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Mar 10, 2022

How to Stay in Compliance When You Leave Your PEO

Jay Patel

The last 2 years have seen a boom in remote-friendly start-ups. YC reports that the number of small companies building remote organizations has jumped from 15% to 86%. As these companies hire in new states, many have relied on PEOs to help them manage their growing workforce.

Professional Employer Organizations can make it easier for small businesses to manage their payroll, taxes, benefits, and HR compliance. In the early days, startup founders often offload the stress of maintaining multi-state compliance to a PEO so they can focus on growing their business and achieving product-market fit.

But once a startup reaches 50 employees, the cost of keeping a PEO often surpasses the initial value. At this stage, many companies will decide to bring their operations in-house.

With the number of federal, state, and local compliance requirements, leaving a PEO can be complicated. However, many startups successfully graduate from their PEO and create robust HR systems to take care of payroll while also encouraging a stellar employee experience.

In this piece, we’ll discuss reasons why you might consider leaving your PEO and share six steps to ensure a painless transition.

When should you leave your PEO?

As your startup hires more employees, you may start to outgrow your PEO and explore opportunities to reduce costs, improve your employee experience, and take advantage of more advanced HR software.

Growing costs

PEOs are often cost effective when you have a handful of employees, but not when you start to surpass 50 employees. That’s because they typically charge in one of two ways:

  1. PEPM (per employee, per month): this model charges an admin fee for each employee per month, often priced at $100 or more. Once you hire 50 employees, those costs add up and you’ll be paying your PEO at least $60,000 annually. That’s enough to hire an HR specialist in-house.  
  2. POP (percentage of overall payroll): PEOs can also bill as a percentage of total gross payroll. They usually bundle this together with other state and federal taxes. Fees range from as low as 2% to as high as 12%.

If your PEO isn’t a Certified Professional Employer Organization (CPEO), you can also miss out on employer tax credits since the PEO is the entity submitting your employees’ tax documents.

You may realize that your PEO costs outweigh the benefits of outsourcing as your team grows.

A better employee experience

In the war for talent, employers want to craft the best possible employee experience. Growing companies often find that relying on a PEO means they have less flexibility to meet these goals.

PEOs can define your employee experience in two ways: they are in charge of your employee benefits and they set key company policies. These can affect how your business attracts and retains talent.

When PEOs determine your benefits package, your business has less flexibility to create compelling compensation. Furthermore, since PEOs don’t design their policies to match your unique business culture and values, you may need to navigate through potential misalignment when it comes to hiring, managing, and terminating employees.

As your team scales, you may decide you want to own more of your employee experience.

The best HR technology

The last two years brought about an innovation wave in HR software that makes it easier for companies to support a remote workforce. These tools can help with onboarding, learning management, performance management, and more.

PEOs can provide a great initial out-of-the-box HR system for your new business, but their software often lags behind what’s available elsewhere in the market. For example, PEOs rarely offer integrated human capital and performance management systems to help your business scale. These gaps can restrict the creativity of your HR team and people managers, who won’t have access to the real time data needed to make decisions.

You may decide to invest in more modern software to support your growing team.

6 steps to ensure a successful transition

Leaving your PEO may help you control your costs, improve your employee experience, and make use of the latest in HR technology. Planning a successful exit requires giving your HR and finance teams enough time to prepare. Most companies take about 3 months to properly research and evaluate new HR systems.

You must also decide on the right time to make your transition. The two best periods to schedule your exit from your PEO are your company’s renewal date or January 1st. This helps you avoid double taxation and ensures a smoother transition.

Now that you know when to transition, here are our six steps to successfully leave your PEO.

1. Create your stakeholder team

Team “Leave the PEO” should include representatives from your HR team, IT team, and your CEO and/or CFO. For extra help, you can also partner with brokers and HR and technology consultants.

Employment benefits brokers can help you choose and implement benefits packages that are aligned with your organization, culture, and size. They can also help answer local and regional compliance questions.

For guidance on how to set up your HR processes and systems, you can hire a technology consultant. Our partner Outsail provides customers with advisory services that cover benefits, recruiting, auditing, payroll, and more.

2. Choose your HR systems

Before you talk to any vendors, determine what HR functionality you need. This will help you create a shortlist of providers that include your requirements and prevents you from missing out on important features.

Start by defining your requirements, including which modules you’ll need. Modules include benefits management, time tracking, payroll, onboarding, talent sourcing, learning management, performance, and employee engagement. Some of these modules may be nice-to-have while others are need-to-have.

Next, put together a shortlist of vendors that may be a good fit for your needs. Try to narrow down your list to three or four companies. At the same time that you’re talking to providers, you can also ask your community for advice on your short list. LinkedIn groups for HR professionals and Quora are good places to start. Before you buy, ask the vendor to introduce you to existing customers.

Once you choose your vendors, it’s time to negotiate on features, price, contract terms, and support packages. Make sure that your stakeholder team is involved in discussions on pricing commitments, legal terms, and contractual clauses.

3. Design your benefits and insurance plans

Benefits brokers can help you understand the intricacies of creating your benefits and insurance plans and help you integrate those plans into your new HR software and processes. When choosing a broker, make sure they fulfill these requirements:

  • They must understand the needs of companies like yours and the regulations in your region
  • They must be verifiably licensed and show sufficient liability coverage
  • They should be experts in compliance, HR support, and benefits
  • They’re able to help with medical, dental and vision insurance coverage
  • They can ensure your Workers Comp package takes over right away after you leave your PEO
  • They’re willing to help you choose providers for HSA, FSA, 401k, and COBRA

4. Apply for federal, state, and local tax accounts

Leaving a PEO is tricky because you’ll need to re-hire your employees in the states in which they work. You can’t miss any state registration, otherwise you’ll have to contend with fees, penalties, or even be barred from operating in that state until you resolve open issues.  

Registering for federal, state, and local tax accounts requires:

  • 5+ hours of admin per state
  • Back-and-forth discussions with state agencies
  • Monitoring state agency mail
  • Paying registration fees (which can be up to $800 per state!)
  • Managing ongoing compliance with each state agency

Middesk Agent will partner with your startup to help you manage your tax accounts when you decide to switch away from your PEO.

Agent takes care of:

  • Setting up tax accounts in all 50 states
  • Monitoring all state mail, including notices, service of process, and changes to your SUI rates
  • Covering all registration fees for each state
  • Filing annual reports with each Secretary of State
“When we were leaving our PEO, we had employees in four states and planned to add two new states as well. It was daunting to think of having to register with all the various agencies. Middesk Agent handled the entire process, allowing us to focus on growth initiatives instead of administrative tasks." - Rob Tompkins, CFO of RiskScout

Learn more here.

5. Design new locally-compliant policies

There are multiple policies you’ll need to stand up to ensure local compliance. For example, two key policies that you’ll need to design and implement are Leave of Absence and Paid Time Off. The legal requirements for these vary by state.

Plan to implement these policies at the same time as your new HR systems. Your vendors or technology consultant should be able to advise you on how. Next, document your onboarding process for new hires and include compliance requirements like sexual harassment training.

While many of your other corporate policies will apply to all employees regardless of state, you’ll still need to tailor local employee handbooks. You’re technically re-hiring your employees when you leave a PEO, so you’ll need all employees to sign off on the new employee handbooks.

6. Manage the implementation

Finally, you’ll need to transfer all employee data from your PEO systems to your new HR systems. Have your new payroll vendor run payroll data against your old PEO’s payroll to identify any discrepancies when making the transfer. Two requirements you can’t miss are:

  • Obtaining new I-9 forms for all current employees
  • Drafting new offer letter templates

Request that your PEO sends through a report showing your payroll and compliance data as well as any benefit data. You’ll also need a report on employee wage garnishments. For a comprehensive checklist, Namely has compiled additional information you may need when implementing your new HR system.


Transitioning away from your PEO can be a daunting task but it can ultimately save you money, improve your employee experience, and allow your company to access the latest remote-first HR technology.

Middesk Agent and our partners can help ease the transition to keep your company in compliance – so you can focus on growing your business.

Learn more about how Agent supports payroll compliance on the Middesk blog or contact us at [email protected]


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