Washington recently proposed an Excise Tax Advisory (ETA) discussing the taxation of professional employer organizations (PEOs). A PEO that provides services to related or unrelated businesses qualifies for a deduction from its gross income for reimbursements of qualifying costs paid on behalf of covered employees if it meets the requirements of RCW 82.04.540.
Unlike a standard temporary staffing arrangement, the PEO is a “co-employer” with its clients. All parties to the PEO agreement must agree to be co-employers and cannot disclaim the employment relationship. The specific employment responsibility of each co-employer is spelled out in the PEO agreement. The ETA specifically notes that common paymasters, shared employees and staffing services do not qualify as PEO arrangements.
The sole example in the proposed ETA emphasizes the primary issue of B&O taxation that the Washington Department of Revenue is intending to address. In the example, a property management company provides property management services to entities owning and operating real property. The property management company creates an affiliate that is organized to operate as a PEO. The property management company, the entities owning the real property and the PEO enter into an agreement whereby each entity is a co-employer of the employees that provide the on-site property management services. The entities owning the real property pay 100% of the salaries, benefits, workers compensation, payroll taxes, etc. paid on behalf of the employees that staff and operate the properties.
The proposed ETA concludes that the while the PEO is allowed a deduction for the payments that it receives from the property owners, the management company must include such amounts in its gross income because “the management company is selling comprehensive property management services, and the employment costs of the employees are a non-deductible cost of its business.” The proposed ETA even appears to condition the deduction for the PEO on the inclusion of the payroll reimbursements in the gross income of the property management company.
This result is clearly contrary to rulings that I have received in the past regarding the taxability of similar arrangements in connection with the operation of hotel properties. A common structure in the hotel industry consists of a company that owns the hotel, a company that employs the bulk of on-site personnel and a separate company that manages the hotel. The hotel management company manages the hotel, and pays the employees and other vendors out of the gross receipts that are earned by the hotel owner, but managed by the hotel management company.
This type of ownership and operating structure is very efficient in the context of the hotel industry. The company owning the hotel has the option of changing management companies without having to turnover its on-site workforce. Further, the hotel itself can be sold without disrupting operations. Under most taxing regimes, this type of structure creates no taxation problems. However, the unique structure of the Washington B&O tax would ordinarily cause a B&O tax to be incurred by the company employing the on-site hotel staff, merely by reason of the employees being employed by this separate legal entity.
In earlier rulings, the use of a PEO as the employer of the on-site hotel personnel eliminated the tax on the payment by the hotel ownership company to the PEO. Further, these rulings concluded that the hotel management company was not subject to B&O tax on the amounts paid to the PEO as the hotel management company had no liability to pay the on-site hotel workers, except in connection with its duties as the hotel manager. Given the unique structure and circumstances of the hospitality industry, it is possible that the Washington DOR will stay the course and not require the hotel management company to include the amounts paid by the hotel owner to the PEO as additional compensation. However, I wouldn’t count on it.