In order to save money on benefits such as health and life insurance, as well as administrative costs, a company can use workers provided through an employee leasing company or professional employer organization (PEO).

Here’s How it Works

An employee leasing firm hires people for your company and pays all the related costs for them. You then pay the leasing firm those costs, plus an additional fee to cover the administrative overhead.

Many of these firms will hire the employees as their own, if you already have a staff. Your company then leases them back from the company to essentially perform the same duties as before. Leasing firms allow small companies to provide better benefits and services, in some cases.

But what if the company that has been leasing employees fails to meet its financial obligations? Which entity is responsible for the payroll taxes for the employees – the leasing company or the company that leases the employees?

Here is one case that helps clarify the situation. In the case, Total Employment Company (TEC), an employee leasing company, offered benefits and paid wages for the employees used by American Enterprise Solutions, Inc. (AESI). After the employer fell behind on its payments, TEC advanced payroll on behalf of the client. However, it failed to pay federal employment taxes. The leasing company continued to advance payroll until the contract with AESI was terminated.

The Internal Revenue Service determined unpaid payroll taxes for the leased employees and assessed the tax against TEC, the leasing company. Eventually, the District Court of Florida, overturning a bankruptcy court decision, held that the leasing company controlled the payment of wages to employees.

The court stressed that the entity controlling payment of the wages is in the best position to make the proper accounting and payment of federal payroll taxes. Therefore, joint payroll tax liability is warranted, even though employee leasing companies technically may not be the common law employers of leased workers.

Bottom line: Both the taxpayer and the client were responsible for withholding on leased employee income and for the collection and payment of payroll taxes. However, it was also noted by the District Court that AESI had the ultimate responsibility for the taxes and would be liable to the employee leasing company. (Total Employment Co. Inc., DC-FL., 2/12/04).