This article is a revision of the article originally published in June to take into account the revisions later made by Notice 2016-49 to the requirements for the program.
The IRS has released a Revenue Procedure (Revenue Procedure 2016-33) that outlines how organizations will apply for Certified Professional Employer Organization (CPEO) status. The CPEO status, added by the Tax Increase Prevention Act of 2014, is meant to address an issue that arises when PEOs collect payroll taxes from employers but fail to pay those taxes over to the government.
Normally in such a situation the organization that hired the PEO remains on the hook for the payroll taxes, even if they were the victim of a fraud perpetrated by the PEO to walk off with payroll taxes. See the case ofCity Wide Transit, Inc. v. Commissioner, CA2, 2013-1 U.S.T.C. ¶50,211, reversing TC Memo 2011-279, 3/1/13.
Congress created the CPEO program to allow PEOs to apply to the IRS for a special status (CPEO) which serves, if other criteria are met, to allow the entities employing such PEOs to transfer full responsibility for any nonpayment of such taxes. To obtain this status an organization must apply for the status with the IRS, pay a fee and meet other criteria.
The bill provided the IRS was to begin accepting applications on July 1, 2015 with the program to start in full on January 1, 2016, but the IRS was unable to meet that deadline and instead pushed the program back one year. The IRS earlier in 2016 published temporary and proposed regulations for the program (TD 9768, Regs. §§301.7705-1T and 301.7705-2, REG-127561-15, Proposed Regs. §§31.3511-1, 301.7705-1 and 301.7701-2, 5/6/16) with this Revenue Procedure providing specifics for applying for the program.
Following some concerns received by the IRS regarding the provisions in the proposed regulations, the IRS made revisions to the requirements in Notice 2016-49 published on August 5, 2016.
The IRS will begin accepting applications on July 1, 2016 with the program officially getting underway on January 1, 2017. The applications will be submitted electronically to the IRS, along with a $1,000 user fee.
As part of the application the organization must submit proof of a surety bond where a surety agrees to issue a bond upon acceptance (a surety letter) followed by a Form 14751 showing actual issuance of the bond after acceptance as a CPEO.
The applicant also will need to include an annual financial statement accompanied by a report from an independent CPA. Per the proposed regulations, the CPA in question must:
- Be currently independent of the CPEO applicant per AICPA Standards
- Not currently be under suspension or disbarment from practice before the IRS
- Must be duly qualified to practice in any state and
- File a written declaration with the IRS that the person qualifies as a CPAand submit an authorization, pursuant to §601.503(a), to represent the CPEO before the IRS
However the requirement that the CPA be authorized to represent the client before the IRS effectively would render the CPA not independent per the AICPA Code of Professional Conduct. In Notice 2016-49 the requirement to submit the authorization to represent the client before the IRS.
Per the original regulation the financial statement must include a report from the CPA that provides an opinion that:
- The financial statements are presented fairly in accordance with generally accepted accounting principles
- The financial statements reflect positive working capital or meet the requirements for the limited cases when the working capital may be negative, as well as a detailed computation of working capital and
- Reflect that the CPEO computes its taxable income on the accrual basis of accounting.
The auditor’s opinion must be an unmodified opinion—that is, any modification would disqualify the organization from obtaining CPEO status.
However the requirements with regard to reporting on working capital also presented issues with regard to the regulations imposed on CPAs performing attest services, causing changes to be made in Notice 2016-49. As the Notice provides:
Treasury and IRS have received comments suggesting that CPAs may be prevented from including statements on working capital and the accrual method in their opinions due to certain American Institute of Certified Public Accountants (AICPA) limitations on what can be included in a CPA opinion. These commenters have requested clarification that the inclusion of these items in the financial statements, which are covered by the CPA opinion, rather than in the CPA opinion itself, would satisfy the regulatory requirements.
The IRS therefore has simply declared that a note to the financial statement must be included in the statements the CPA is reporting on. As the notice provides:
To ensure consistency with the AICPA guidelines applicable to CPA opinion letters, Treasury and IRS anticipate revising the requirements of § 301.7705-2T(e)(1) and section 2.05(2) of Rev. Proc. 2016-33 to require a CPEO applicant or CPEO to submit a copy of its annual audited financial statements and an unmodified opinion of a CPA that the annual audited financial statements are presented fairly in accordance with GAAP, provided that the audited financial statements covered by the opinion include a Note to the Financial Statements that states that the financial statements reflect positive working capital or that the CPEO applicant or CPEO satisfies the requirements of § 301.7705-2T(e)(3). The Note described in the previous sentence must also provide in detail a calculation of the working capital. In the case of a CPEO applicant that is a member of a controlled group of which other members are CPEO applicants or CPEOs, the Note to the Financial Statements of the combined or consolidated annual audited financial statements for the controlled group must state that the individual financial statements of each CPEO applicant or CPEO that is a member of the controlled group reflect positive working capital (as defined by GAAP) or that the individual CPEO applicant or CPEO satisfies the requirements of § 301.7705-2T(e)(3), in either case setting forth in detail a calculation of each individual CPEO applicant's or CPEO's working capital. Similarly, Treasury and IRS anticipate revising the requirements of section 2.05(6) of Rev. Proc. 2016-33 to allow the name and EIN of each member of the controlled group that is included within the consolidated audited financial statements of the controlled group to be listed in either the Note to the Financial Statements or in a separate attachment signed by a responsible individual of the CPEO applicant or CPEO under penalties of perjury, rather than in the CPA opinion.
Similarly, the requirement for the CPA to note that the accrual method of accounting is used was deemed redundant since GAAP requires the use of the accrual basis. Thus Notice 2016-49 modified the rules as follows:
Because GAAP requires the use of an accrual method of accounting and the required CPA opinion must state that a CPEO applicant's or CPEO's audited annual financial statements are presented fairly in accordance with GAAP, the separate requirement in paragraph (c) of section 2.05(2) of Rev. Proc. 2016-33 for a CPA opinion stating that such financial statements "reflect that the CPEO . . . computes its taxable income using an accrual method of accounting" is unnecessary. Treasury and IRS anticipate revising Rev. Proc. 2016-33 to eliminate paragraph (c) of section 2.05(2).
The organization will also need to submit quarterly assertions that it has withheld and made all applicable payroll tax deposits and will need to submit an examination level attestation from an independent CPA indicating that statement is fairly stated. As well, the procedure provides:
The attestation must be accompanied by a written declaration, signed by the CPA, that the CPA is currently qualified as a CPA and is authorized to represent the CPEO applicant before the IRS.
As with the annual financial statement noted above, Notice 2016-49 removes the requirement that the CPA state he/she is authorized to represent the CPEO before the IRS.
Notice 2016-49 also removes the initial requirement that the CPEO could not be a disregarded entity for tax purposes. As well, special relief is granted for the first year and the audited financial statement requirement. As the Notice continues:
Treasury and IRS have received comments expressing the concern that, for persons applying for certification in the first year of the program, the regulatory requirements regarding submission of annual audited financial statements and CPA opinions with respect to those statements apply to fiscal years predating promulgation of the temporary regulations for which the audit is already closed and could require a CPEO applicant to undertake the costly process of amending prior financial statements or conducting financial audits of those years anew.
The transitional relief for this issue is described as the Notice continues:
In response to this concern, this notice provides transition relief for any CPEO applicant required to submit a copy of its annual audited financial statements and CPA opinion with respect to a fiscal year ending before September 30, 2016, as a part of its application for certification. Specifically, a CPEO applicant will not fail to meet the requirements of § 301.7705-2T(e)(2) or section 2.05(1) and (2) of Rev. Proc. 2016-33 if the CPEO applicant submits, together with annual audited financial statements for a fiscal year ending before September 30, 2016: (1) an unmodified opinion of a CPA that the annual audited financial statements are presented fairly in accordance with GAAP; and (2) a separate statement, signed under penalties of perjury by a responsible individual of the CPEO applicant, that the financial statements reflect positive working capital for the fiscal year or that the CPEO applicant satisfies the requirements of § 301.7705-2T(e)(3), in lieu of such information being provided in the CPA opinion or in a Note to the Financial Statement, as described in section III of this notice. The statement by the responsible individual must also provide in detail a calculation of the CPEO applicant's working capital. In the case of a CPEO applicant that is a member of a controlled group of which other members are also CPEO applicants or CPEOs, the CPEO applicant must submit its own separate statement by a responsible individual that the individual financial statements of that CPEO applicant reflect positive working capital (as defined by GAAP) or that the requirements of § 301.7705-2T(e)(3) are satisfied, in either case setting forth in detail a calculation of the individual CPEO applicant's working capital.
Regardless of its fiscal year end date, a CPEO applicant has until the last day of the sixth month after the end of its fiscal year to submit the annual audited financial statements, accompanying CPA opinion, and, if applicable, separate statement of positive working capital, signed by a responsible individual, for that year. For example, if a CPEO applicant with a fiscal year ending September 30, 2016, submits an application for certification on September 14, 2016, the CPEO applicant must provide with its application the annual audited financial statements and CPA opinion for its most recently completed fiscal year (the year ending September 30, 2015), which qualify for the transition relief described in the preceding paragraph. In addition, the CPEO applicant will have until March 31, 2017 (the last day of the sixth month after that fiscal year ends), to subsequently provide to the IRS annual audited financial statements (as well as the accompanying CPA opinion) for the year ending September 30, 2016, that comply with the requirements described in § 301.7705-2T(e) and section 2.05 of Rev. Proc. 2016-33 (and with the anticipated revisions to these requirements that Treasury and IRS intend to make when publishing final regulations and updating the revenue procedure, as described in section III of this notice).
The ruling goes to provide additional information on the process that will be undertaken, including background and tax compliance checks the IRS will make regarding the applicant and responsible individuals of the organization.
The IRS will issue notification of acceptance of a CPEO and will also make the list of such organizations public (though the latter will happen only after the IRS receives the Form 14751). Normally the effective date of a certification would be the first date of the first quarter beginning after the certification is issued, but the IRS will grant a January 1, 2017 effective date to all organizations that submit an accurate and complete application before October 1, 2016 (the original announcement had set this date as September 1, 2016, but in Notice 2016-49 the IRS pushed this deadline back one month).
The Revenue Procedure also describes options an applicant has in the situation where an application is denied, including situations in which no appeal will be possible.
The Revenue Procedure was given a July 1, 2016 effective date which, not coincidentally, is the day on which the IRS will begin to accept applications for CPEO status.