What is payroll outsourcing? (definition, considerations, and best practices)
In this guide, we explain what payroll outsourcing is and how teams may be able to benefit from it.
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1 minute
October 4, 2024
Kevin Flynn is a guest contributor. The views expressed are theirs and do not necessarily reflect the views of Rho.
Outsourcing payroll can increase in-house efficiency for businesses. It puts a critical function in the hands of professionals specializing in payroll processing. That removes the burden from your finance team, allowing them to work on core business functions like funding acquisition and cash flow management. This article will explain how payroll outsourcing works and how it can benefit your company. Some key takeaways to watch for:
A small business can spend a significant portion of its revenue on payroll costs.
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Payroll outsourcing is hiring a third-party provider to handle payroll-related tasks, including calculating and verifying wages and salaries, deducting and depositing funds for tax withholdings, ensuring pre- and post-tax benefit deductions are processed, printing paychecks, setting up direct deposits, and preparing payroll reports and journals for general ledger entries.
An outsourced payroll company will need access to your business bank account and employee time tracking system. This requires trust between the company contracting the payroll service and the service itself. A legally binding service agreement outlining the payroll outsourcing company's terms, conditions, and expectations solidifies that trust.
Companies that hire a payroll outsourcing provider may also want to outsource PEO or HR services. Look for a “full-service payroll provider” to handle that. Their services generally include managing employee benefits, tax filing, and human resource functions like onboarding and evaluating health insurance providers. Pricing will be based on the number of employees.
There are several reasons why a business should consider outsourcing payroll. Two of them are tax compliance and accurate tax reporting. A payroll specialist is trained in both functions. A third-party provider will have a payroll team of specialists working on your account. They’ll handle the payroll responsibilities, tax withholdings, and employee benefits.
Please consult with a tax professional to provide further guidance.
Payroll processing is time-consuming. Payroll administrators track and implement benefit deductions, wage garnishments, paid time off, unpaid time off, taxes, and payroll errors. They also need to be aware of data security issues that could arise during the onboarding when they gather employee data. A payroll company can handle all that for you.
The time employees spend processing payroll in-house and the salary of the payroll manager are costs. A small business can spend a significant portion of its revenue on those costs. It’s often cheaper to hire a payroll processing service. Prices for some payroll services are as low as $40 per month to handle basic payroll functions.
Small businesses cannot afford mistakes in payroll taxes. The penalties and fees assessed by state and IRS tax auditors can be significant. An established payroll service provider will guarantee that the right amount of taxes will be withheld and deposited on time. They assume the responsibility and liability for that, giving your company peace of mind.
Please consult with a tax professional to provide further guidance.
Payroll companies employ advanced security measures to protect employee information. That includes maintaining confidentiality on issues like wage garnishment, payroll mistakes, and corporate tax filing. Companies with a self-service payroll system or on-site benefits manager do not typically implement the same security protocols.
The costs of installing, maintaining, and repairing payroll software accumulate rapidly when you have a large workforce. Hiring the right payroll company eliminates that problem. They have their own software, and it’s included in what you pay them. That can simplify accounting processes like expense management and streamline your cash flow.
Companies that do payroll independently typically have one person responding to support issues. Outsourcing brings in a support team that can handle questions about direct deposit, benefit deductions, tax liability, and more. This also falls under “cost saving” because someone who would otherwise be handling service issues can be redeployed elsewhere.
Another option for small businesses that need assistance is payroll co-sourcing. This is a hybrid model in which payroll tasks are split between the business and the third-party payroll provider. For example, the payroll company handles tasks like data entry, tax calculations, and issuing paychecks or direct deposits. The primary business maintains control over the movement of payroll funds and making tax withholding deposits.
Most small business owners in the United States don’t need to deal with international payrolls. If you expand your services or hire specialized workers outside the country, that could change. International payroll solutions include multi-currency capability, compliance for the countries you’re doing business in, and international tax rates and tables.
The payroll needs of employees in other countries differ from those in the United States. For example, 35 hours is considered a full-time workload in France. Your company would need to pay overtime for anything over that. You don’t need to pay social security tax. That’s strictly for Americans. You may, however, need to pay US corporate income tax.
Benefits administration for a global payroll is different also. HR teams with companies doing in-house payroll will be responsible for checking health insurance requirements and maximum retirement contribution rules in the countries where you have employees. The business needs to do that every pay period if you’re actively recruiting. That’s a lot to keep track of.
Outsourcing involves transferring payroll data. Automation simplifies that, so you’ll want to find a payroll service with good technology. Best practices suggest opening a separate business bank account specifically for payroll. Many companies set up sub-accounts of their primary bank account to simplify the transfer of funds to cover payroll checks and direct deposits.
The next step is to decide what degree of outsourcing is appropriate. Turning “all things payroll” over to a third-party provider may not be the most cost-effective solution. Some businesses choose to co-source payroll, keeping some of the payroll tasks in-house. That gives the business control over the process without taking on a heavy workload.
A lot goes into choosing the right payroll outsourcing partner. Doing business with someone you trust is important, so find a payroll company with a good reputation. If you’re co-sourcing, you’ll need a partner willing to share the workload. Using payroll software is also an alternative. Many payroll software providers have live support teams.
Decide how often you want to run payroll. Some companies do it weekly, while others prefer biweekly or monthly. Once you choose a payroll cycle, run a sample check with a pay stub to ensure the system works properly. Your outsourced payroll company will likely do that anyway. If not, request it so you can see how the process works.
Outsourced payroll companies typically offer online portals where employees can view their take-home pay, benefits, and tax deductions. Directing them there rather than to a live support center is a great way to reduce corporate spending. It may take some time for employees to adopt this approach. Stay consistent with your messaging until it takes hold.
Employers are ultimately responsible for paying payroll taxes, even if they outsource payroll to a third-party provider. The payroll company can streamline your operations to make them more cost-effective, and it can take on the responsibility of tax withholdings and deposits. However, any IRS penalties for mistakes will be levied against the primary business.
IRS correspondence is always sent to the primary business, not the third-party provider. They do not send a copy to your payroll company. You can change your address to the payroll company, but the IRS does not recommend that. If mail is mishandled or responsible parties are not in the office, your firm could be on the hook for their mismanagement.
Federal tax deposits should be made via electronic funds transfer (EFT) to comply with IRS regulations on payroll. The IRS has a system called the Electronic Federal Tax Payment System (EFTPS) to facilitate that. Businesses are assigned an employer identification number (EIN) that needs to be provided to the payroll company if you’re going to outsource.
Please consult with a tax professional to provide further guidance.
Relinquishing control over your payroll is a big deal. Following these best practices will help make the search for a provider and the transition smoother. It’s also recommended that you don’t do this alone. Form a team at your company to investigate payroll outsourcing, then take a moment to review these and the “Frequently Asked Questions” section below.
Reputation should be critical in your search for a third-party payroll company. This is not a service you want to shop by price. Look for online reviews. Ask other business owners who they are using. You can also speak with your bank or check the Integrations Page on our website. Rho connects to accounting, ERP, and human resources companies with payroll partners.
Your company is ultimately responsible for employee tax withholdings and payroll tax deposits to local, state, and federal revenue departments. You can outsource those responsibilities, but you’ll pay the price for any mistakes. Read up on this and other regulations that affect how you pay your employees. Make sure you understand what your tax obligations are.
Your employees are your stakeholders. Consulting them about moving to an outside payroll company will make the transition easier for you and your management team. Many employers start the outsourcing process by conversing with their workers about what they want from a payroll company. This can also help you build a benefit package.
One alternative to outsourcing is using payroll software that automates much of the payroll processing. While this may not fully free you from dealing with payroll issues, it could simplify preparing and issuing paychecks and direct deposits. Review software alternatives before selecting an outside company to handle payroll and benefits.
Running a payroll in parallel with the payroll being run by an outsourced provider creates a redundancy to ensure accuracy. Think of it as a check and balance system that protects you if the payroll company goes down for any reason. When things run smoothly, you won’t need to process checks. When they don’t, you’ll have the ability to do so.
Payroll outsourcing is transferring payroll tasks and responsibilities to a third-party payroll provider. Depending on the agreement between the primary business and the payroll provider, the provider can be responsible for all or just some of the payroll tasks. Examples of payroll tasks are verifying wages, deducting and depositing payroll taxes, and printing paychecks.
Companies that outsource payroll can reduce the costs of managing and delivering employee compensation. Some outsourced payroll companies also offer human resources, which can streamline business operations. Those are both good ideas, but outsourcing will come down to your business needs. It’s a good idea if it improves your bottom line.
Gusto, Paychex, and ADP are three of the most well-known payroll companies. QuickBooks, a popular accounting platform for small businesses, also has a payroll service. If you do business internationally and need multiple currencies and global compliance, check out Rippling Global Payroll. For human resources, take a free demo of BambooHR.
Yes, you can do payroll yourself. However, if you want to do it accurately, you'll need the right payroll software. Doing it without software leaves too much room for error.
Companies can outsource their payroll at any time. It’s usually a good idea to start pricing payroll services when you get close to ten employees. Evaluate the cost and the time it takes to process payroll every week. You’ll know when it’s time to make a move.
Outsourcing payroll to another company can be a good move, but that doesn’t mean it’ll be easy. Carefully research the outsourcing process, understand your tax obligations, and fully vet any company you’re considering as a third-party payroll processor.
Once you do decide on one, Rho has direct integrations with one of the most popular options on the market today: Gusto. Through this direct integration, teams on Gusto can get set up quickly with Rho and start running payroll more efficiently. With Gusto, teams can look forward to not only improved payroll processes, but HR, too. By removing the friction from these critical work streams, teams can focus on other aspects of their business, all while remaining a compliant, efficient, and trustworthy.
Learn more about Rho’s integrations today.
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Note: This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.