs. HR software and PEO vs. payroll companies is essential.

PEO vs. HR Software

A PEO differs significantly from solely leveraging HR technology. A PEO allows your company to outsource HR functions such as payroll, benefits, employee training, and access guidance to comply with federal and state employment laws. Software only provides a platform for you to manage these activities on your own.

PEO vs. Payroll Company

When it comes to payroll, PEOs and payroll services companies both aim to streamline the process, but there are significant differences in how the process is executed. Depending on your provider, outsourcing to a payroll company means you receive assistance running payroll and help calculating, preparing, and remitting payroll taxes and returns to government agencies. However, the business is ultimately responsible for meeting its payroll and tax obligations, even using a third party. A PEO offers a more comprehensive solution. The PEO generally assumes responsibility for processing employee wages under the terms of the service agreement, as well as benefits, and withholdings and remitting and reporting taxes to any applicable state and federal authorities on behalf of the client company. Additionally, PEOs go beyond payroll and offer support in other areas such as regulatory compliance, workplace safety, workers' compensation, and HR administration.

How To Choose a PEO

Although PEOs offer multiple cost- and time-saving strategies, working with a PEO may not suit every business. Even after determining that a PEO can benefit your company, selecting the PEO that offers the right combination of add-on services, a range of benefits, flexibility, stability, and reputation remains essential for any employer. Learn more about choosing a PEO.

Free Up Time and Resources With a PEO

Choosing the right professional employer organization can take your company to the next level — resulting in increased retention, better benefits, and significant cost savings for your business.

Learn more about Paychex PEO Services, which provides various options to help you meet your business needs. This investment can reap significant rewards for your small business moving forward and free you to focus on continued business growth.

FAQs About PEOs

Do PEOs Provide Employee Benefits?
Do PEOs Provide Employee Benefits?

A company's employees may gain access to benefits typically available only to large companies when they work with a PEO. This can include health insurance, disability insurance, employee assistance and discount programs, 401(k) plan administration, and other benefits. Beyond these, PEOs may provide online access to employees' payroll reports, pay stubs, and W-2 forms to enable employee self-service, often leading to better engagement in the programs and the company culture.

Companies that work with a PEO usually experience lower group health insurance costs since PEOs can negotiate rates with insurance companies with a larger employee count. PEOs may offer a lower state unemployment insurance (SUI) rate in certain states because their clients' employees are listed under the PEO's ID number for payroll purposes.
Who Is the Employer and Who Is Responsible for Employees?
Who Is the Employer and Who Is Responsible for Employees?

Organizations that enter into a PEO relationship maintain control of their business. The PEO assists with many employment-related aspects of a company, such as payroll, HR administration, employment-related taxes, and employee benefits. This support helps the organization to find more time to oversee its day-to-day business operations, encompassing employee hiring, performance management, leadership development, and accounting.
How Many Businesses Use a PEO?
How Many Businesses Use a PEO?

PEOs in the United States provide services to 200,000 small and mid-sized businesses, employing 4.5 million people.²
Is the Use of PEOs Growing?
Is the Use of PEOs Growing?
Seventy-eight percent of business leaders report it's extremely or very likely that they will outsource HR administration in the year ahead.¹The top priority for outsourcing to a PEO was to help with HR management for employee relations, strategy, policies, and procedures.

Where does outsourcing to a PEO deliver the most value? Leaders rank these areas as most helpful to outsource:¹
1. HR management support
2. Recruiting and onboarding
3. Payroll processing
4. 401(k) administration
5. Benefits administration
6. Assistance with managing employee performance
7. Risk management/workers' compensation
8. Assistance with maintaining regulatory compliance
How Can a PEO Help Control HR Costs?
How Can a PEO Help Control HR Costs?

A PEO's economies of scale and buying power can help to lower certain employment costs and increase the bottom line. You may be able to maintain a simple in-house HR infrastructure or none at all by relying on the PEO, thereby reducing hiring overhead. A PEO can assist with employer compliance and time savings by handling routine and redundant activities. Businesses that work with a PEO can save an average of $1,775 per employee per year.³
How Much Does a PEO Cost?
How Much Does a PEO Cost?

The PEO cost is determined by several factors, including the size of the business, which HR services will be outsourced, and the number and type of employees on the payroll. PEOs typically charge either a flat fee per employee or a percentage of the total payroll.

Suppose you have the choice of using either pricing model. In that case, you may wish to calculate the yearly expenses using both pricing models to evaluate expected PEO costs to know which option makes the most financial sense for your business.
How Do PEOs Make Money?
How Do PEOs Make Money?

PEOs generally generate revenue through fees associated with their service agreement with their clients. The charges typically vary based on the total number of employees in the organization and the extent of services requested.
Are PEOs Accredited and Audited?
Are PEOs Accredited and Audited?

When researching PEOs, knowing how or if they are accredited and independently audited should be an essential part of your selection process. For example, Paychex HR PEO has a SOC 1 Type II certification, focusing on outsourced services performed by service organizations relevant to a company's financial reporting. Paychex is accredited by the Employer Services Assurance Corporation (ESAC). ESAC is the nationally recognized financial assurance, standard-setting, and monitoring entity for the Professional Employer Organization (PEO) industry. Through its voluntary accreditation process, ESAC ensures that participating PEOs adhere to necessary ethical, financial, and operational standards to promote high integrity and responsibility within the PEO industry. As a condition of continued accreditation, we are required to submit quarterly reports to ESAC, including financial statements and an independent Certified Public Accountant's verification of the timely and accurate payment of all payroll taxes, employee benefits contributions and insurance premiums.
What Is a Staffing Agency?
What Is a Staffing Agency?

Staffing agencies generally find and place employees at a client organization for a fee. While A PEO may help with aspects of the hiring process (such as posting open positions on job boards, helping to write position descriptions and applicant tracking), they are not responsible for hiring and placing employees for a client organization. Instead, a PEO will generally provide payroll, benefits, HR administration, and compliance monitoring services.
What Is Employee Leasing?
What Is Employee Leasing?

"Employee leasing" generally refers to a business arrangement in which a staffing agency supplies its employees to another business, typically for a specified period or project duration.
What Are Some Potential Advantages of Working With a PEO?
What Are Some Potential Advantages of Working With a PEO?

PEO specialists bring a breadth of cross-industry expertise, encountering diverse challenges and using a comprehensive toolbox for effective problem-solving. This versatility can result in helpful employee- or HR-related resolutions.

Look for a PEO that prioritizes continuous training, helping to ensure specialists stay abreast of the latest employee relations and HR developments. This commitment places PEOs at the forefront, providing clients with up-to-date solutions and strategies.

Moreover, PEOs often provide digital technology platforms for employees to access essential documents, including pay stubs, W2s, and PTO balances. Additionally, PEOs can improve a company's benefits package, introducing valuable features like Flexible Spending Accounts (FSAs) and employee assistance programs (EAP), helping to enrich the overall employee experience.
What Is a BPO?
What Is a BPO?

Business Process Outsourcing (BPO) involves delegating internal company practices to a third party, covering payroll, IT management, website and social media management, benefits administration, and customer service. BPO companies assist businesses in saving costs by offering outsourced services as needed. For instance, small businesses may benefit from outsourcing IT management without the expense of hiring a full-time IT manager.

PEOs, unlike temp or staffing agencies, allow businesses to control hiring and firing decisions. PEOs offer a comprehensive range of employee and HR-related services, including payroll processing, tax handling, onboarding, benefits, and insurance.

While BPOs charge for specific services, PEOs often involve a more comprehensive bundled arrangement, offering multiple HR solutions for a combined fee.
What Are the Tax Implications of Working With a PEO?
What Are the Tax Implications of Working With a PEO?

Several PEOs handle payroll taxes on behalf of a client by using the PEO's tax ID. Upon exiting the PEO arrangement, the shift occurs to pay taxes under the client's tax ID, and all wage bases must be met. This underscores the importance of strategically timing the exit from a PEO, making January 1st an ideal choice to ensure a smooth transition and compliance with tax obligations.
Does Working With a PEO Affect Company Culture?
Does Working With a PEO Affect Company Culture?

Working with a PEO won't inherently impact your organization's culture unless that aligns with your specific goals. Some PEOs may offer guidance and recommend strategies to shape your company's culture and brand, where this is part of your objectives. This can support your goal of employees perceiving your business in a manner that reflects your desired image both presently and in the future.