When you need help with your payroll, should you hire a payroll service or a PEO?
- When a business hires a PEO for payroll, the PEO becomes co-employer, and assumes the responsibility of managing the client's payroll and employee taxes by using their own tax identification numbers, rather than the client's.
- If you choose a standard payroll processor, you are responsible, as an employer, to be insured for worker's compensation if your state's laws require it.
- Payroll frequency defines how often your employees are paid. The standard payroll schedules include weekly, biweekly, semimonthly and monthly.
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).
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 it, you'll be 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.
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What is a PEO payroll?
When a business hires a PEO for payroll, the PEO becomes 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's relying on the PEO to accurately process payroll, and ensure compliance in all states and municipalities, according to Andrew Lubash, founding partner and CEO 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 in order 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 payroll services 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.
Is it more beneficial to choose a standard payroll service or a PEO payroll service?
With standard payroll services, employers retain sole responsibility of their workforce while offering standard HR services, according to Simon Hansen, founder and sports blogger of Best Sports Lounge.
"PEOs, on the other hand, do all the things that standard payroll services do, only better and with added benefits," Hansen said. "Having a partner company means that not only do you get to save on costs, you also make sure that your employees get the best service they need, all while maintaining full control of your staff."
Standard payroll services do not handle many administrative responsibilities, while PEOs can provide complete HR services, including health insurance, employee onboarding and training, 401(k) and retirement plans, workers' comp, new hire recruiting, and regulatory compliance assistance.
With payroll service providers, you are responsible for the payroll taxes, insurance and compliance programs, according to Brian Cairns, CEO of ProStrategix Consulting.
"They [payroll services] do provide options, but in the end, if they are wrong, you get the bill," Cairns said.
There are a few differences between standard payroll services and PEO payroll services in terms of employer record, workers' compensation, pricing and ease of use, according to Nidhi Joshi, business consultant for iFour Technolab Pvt. Ltd. Joshi explains these differences below:
- Standard payroll services provide payroll processing for the business, and the business remains the employer of record. If you choose a standard payroll service, you are responsible, as the employer, to be insured for worker's compensation if your state's laws require it.
- PEO payroll services provide payroll processing with the PEO as the employer of record, also known as co-employment. This is not to be confused with employee renting. Your business is responsible for recruiting, hiring and training, even though the PEO is the employer of record.
Joshi says that there is usually a pay-as-you-go program that allows you to pay the PEO each pay period based on your actual payroll, similar to how a standard payroll company charges for its services.
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.
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."
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.
Why should you not use a PEO for payroll?
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. "A secondary consideration is that most PEO software is less user-friendly than standard payroll services. This is largely due to the complexity and nature of PEO businesses."
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.
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.
Overall, a PEO allows you to outsource your business's payroll and HR tasks. They can manage payroll, pay taxes, maintain and sustain workers' compensation insurance, and provide a solid benefits administration. A PEO works as a co-employer that shares employee responsibilities with your business.
When choosing between standard payroll services and PEO payroll services, it's best to consider the size and needs of your business.
While there are many pros and cons to using an employer organization for payroll, the biggest takeaway here is that using the PEO model can be a great way for entrepreneurs and small business owners to lower their employer costs. [To learn more about PEO services, read our review of The Best PEO Service Providers of 2020.]