There's always the option for small business owners to manage payroll processing on their own, but the thought of gathering employee information, issuing paychecks, and recognizing required taxes and withholdings can be daunting. When considering the alternatives to DIY payroll, you have multiple options, including standard payroll services and payroll software. But, if in addition to payroll, your business needs other services – such as HR, compliance and taxes – consider working with a professional employer organization (PEO).
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Whether you're a new business considering a PEO or a business owner looking to manage your own payroll administration more efficiently, there are several key pieces of information you'll want to gather and some decisions to make to ensure your payroll is operating smoothly.
- Employer identification number (EIN) and state tax ID. Your business needs a unique identifier, and for the purposes of federal filings, you're required to have an EIN to process payroll and submit payroll taxes. For some states, an EIN is all you need, while for others, you may also need a state tax ID for your business.
- Employer information. It's crucial to have each employee complete Form W-4. With that form, you're able to calculate how much federal income tax to withhold from your employees' paychecks. Employees should also complete their respective state withholding forms.
- Payroll scheduling. You need to decide on your business's payroll frequency, which determines how often you will pay your employees. The standard payroll schedules include weekly, biweekly, semimonthly and monthly. Make sure your schedule follows state law and industry requirements.
- Tax withholding. From each paycheck, your business is obligated to calculate and withhold the correct amount of taxes. Once your calculations are accurate, make sure your employees understand how to read their pay stubs. This can improve employee trust and satisfaction in the long term.
- Pay taxes. This is the final step of payroll processing. Due dates vary for various taxes, so it's a good idea to make note of each date. If you're using PEO payroll, ask about the tax filing process and if there are any guarantees or liabilities in the event an error is made.
What is a PEO payroll?
When a business hires a PEO for payroll, the PEO becomes a co-employer and assumes the responsibility of managing the client's payroll administration and employee taxes by using its own tax identification numbers, rather than the client's.
The PEO is generally responsible for payroll-related tasks, including paying wages, depositing employment taxes and issuing employee W-2s. PEO payroll helps administer payments to full- and part-time employees, and occasionally vendors and contractors. Your business still maintains responsibility for day-to-day operations and management.
When a business engages the services of PEO, it relies on the PEO to accurately process payroll, and ensure compliance in all states and municipalities, according to Andrew Lubash, founding partner and Principal of Prestige PEO. "PEOs report federal and many state payroll taxes under the PEOs tax identification number," Lubash told business.com. "In some instances, the PEO's state unemployment rate may be lower than that of the client company, thus generating a savings."
Lubash says that to reduce risks, clients should ensure they partner with a PEO that's an IRS-certified PEO (CPEO) and is accredited by the Employer Services Assurance Corporation (ESAC), because they are required to maintain strict financial and tax reporting requirements, provide financial assurance, and adhere to industry best practices.
What are the differences between standard payroll services and PEO payroll services?
For many businesses, using a payroll service is an assurance that their company's payroll processing is done correctly. Plus, having one less task to manage can make filing taxes and accounting for the fiscal year much easier. When comparing a standard payroll service and a PEO payroll service, there are five key differences.
- Employer of record: Standard payroll services provide payroll processing for your business, but your business remains the employer of record. PEO payroll services provide payroll processing with the PEO as the employer of record. This type of structure is known as a co-employment model.
- Liability: With standard payroll services, employers retain sole responsibility for their employees and compliance, whereas businesses that partner with a PEO share the liability with the PEO. The best PEO service providers are well-versed in federal, state and industry-specific legal risks and compliance obligations.
- Workers' compensation: If you choose a standard payroll service, it is your responsibility to have the proper worker's compensation (workers' comp) coverage based on your state's requirements. If you partner with a PEO, they can take care of obtaining the correct workers' compensation insurance and handling all workers' comp claims for you.
- Administrative HR tasks: Standard payroll services typically do not handle many administrative responsibilities, while PEOs can provide complete HR services. This can include handling employee onboarding and training, health insurance administration, 401(k) and other retirement plan management, new hire recruitment, and regulatory compliance assistance.
- Employee benefits: PEOs can offer competitive employee benefit packages with group policy rates. This is something small businesses typically won't have access to with a standard payroll service.
Is it more beneficial to choose a standard payroll service or a PEO payroll service?
As with most things in business, the answer depends on your business's specific needs. You should evaluate the ways in which a PEO and a standard payroll service differ, and weigh out the pros and cons. There are a few questions you can ask to determine which option is most beneficial to your business:
- Do you want to remain the sole employer of your employees?
- Do you want sole liability or shared liability over your employees?
- Do you want to handle workers' compensation, or pass that responsibility to another party?
- Do you need access to more competitive employee benefits?
- How much time and money can you spend on managing employee payroll yourself?
If you want to remain the sole employer over your staff, and you have the time and resources to process payroll with a standard payroll service, that will likely be your best option. There are several highly-rated online payroll service providers on the market, and some of them even offer PEO plans as well.
If you want additional assistance with processing payroll, managing workers' compensation claims and maintaining legal compliance, partnering with a PEO can be a great option. Small and midsize businesses that can't manage their payroll or HR functions on their own often benefit from a PEO partnership.
What does PEO payroll cost?
The cost of PEO payroll can vary depending on several factors, including employee salaries and the employee benefits that a client wants to take advantage of. Most PEOs charge a flat fee per employee or a percentage of each employee's salary.
- Payroll percentage. This is a percentage of the total payroll for each pay period, plus local, state and federal taxes, workers' compensation, and employer practice liability insurance (EPLI).
- Per employee, per month (PEPM). The PEPM fee is calculated directly by the PEO when you sign up.
The more employees you have, the greater the discount per employee that is offered, according to Josh Knauer, adjunct professor at Carnegie Mellon University and former tech entrepreneur. "Rates usually start between $100 and $150 per month, per employee and can get as low as $50 to $80 per month, per employee for larger companies," Knauer said. "That fee usually covers all basic HR services offered by the PEO."
The costs calculated by percentage of payroll vary and tend to be directly tied to the amount of payroll you do with the company, according to Alexander Kehoe, co-founder and operations director of Caveni Digital Solutions. "In our experience, 3 to 5% has been fairly standard in our dealings, but smaller companies should be wary of companies that are asking for between 10 and 15%," Kehoe said.
Why should you use a PEO for payroll?
PEOs handle all compliance and help their clients avoid legal missteps and mistakes when hiring and managing employees.
It can reduce your liability and time spent on payroll-related services.
One of the major benefits of using a PEO for payroll-related services is that they take a large portion of the work away from a business's employees, according to Michael Frederick, CEO of Flatirons Development. "This makes it easier for businesses to focus more of their time on their day-to-day operations, rather than managing simple payroll operations," Frederick said. "At the same time, since a PEO payroll service assumes all responsibilities related to filing taxes for a company's employees, this takes a significant amount of liability away from small or medium-sized business owners. This can be especially beneficial if a company is still in the early stages of establishing itself."
It can save you money on offering competitive employee benefits.
Another advantage of using a PEO for payroll is that it can help you save money on the benefits you offer your employees. Since PEOs work with many employees from different clients, you can take advantage of the buying power they provide when searching for group rates on health insurance, workers' compensation insurance, retirement plans and other employee benefits. These rates are generally significantly less expensive than if you were to seek them out on your own.
It can help you minimize risk and maintain legal compliance.
One of the most impactful reasons to use PEOs is because of the many complicated and always changing regulations that affect both payroll and general employment services. Working with a PEO allows companies to focus on their core lines of businesses, and allow a dedicated co-employment team to handle many administrative duties.
Why should you not use a PEO for payroll?
It can have a higher per-employee cost.
While there are numerous benefits of using PEO payroll, there are some downsides. Frederick says that one downside to using PEO payroll services is that there is often a higher cost per employee compared to when a business manages payroll on their own.
"Unfortunately, while this extra cost can often be managed by larger companies, small and medium-sized enterprises might often have trouble covering the extra cost per employee," Frederick said.
Because of this cost imbalance, it can be more beneficial for small and medium-sized businesses to look for other alternatives. However, this decision should be made on a case-by-case basis, as there are many situations where a PEO can be the best option for a small company.
You lose control over some internal processes.
Another major drawback is loss of control of internal processes. Most small businesses are run by hands-on owners, and many find it difficult, if not impossible to relinquish any type of control.
Finally, companies that want their employees to have an in-house contact handle their HR and payroll tasks may be better without a PEO. Customer service shortfalls and a lack of personal touch in communication between PEOs and employees are two factors that can influence a company to keep their payroll and HR services in-house. If your firm is tightly knit and values the personal touch as well as flexibility, a PEO may not be the right fit.
Hiring a payroll services provider rather than a PEO may give you the best of both worlds. You will lighten the load of your in-house team while retaining control over your processes and systems. This will also allow you to stay up to date on any changes to payroll laws and regulations.
If you have specific benefits you'd like to use and want to remain in control of payroll processing, a PEO is most likely not the best fit for your business.
It is better suited for smaller organizations.
Although some PEOs can service large enterprises, Lubash believes that large businesses with thousands of employees are more likely to have fully staffed payroll, human resources, risk management, and retirement services departments and may not benefit from the economies of scale that PEOs provide.
When choosing between standard payroll services and PEO payroll services, it's best to consider the size and needs of your business.
Additional services provided by PEOs
In addition to payroll services such as handling paychecks and taxes, PEOs can provide additional services:
- Human resources services
- The administration of health insurance and other employee benefits
- Employee onboarding and training
- 401(k) and retirement plan administration
- Workers' compensation insurance
- New hire recruiting
- Regulatory compliance assistance
As the above list clearly illustrates, there is a lot more to PEOs than just payroll. Firms that are growing and are finding themselves buried under administrative paperwork can find a significant benefit in enlisting the services of a PEO. Issues such as compliance and payroll taxes can keep your HR and payroll departments busy on tasks that may not best address the firm’s needs. Outsourcing the less employee-focused work can allow your HR team to focus on such initiatives as employee development and satisfaction.
There are pros and cons to PEOs, and appropriateness of such services will differ from company to company. There are many advantages to streamlining these workflows with a PEO, but remember, the firm will have to relinquish some amount of control and flexibility. If you decide that a PEO is right for your business, some of the top options you may want to consider are Oasis and TriNet. Learn more in our comprehensive Oasis review and our complete review of TriNet.
Additional reporting by Joshua Stowers. Some source interviews were conducted for a previous version of this article.