Notice 2016-49

Interim Guidance Under Section 7705 for Certified Professional Employer Organizations

Notice 2016-49

I. PURPOSE AND OVERVIEW
This notice provides interim guidance on certain requirements for persons
seeking certification as Certified Professional Employer Organizations (CPEOs), as
defined in §301.7705-1T(b)(1). The Department of the Treasury (Treasury) and the
Internal Revenue Service (IRS) recently issued temporary and proposed regulations
under section 7705 of the Internal Revenue Code (Code) addressing the requirements
relating to applications for and maintenance of certification as a CPEO, as well as a
revenue procedure setting forth detailed procedures for applying for certification as a
CPEO. Treasury and IRS have received comments that certain provisions of the
regulations and revenue procedure may unnecessarily limit the ability of persons to
apply for and maintain certification as a CPEO, including: (1) the requirement that a
CPEO applicant, as defined in §301.7705-1T(b)(2), or CPEO provide a certified public
accountant (CPA) opinion that its annual audited financial statements reflect positive
working capital (or meet certain rules that permit negative working capital in limited
circumstances) and that it computes its taxable income using an accrual method of
accounting; (2) the requirement that a CPEO applicant or CPEO submit a written
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declaration of an independent CPA, who submits opinions and attestations regarding
the CPEO applicant’s or CPEO’s annual audited financial statements and ongoing
federal employment tax compliance, declaring that the CPA is authorized to represent
the CPEO applicant or CPEO before the IRS; and (3) the requirement that a CPEO be a
business entity that is not a disregarded entity. This notice describes modifications to
these requirements that Treasury and IRS intend to make when publishing final
regulations and updating the revenue procedure. Taxpayers may rely on the guidance
provided in this notice until the final regulations and updated revenue procedure are
published.
In addition, Treasury and IRS are aware that, for persons submitting applications
during the first year of the program, the audited financial statements that must be
included as part of the application for certification might not include some of the
elements required by the regulations because the statements relate to fiscal years that
end before or shortly after the regulations were issued. To address this issue, this
notice provides transition relief for meeting the audited financial statement requirements
in the regulations and revenue procedure.
Finally, in recognition that this notice provides interim guidance on requirements
applicable to persons who may already be engaged in the process of applying for
certification as a CPEO, this notice extends to September 30, 2016, the deadline by
which a complete and accurate application for certification must be submitted in order to
be eligible for an effective date of certification of January 1, 2017.

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II. BACKGROUND
The Stephen Beck, Jr., Achieving a Better Life Experience (ABLE) Act of 2014,
enacted on December 19, 2014, as part of The Tax Increase Prevention Act of 2014
(Pub. L. No. 113-295), added new sections 3511 and 7705 to the Code relating to the
federal employment tax consequences and certification requirements, respectively, of a
CPEO. The ABLE Act requires the establishment of a voluntary program for persons to
apply to become certified as a CPEO. Temporary and final regulations (TD 9768)
describing the requirements relating to applications for and maintenance of certification
were published in the Federal Register on May 6, 2016 (81 Fed. Reg. 27315).
Proposed regulations (REG-127561-15), also published in the Federal Register on May
6, 2016 (81 Fed. Reg. 27360), provide guidance on the federal employment tax
liabilities and other obligations of persons certified by the IRS as CPEOs, propose to
adopt the text of the temporary regulations by cross-reference, and solicit public
comments on the provisions contained in both the proposed and temporary regulations.
Rev. Proc. 2016-33, 2016-25 I.R.B. 1034 (released June 4, 2016), sets forth detailed
procedures for applying for certification as a CPEO. A future revenue procedure will
address requirements for a CPEO to remain certified and the procedures relating to
suspension and revocation of CPEO certification.
III. REQUIREMENT FOR A CPA OPINION REGARDING THE CPEO APPLICANT’S
OR CPEO’S WORKING CAPITAL AND METHOD OF ACCOUNTING
The temporary regulations and Rev. Proc. 2016-33 provide guidance on the
statutory requirements for certification as a CPEO, pursuant to section 7705.
Specifically, section 7705(b) sets forth the certification requirements that a person must
satisfy in order to become a CPEO. Among other requirements, a person must
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demonstrate that it meets such requirements as the Secretary shall establish, including
requirements relating to tax status, background, experience, business location, and
annual financial audits; agree to satisfy (on an ongoing basis) certain bond and
independent financial review requirements; and compute its taxable income using an
accrual method of accounting unless the Secretary approves another method. Section
7705(c) prescribes the bond and independent financial review requirements that a
person must satisfy to become and remain a CPEO. Under section 7705(c)(3)(A), a
CPEO must, as of the most recent audit date, cause to be prepared and provided to the
Secretary (in such manner as the Secretary may prescribe) an opinion of an
independent CPA as to whether the CPEO’s financial statements are presented fairly in
accordance with generally accepted accounting principles (GAAP). Section 301.77052T(e)(1)(i) reiterates this statutory requirement, while §301.7705-2T(e)(2) describes how
this requirement applies to CPEO applicants.
As explained in the preamble to the temporary regulations, Treasury and IRS
consider a CPEO with annual audited financial statements that reflect positive working
capital (as determined in accordance with GAAP) to present a materially lower risk to
the IRS’s collection of federal employment taxes than a CPEO without such financial
statements. Accordingly, pursuant to section 7705(b)(1) and consistent with several
state certification and registration laws governing professional employer organizations,
§301.7705-2T(e)(1) requires a CPEO applicant or CPEO to cause to be prepared and
provided to the IRS, by the same date by which it must provide its annual financial
statements to the IRS, an opinion of an independent CPA that the financial statements
reflect positive working capital for the fiscal year or that the CPEO applicant or CPEO

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satisfies the requirements of §301.7705-2T(e)(3) (the exception to the positive working
capital requirement). In addition, the temporary regulations require this opinion to set
forth in detail a calculation of the CPEO applicant’s or CPEO’s 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, section 2.05(6) of Rev. Proc. 2016-33
clarifies that the CPEO applicant must submit copies of combined or consolidated
annual audited financial statements for all CPEO applicants and CPEOs in the
controlled group and an accompanying unmodified opinion of a CPA that such financial
statements are presented fairly and in accordance with GAAP. The statements and
opinion must contain the name and employer identification number (EIN) of each CPEO
applicant and CPEO in the controlled group, as well as the name and EIN of controlled
group members that are not CPEO applicants or CPEOs, if the statements and opinion
include such members. A CPEO applicant that is a member of a controlled group of
which other members are CPEO applicants or CPEOs must also submit an opinion of a
CPA that the individual CPEO applicant’s financial statements reflect positive working
capital (as defined by GAAP) or that the requirements of §301.7705-2T(e)(3) are
satisfied, with the opinion in either case setting forth a calculation of the individual
CPEO applicant’s working capital.
Consistent with section 7705(b)(4), §301.7705-2T(l) requires a CPEO to compute
its taxable income using an accrual method of accounting or, if applicable, another
method that the Commissioner provides for in further guidance. Further, section
2.05(2)(c) of Rev. Proc. 2016-33 requires the CPA opinion accompanying submission of

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the annual audited financial statements to reflect that the CPEO applicant computes its
taxable income using an accrual method of accounting.
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.
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

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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.
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).
IV. TRANSITION RELIEF FOR CPEO APPLICANTS SUBMITTING ANNUAL
AUDITED FINANCIAL STATEMENTS FOR FISCAL YEARS ENDING BEFORE
SEPTEMBER 30, 2016
Section 301.7705-2T(e)(2) and section 2.05(1) of Rev. Proc. 2016-33 require a
CPEO applicant to provide to the IRS, with its application, a copy of its annual audited
financial statements for the most recently completed fiscal year as of the date it applies
for certification, as well as a CPA opinion with respect to those statements (as
described in §301.7705-2T(e)(1) and section 2.05(2) of Rev. Proc. 2016-33, and further

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addressed in section III of this notice). If a CPEO applicant applies for certification
before the last day of the sixth month following its most recently completed fiscal year,
and the audit of the financial statements for that fiscal year has not been completed at
the time of application, a CPEO applicant must provide with its application the annual
audited financial statements and opinion for the immediately preceding fiscal year, if
any, and must subsequently provide to the IRS by the last day of the sixth month after
that fiscal year ends the annual audited financial statements and opinion for the most
recently completed fiscal year. In addition, for any fiscal year that ends after the CPEO
applicant submits its application for certification and on or before the effective date of
certification, if applicable, the CPEO applicant must provide the annual audited financial
statements by the last day of the sixth month after such fiscal year ends. The obligation
of a CPEO applicant to provide a copy of its annual audited financial statements and an
opinion for the most recently completed fiscal year as of the date it applies for
certification continues even if the CPEO applicant is certified as a CPEO before the IRS
has received the annual audited financial statements.
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. In response to this concern, this
notice provides transition relief for any CPEO applicant required to submit a copy of its

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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 §301.77052T(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,

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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).
V. DEFINITION OF CERTIFIED PUBLIC ACCOUNTANT
In accordance with section 7705(c)(3)(A), the temporary regulations require the
opinion regarding a CPEO's financial statements to be provided by a CPA who is
independent of the CPEO. For this purpose, §301.7705-1T(b)(4) and section 1.01 of
Rev. Proc. 2016-33 require a CPA to be independent as prescribed by the AICPA’s
Professional Standards, Code of Professional Conduct, and its interpretations and
rulings. Additionally, §301.7705-1T(b)(4) and section 1.01 of Rev. Proc. 2016-33
provide that, among other requirements, the CPA must file with the IRS a written
declaration that he or she is currently qualified as a CPA and authorized to represent
the CPEO applicant or CPEO before the IRS. A similar written declaration must
accompany the quarterly submission of the examination level attestation of a CPA that

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the CPEO applicant’s or CPEO’s assertion that it has withheld and made deposits of all
federal employment taxes for which the CPEO applicant or CPEO is liable for the
quarter, as required by §301.7705-2T(f), is fairly stated in all material respects. See
Rev. Proc. 2016-33, §2.06(2).
Treasury and IRS have received comments raising a concern that the
requirement that a CPA be authorized to represent the CPEO or CPEO applicant before
the IRS could conflict with CPA independence requirements of the AICPA. To ensure
that the CPA may be “independent” within the meaning of the AICPA guidelines,
Treasury and IRS anticipate revising the definition of “certified public accountant,” as set
forth in §301.7705-1T(b)(4) and section 1.01(3) of Rev. Proc. 2016-33, to omit the
requirement that the CPA file with the IRS a written authorization to represent the CPEO
applicant or CPEO before the IRS. Accordingly, the revised definition of “certified public
accountant,” to be provided in the final regulations, will refer to a CPA who—
(i) With respect to a CPEO applicant or CPEO, is independent of the CPEO
applicant or CPEO (as prescribed by the American Institute of Certified Public
Accountants’ Professional Standards, Code of Professional Conduct, and its
interpretations and rulings);
(ii) Is not currently under suspension or disbarment from practice before the IRS;
(iii) Is duly qualified to practice as a CPA in any state;
(iv) Files with the IRS a written declaration that he or she is currently qualified as
a CPA; and
(v) Meets such other requirements as the Commissioner may prescribe in further
guidance.

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Furthermore, section 2.06(2) of Rev. Proc. 2016-33 will be revised to require that
the written declaration accompanying the quarterly examination level attestation state
only that the CPA is currently qualified as a CPA.
VI. REQUIREMENT THAT A CPEO BE A BUSINESS ENTITY THAT IS NOT A
DISREGARDED ENTITY
The temporary regulations provide in §301.7705-2T(c)(2) that a CPEO may not
be a business entity that is disregarded as an entity separate from its owner for federal
tax purposes under §§301.7701-2 and 301.7701-3 (without regard to the special rule in
§ 301.7701-2(c)(2)(iv) that provides that such entities are corporations for federal
employment tax purposes 1). Commenters have explained that professional employer
organizations are structured in varied ways, and that it is not uncommon for professional
employer organizations to be entities disregarded as separate from their corporate,
partnership, or individual owner. Commenters emphasized that professional employer
organizations may choose such a structure for legitimate business reasons, such as to
reduce the overall compliance burden with respect to filing of state income tax returns.
Commenters expressed concern that precluding disregarded entities from being
certified as CPEOs would unfairly prevent a number of existing professional employer
organizations from applying to the CPEO program without undergoing restructuring.
To address this concern, and in recognition that disregarded entities are
generally treated as corporations for federal employment tax purposes, Treasury and
IRS anticipate that the final regulations under section 7705 will not prohibit a business

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Section 301.7701-2(c)(2)(iv)(B) provides that, with certain exceptions, an entity that is disregarded as an
entity separate from its owner for any purpose under §301.7701-2 is treated as a corporation with respect
to taxes imposed under Subtitle C—Employment Taxes and Collection of Income Tax (Chapters 21, 22,
23, 23A, 24, and 25 of the Internal Revenue Code).

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entity that is disregarded as separate from its owner under §§301.7701-2 and 301.77013 from becoming a CPEO. Instead, it is anticipated that the final regulations will provide
that a business entity that is disregarded as an entity separate from its owner for any
purpose under §301.7701-2 and that is wholly owned directly (including through one or
more disregarded entities organized in the United States) by a United States person (as
defined in section 7701(a)(30)) may apply for certification as a CPEO. Treasury and
IRS anticipate that, consistent with §301.7705-2T(d)(1), the final regulations will
continue to require that a CPEO applicant or CPEO must be created or organized in the
United States or under the law of the United States or of any state. Therefore, only
domestic disregarded entities would be eligible to apply for certification. Treasury and
IRS request comments on the appropriateness of allowing a disregarded entity that is
domestically organized but not wholly owned directly by a United States person to apply
for certification as a CPEO.
In addition, Treasury and IRS anticipate revising the definition of “responsible
individual,” as provided in §301.7705-1T(b)(13) and section 1.01(11) of Rev. Proc.
2016-33, to also include: (1) in the case of a disregarded entity owned by a corporation
or partnership, the responsible individuals of that corporation or partnership (as defined
by the regulations); and (2) in the case of a disregarded entity owned by an individual,
the individual owner. Finally, Treasury and IRS anticipate providing in the final
regulations that CPEO applicants and CPEOs that, but for their status as disregarded
entities would separately be members of a controlled group, are treated as members of
a controlled group for purposes of section 7705 and related regulations.

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The temporary regulations also provide in §301.7705-2T(c)(2) that a CPEO must
be a business entity described in §301.7701-2(a). Because an individual conducting
business through a sole proprietorship is not a business entity described in §301.77012(a), an individual may not be a CPEO under the temporary regulations. One
commenter expressed concern that this rule precludes certification of smaller
professional employer organizations that are operated by individuals through their sole
proprietorships. In response to this comment and to ensure parity between sole
proprietorships and disregarded entities that are wholly owned by individuals, Treasury
and IRS anticipate that the final regulations will expressly allow sole proprietorships to
apply for certification as a CPEO.
VII. EXTENSION OF APPLICATION SUBMISSION DEADLINE FOR JANUARY 1,
2017, EFFECTIVE DATE
A person seeking certification as a CPEO must submit a properly completed and
executed application for certification as a CPEO in the time and manner prescribed by,
and providing such information required by, §301.7705-2T, Rev. Proc. 2016-33, and
instructions accompanying the application. The IRS will issue a notice of certification to
a CPEO applicant that has been approved for certification specifying the effective date
of certification. The first sentence of section 6.03 of Rev. Proc. 2016-33 provides the
general rule that the effective date of certification will typically be the first day of the first
calendar quarter following the date of the notice of certification. However, the second
sentence of section 6.03 of Rev. Proc. 2016-33 provides the special rule that a CPEO
applicant that submits a complete and accurate application before September 1, 2016,
and is certified will have an effective date of certification of January 1, 2017, even if the
date of the CPEO’s notice of certification is after January 1, 2017.
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In recognition that this notice provides interim guidance regarding documents
that must be submitted as a part of an initial application for CPEO certification and will
directly affect applications by persons interested in seeking CPEO certification that are
already in progress, Treasury and IRS are extending the period in which a person must
apply in order to be eligible for an effective date of January 1, 2017, under the second
sentence of section 6.03 of Revenue Procedure 2016-33. CPEO applicants now have
until before October 1, 2016, to submit an application for certification in order to be
eligible for a January 1, 2017, effective date. That is, the effective date of certification
for a CPEO applicant that submits a complete and accurate application for certification
on or before September 30, 2016, and is certified will be January 1, 2017, even if the
date of its notice of certification is after January 1, 2017.
VIII. RELIANCE
Treasury and IRS intend that the final regulations under section 7705 and the
updated revenue procedure, when issued, will address the issues identified in this
notice in the manner indicated in this notice. Pending the issuance of final regulations
and the updated revenue procedure, taxpayers may rely on the guidance contained in
this notice.
IX. DRAFTING INFORMATION
The principal authors of this notice are Melissa L. Duce and Andrew K. Holubeck,
Office of Associate Chief Counsel (Tax Exempt and Government Entities). For further
information regarding this notice, contact Ms. Duce at (202) 317-6798 or Mr. Holubeck
at (202) 317-4774 (not toll-free numbers).

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