Can I use a PEO and still be a Small Business Government Contractor?

This question comes up from time to time both for small business set-aside procurements, and for the SBIR (Small Business Innovation Research) program.  In both cases, there are questions about the number of employees a company has.  If a small business is using a PEO (Professional Employer Organization), then their “employees” actually receive W-2s at year end from the PEO and not the small business.  Does this mean (for Government contracting purposes), they have no employees, or could it mean the number of “employees” is actually the total number of employees of the PEO?

In either case, this could mean trouble for the small business.  Fortunately, this issue has been formally addressed in 13 CFR (Code of Federal Regulations) part 121 – Small Business Size Standards:

         13 CFR 121.103 How does SBA determine affiliation?(b)(4) now states “(4) Business concerns which lease employees from concerns primarily engaged in leasing employees to other businesses or which enter into a co-employer arrangement with a Professional Employer Organization (PEO) are not affiliated with the leasing company or PEO solely on the basis of a leasing agreement. “

            13 CFR 121.106 How does SBA calculate the number of employees? now states: (a) In determining a concern's number of employees, SBA counts all individuals employed on a full-time, part-time, or other basis. This includes employees obtained from a temporary employee agency, professional employee organization or leasing concern. SBA will consider the totality of the circumstances, including criteria used by the IRS for Federal income tax purposes, in determining whether individuals are employees of a concern. Volunteers (i.e., individuals who receive no compensation, including no in-kind compensation, for work performed) are not considered employees.

In short, there is no issue with a small business (or any other business) using a PEO for their employment of individuals and in contracting with the Federal Government.  The employees the small business “leases” from the PEO are the only “employees” that count toward their size standard and they are considered “employees” of the small business.