Payroll outsourcing is the practice of transferring some or all payroll-related administrative functions from an organization's internal staff to an external service provider. Depending on the arrangement, a provider may calculate employee wages, process payroll, prepare payslips, administer deductions, prepare employment tax returns, make tax payments, and provide payroll reporting.
Thank you for reading this post, don't forget to subscribe!Thank you for reading this post, don't forget to subscribe!Businesses may outsource payroll to a payroll service bureau, payroll service provider, accounting firm, professional employer organization, or other specialized payroll company. The scope of services depends on the agreement between the employer and the provider.
Reasons for outsourcing payroll
Payroll can require specialized knowledge of employment regulations, taxation, deductions, reporting requirements, and payment schedules. Businesses may therefore outsource payroll to reduce the amount of administrative work performed internally or to obtain access to specialized payroll systems and personnel.
For some organizations, outsourcing can reduce the need to employ dedicated payroll staff and maintain payroll infrastructure. It can also allow managers and administrative employees to spend more time on other business activities.
However, outsourcing does not necessarily reduce costs in every situation. The total cost depends on factors such as the number of employees, payroll frequency, geographic locations, complexity of compensation, tax requirements, integrations, reporting requirements, and the services included in the provider's contract.
Types of payroll outsourcing
Payroll outsourcing arrangements vary in scope. Common arrangements include the following:
Payroll service providers
A payroll service provider (PSP) is a third party that performs payroll and payroll-related functions on behalf of an employer. In the United States, for example, a PSP may prepare employee paychecks, prepare employment tax returns, file certain returns, and make federal tax deposits when authorized by the employer.
The exact responsibilities of the provider depend on the contractual arrangement and applicable law. The U.S. Internal Revenue Service identifies payroll service providers and reporting agents among the common forms of third-party payroll arrangements.
Payroll service bureaus
A payroll service bureau specializes in processing payroll for multiple businesses. A bureau may calculate wages and deductions, produce payslips, process direct deposits or other payments, and assist with payroll reporting and tax administration.
Payroll bureaus have traditionally provided services to businesses that do not maintain a dedicated internal payroll department. Modern payroll bureaus may use cloud-based payroll systems to collect employee information, process payroll, produce reports, and provide online access to payroll records.
Fully managed payroll services
A fully managed payroll service transfers a broader range of payroll responsibilities to an external provider. Depending on the agreement, the provider may manage payroll calculations, employee payments, payroll records, tax filings, reporting, and related administrative tasks.
Fully managed arrangements are generally intended for organizations that want to reduce the amount of payroll administration performed internally. The employer normally remains responsible for providing accurate employee and compensation information and for complying with applicable employment requirements unless the particular legal arrangement provides otherwise.
Services commonly included
The services included in payroll outsourcing vary among providers. They may include:
- Employee payroll calculations
- Calculation of wages, salaries, overtime, bonuses, and other compensation
- Calculation and administration of payroll deductions
- Preparation of payslips
- Direct deposit or other employee payment processing
- Payroll tax calculations
- Preparation and filing of payroll tax returns
- Tax withholding and payment administration
- Year-end payroll reporting
- Payroll record keeping
- Employee self-service portals
- Payroll reports for accounting and management
- Integration with accounting, human resources, and time-tracking systems
According to the Internal Revenue Service, a payroll service provider can prepare the paychecks, file employment tax returns, file other types of returns, and make federal tax deposits for an employer under its authorization.
Costs of payroll outsourcing
The price for outsourcing of payroll will vary according to the provider, the number of employees, how often the payroll is calculated, and the payroll requirements of the employer.
A provider may calculate the price on a basis of a subscription fee, a per employee fee, a per payroll fee, or any combination of these pricing models. Other fees can be charged by the providers for additional services, such as tax filings, year-end forms, employee onboarding, integrations, advanced reporting, or multiple jurisdiction payroll processing.
Payroll outsourcing can lead to reduction in internal costs in such areas as payroll personnel, software support, training, and administration. Nevertheless, the external payroll process can be more expensive than an internal one in some cases, especially for organizations with complicated payroll processes.
Advantages
Potential advantages of payroll outsourcing include:
- Reduced administrative workload: Routine payroll processing can be transferred to an external provider.
- Access to specialized expertise: Providers may employ payroll and tax specialists who monitor payroll requirements.
- Technology access: Businesses may gain access to payroll software without developing or maintaining the system themselves.
- Automation: Automated calculations, employee portals, reporting, and payment processes can reduce manual administration.
- Scalability: An external payroll system can support organizations as their workforce changes.
- Administrative consistency: Standardized payroll procedures can help businesses manage recurring payroll activities.
Risks and disadvantages
Payroll outsourcing can also introduce risks and additional costs. An organization transfers part of its payroll operation to another party and therefore becomes dependent on the provider's systems, procedures, security controls, and service availability.
Potential disadvantages include:
- Service fees and additional charges
- Dependence on an external provider
- Reduced direct control over payroll processing
- Data security and privacy considerations
- Integration problems with existing business systems
- Errors caused by incorrect information or processing
- Contract limitations and service-level requirements
- Difficulty changing providers or migrating historical payroll data
Given that payroll service providers work with important employee and financial data, companies may consider the security policy, access control, data protection, reliability, support, and business continuity of a particular payroll provider before signing a contract.
Employer responsibilities
Just because payroll functions are outsourced to a payroll service provider does not mean that all duties of an employer get transferred to this third-party company. The respective responsibilities will vary depending on the applicable legislation and nature of a third-party agreement.
The IRS of the United States notes that employers are normally responsible for their employment tax obligations even when they use third-party payroll providers. In case if the latter fails to deposit necessary tax amounts, then the former remains responsible for all taxes, fines, and interest on them.
There are different third-party agreements that result in different legal consequences. The IRS differentiates between a payroll service provider, a reporting agent, agent appointed under a specific provision of federal law, and a certified professional employer organization.
This is why an employer interested in payroll outsourcing should determine what responsibilities he or she will keep and what will be transferred to a third-party company.
Payroll outsourcing and payroll software
Payroll outsourcing and payroll software are similar yet distinct methods of administering payroll.
In case of payroll software, the firm itself runs the payroll system. This software can be used to automate various processes such as calculations, deductions, payroll reports, employee information, and others, whereas the employer runs the payroll system and does the payroll-related work.
With payroll outsourcing, the outside company carries out some or all payroll processes. This outside company can utilize its own payroll software as part of the process.
There are firms that have a mixed approach with the internal employees running payroll software and an outside company helping out in filing taxes, compliance, technical issues, or other specific tasks.
| Approach | Who performs most payroll processing? | Typical characteristics |
|---|---|---|
| In-house payroll | Employer's employees | Greater internal control but requires staff, systems, and payroll expertise. |
| Payroll software | Employer using software | Automates payroll activities while leaving operational responsibility with the employer. |
| Outsourced payroll | External payroll provider | Transfers some or many payroll administration functions to a third party. |
| Hybrid payroll | Employer and external provider | Responsibilities are divided according to the service agreement. |
Payroll outsourcing for construction companies
Construction companies may have payroll requirements that differ from those of businesses with a stable office-based workforce. Construction employers can have employees working across multiple projects, locations, job classifications, or pay arrangements.
Depending on the jurisdiction and employment arrangements, construction payroll may involve overtime, project-based labor allocation, time tracking, prevailing wage requirements, union rules, certified payroll reporting, or integration with job-costing systems.
These requirements can make payroll administration more complex when compared with a simple salaried workforce. Construction companies may therefore use specialized payroll software or payroll outsourcing services designed to accommodate construction-specific payroll and reporting requirements.
Choosing a payroll outsourcing provider
Businesses considering payroll outsourcing commonly evaluate providers according to factors such as:
- Services included in the contract
- Pricing structure
- Payroll processing capabilities
- Tax filing and payment services
- Supported countries, states, or jurisdictions
- Employee self-service functionality
- Accounting and time-tracking integrations
- Data security practices
- Customer support
- Service availability and reliability
- Data export and migration capabilities
- Contract terms and termination procedures
Businesses may also verify how payroll tax payments are handled. The IRS recommends that employers using third-party payroll providers maintain visibility over their tax accounts and verify that required deposits and payments are being made.
See also
- Payroll
- Payroll service bureau
- Payroll software
- Human resources management system
- Professional employer organization
- Job costing
- Certified payroll