PEOs operate through a co-employment relationship — a specific legal arrangement defined in service agreements and (for federal tax purposes) governed by IRS rules around Certified Professional Employer Organizations. Here's how the mechanics actually work.
When you sign with a PEO, you execute a Client Service Agreement that defines the co-employment relationship. The PEO assumes responsibility for certain employer functions (payroll, taxes, benefits, workers' comp); you retain responsibility for others (day-to-day management, hiring/firing decisions, work direction, business operations). The agreement spells out who does what.
On payroll day, you submit hours and any payroll changes to the PEO (or sync them automatically from your time tracking system). The PEO calculates wages, withholds federal/state/local taxes, processes direct deposit, files all required tax forms, and remits taxes to the IRS and state agencies on schedule. You see net cash pulled from your account; the PEO handles everything downstream.
The PEO sponsors a master health insurance plan with a major carrier (UnitedHealthcare, Aetna, Cigna, Kaiser, BCBS). All client employees enroll in this single plan, which gives the PEO leverage to negotiate large-group rates. Your employees see no difference in their healthcare experience compared to working at a large company — same provider networks, same online portals, same pharmacy benefits.
The PEO carries a master workers' compensation policy covering all client employees. Your business is added as an additional covered entity. Premium is typically charged as a percentage of payroll, with the rate determined by your job classifications (NCCI codes) and your historical MOD rate. The pooling smooths what would otherwise be volatile individual-policy renewal pricing for small businesses.
For CPEO-certified PEOs, federal payroll taxes (FICA, FUTA, federal income tax withholding) are filed under the PEO's EIN — and the PEO assumes sole liability for those taxes. State unemployment (SUTA) is also filed under the PEO's state account. Your business inherits the PEO's experience rating, which is often beneficial for small or newly established employers.
Most PEOs offer a combination of online platform tools (handbooks, training, performance management software) plus access to live HR consultants for specific questions. Higher-touch PEOs (Insperity, ADP TotalSource) assign a named HR business partner; lighter-touch PEOs (Justworks, Gusto) provide chat/email support with on-demand specialists.
Hiring and firing decisions, work direction, compensation setting, business strategy, sales, marketing, operations, and any non-employer activity. The PEO is not running your business; they're handling the administrative employer functions so you can focus on running your business.
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