How PEOs Turned SUTA Arbitrage Around
State by state, regulations for workers’ comp and state unemployment insurance vary considerably. This variance can invite abuse by staff leasing companies, including PEOs (Professional Employer Organizations).
Arbitrage Defined
Arbitrage occurs 24/7 in currency and financial markets. The arbitrage takes advantage of a price differential between two or more markets. It makes a deal to take advantage of the price gap. A simple example follows the buyer who purchases something at a bargain rate and sells it on ebay or craigslist at a higher price. While arbitrage is legal, it can destabilize a market, so the practice is regulated in financial and currency markets.
SUTA Dump Explained
It has been possible for organizations to 'dump' employees into groups with lower unemployment insurance rates. This is called State Unemployment Tax Arbitrage, or, the 'SUTA Dump'. Employers in states with high unemployment insurance rates have been able to dump their employees into subsidiaries that they owned in states with lower unemployment insurance rates. An example of another tax evasion scheme is for an employer to set up a shell company and manipulate it to get a lower UI rate, then shift the payroll from the company with the higher rate to the new shell company. The entity that had the higher rate is then "dumped."
Some employers have also tried using the PEO dump, utilizing existing PEOs to evade the higher workers’ compensation premium rates. They reduce their rates by shifting their high incident experience to a PEO with lower incident experience, taking advantage of a loophole created by the nature of the PEO.
Fraud takes place when a client employer intentionally uses or sets up a PEO for the purposes of transferring its risks to lower its costs. It is fraud because it intends to deceive the workers’ comp underwriters and/or state unemployment insurance underwriters.
Federal Regulation
The SUTA Dumping Protection Act of 2004 requires all states to enact anti-dumping legislation. The states have done their part, but the Act never did specifically address the role of PEOs. Seeing the threat to its value-added marketing advantage, the industry devoted to staff leasing took steps to fix things.
Self-Regulation
- ESAC (Employer Services Assurance Corporation) formed in 1995 to audit the ethics, finances, and standards of operating PEOs.
- NAPEO (National Association of Professional Employer Organizations) became the industry’s trade association developing standards and codes of ethics for organization behavior.
- CI (Certification Institute) promotes a certification that the PEOs’ workers’ comp program meets best practices in risk management.
Arbitrage Abuse
Sadly, in the past, staff leasing businesses have been set up with fraud in mind. They routinely charged their client employers for insurance payments, but they fraudulently channeled the cash flow without remitting it to the legitimate taxing agencies.
With specific reference to the rates for workers’ compensation insurance, they moved the accountability from payrolls with high-risk claims experience to new entities, some of them newly formed PEOs that had no claims history. When things caught up with the PEO, it went out of business.
Other employers, wanting to avoid minimum participation rules, move their low paid employees off payroll onto the PEO payroll. This move takes those employees out of the count for pension or medical insurance plans that require a minimum participation. In this case, only the remaining high paid staff benefit.
New Direction
Today, PEOs have done what they needed to do to honor their obligations in law and ethics. Admittedly, PEOs profit from tax and insurance arbitrage. They maximize the economies of scale to manage costs, mark them up, and bill them to the client company still at a lower cost than they would have paid. Everyone is happy with this value added proposition, so long as some rules are respected.
- Transparent finances allow investigation of all fiduciary functions and responsibilities.
- Compliance reports and audits across all entities and all states involved.
- Vetting of controlling persons assures confidence in their identification, background, and credibility.
- Financial statements are prepared to reveal deep and broad activity, within the PEO and across all related entities.
PEOs continue to provide comprehensive and integrated services to manage employers’ HR duties and risks. At the same time, they take on much of the labor overhead in time and money, so employers can spend their time on growth and sustainable innovation. Small and mid-sized employers continue to pursue the benefits of co-employment, and they can take comfort in recognizing PEOs with integrity, trust, and liability.
To learn more about SUTA dumping visit the U.S. Department of Labor.
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