(Released on 07/15/07)
Who rents employees? Well, it has become a common practice for a lot of businesses, especially those that are so small that they don’t have the resources to do their own payroll and benefits.
So these businesses turn their employees over to a professional employment organization or PEO which then employs the workers as if they belonged to the PEO. The PEO then “rents” or “leases” back the employees to the business in return for the amount used to pay the employees’ salaries and benefits plus a service charge.
The problem is Hawaii’s general excise tax law. Under that law, for the middle person in a three party transaction, which in this case would be the business, the PEO and the employee, the amount reimbursed to that middle party is exempt from the general excise tax as long as there is no additional consideration or remuneration for having made the advance on the part of the business. Thus, when the PEO makes the advance by paying the leased employee and then is reimbursed by the business along with the service fee, the entire amount received by the PEO is subject to the 4% (4.5%) general excise tax.
The cost of the general excise tax makes this type of operation much more costly as the employees’ wages and benefits are taxed as if they were gross income to the PEO when it is merely being passed through the PEO to the employees. What cost savings that might have been realized by outsourcing the overhead costs of payroll and benefits is offset by the cost of the tax on the amount reimbursed to the PEO by the business.
This year after more than seven years of being debated in the legislature, a measure has passed and been signed into law that recognizes that the amount of reimbursement for wages, salaries, benefits and insurance premiums is really not gross income to the PEO and should not be subject to the general excise tax. HB 317 became Act 225 of the 2007 session.
Without this new general excise tax exemption, employment costs would have to be increased to accommodate the 4% tax on salaries, wages, etc., or the employer could choose not to pay as much or limit the number of employee benefits to accommodate the tax or do payroll in house at the expense of his or her time or do without an additional employee. In all cases, these alternatives make it more costly to do business in Hawaii, limiting the potential for expansion and the creation of jobs so badly needed by Hawaii’s people.
Not only will the PEO service help to reduce overhead costs that would otherwise have to be accommodated in house by the employer, but it will also allow employees to benefit from being in a much larger group in bargaining for employee benefits such as health care and life insurance. Thus, there are benefits for not only the employer, and the PEO, but also for employees. Given the trend away from large businesses with hundreds of employees to smaller businesses, PEO services offer an alternative to help support the growth of small, entrepreneurial businesses in the community. And again, it must be remembered that the service fee charged by the PEO to handle all aspects of human resources for the business will still be subject to the general excise tax.
Is this new exemption special interest legislation? Not really, the legislature started recognizing that businesses were beginning to operate in new ways back as far as the late 1980’s when they enacted the first of very similar exemptions. The first exemption of amounts reimbursed as payroll, benefits and other compensation was for hotel operators who were hired by the owners of hotels. Because the owners of hotels were just that, owners, they needed the expertise of a hotel management company that came with the employees to provide the types of services hotels expected. This structure also allows the hotel operator to provide job security to its employees by being able to move to another hotel should the property be sold.
The hotel operators’ exemption was followed by an exemption for operators of orchard properties when similar amounts were received from the owner of an orchard. Again, owners of orchards may not necessarily be able to operate the orchard and would need the expertise of the orchard operator who would come with the expert employees. Then there are management companies of related entities that provide telecommunication services. Again the exemption was limited to the amounts reimbursed for employee wages, salaries and benefits.
Again, because the general excise tax is on the gross proceeds of a business, exemptions such as the one for professional employment organizations are necessary in order to avoid making businesses operate inefficiently.