Processing payroll can seem like a fairly straightforward task when you first start a business. Writing paychecks for a few employees shouldn’t be that hard, right? Why on Earth would you outsource payroll to an accountant or a payroll service provider?
If you’re reading this article, you might be in the process of learning that running payroll can eat up a lot more time than you may have expected. In fact, our research shows that it takes small business owners around 17 hours a month to run payroll by themselves.
For a lot of small businesses owners, outsourcing payroll can save a lot of time, money, and headaches. So if you’re having a hard time remembering the alphabet soup of FICA, FUTA, and SUTA, if you’re struggling to do all the math right, or if you simply find it difficult to stay organized enough to pay your employees on time, we feel your pain.
DIY payroll can take up a lot of mental bandwidth. And if you get an IRS notice or miss a payday? Well, you might be ready to shout forgetaboutit!
It’s not all doom and gloom, though. A lot of small businesses manage to keep everything straight (and you can always check out our guides to getting set up right and calculating payroll). But if you feel like you might be ready to outsource payroll, here are some signs that it’s something you should explore, as well as some information about choosing the right type of provider.
Outsourcing payroll can be a game-changer for small business owners. It enables them to focus their efforts on value-generating activities and mitigate much of the business risk associated with this highly regulated function. That said, before you establish an outsourcing arrangement, make sure you understand the duties you’ll be farming out.
Generally, outsourcing payroll entails paying a third party to calculate your employees’ and contractors’ wages, withhold the appropriate federal, state and local taxes, withhold voluntary and involuntary deductions, remit monies withheld to the appropriate entities and ensure your employees are paid accurately and on a timely basis.
Payroll providers also maintain your payroll records and provide an array of financial and regulatory reports to ensure you can run your business properly. Some providers go a step further and offer business support services that extend beyond the payroll domain.
Who outsources payroll?
The pool of small businesses that outsource payroll is incredibly diverse. From tech start-ups to farms and ranches, leveraging the expertise of an external payroll provider is common practice. This holds true for companies of all shapes and sizes, regardless of geographic reach and the complexity of their business models.
Some of the small businesses that reap the greatest benefits from outsourcing payroll include dentists, healthcare providers, insurance agencies, law firms, restaurants and bars, fitness centers and franchise-based service providers.
To learn more, we spoke with Thomas J. Brock, a Chartered Financial Analyst (CFA) and Certified Public Accountant (CPA) with over 20 years of industry experience.
“Recently, a client of mine that owns multiple critter control franchises outsourced his payroll tasks to a software provider. It has proved to be an incredibly shrewd move, allowing him to eliminate hours of back-office work from his schedule and devote the time to business development endeavors. His top-line growth figures have never been better.”
— Thomas J. Brock, CFA, CPA
How much does it cost to outsource to payroll?
The cost of payroll administration varies, depending on the direction you go. On the higher end of the spectrum you can actually hire someone to join your team and handle payroll-related functions. This approach gives you complete control over the payroll function, but it comes with a hefty price tag (tens of thousands of dollars) and a lot of compliance-related responsibility and risk.
Another route is to work with your accountant, who is likely either going to charge an hourly rate or a headcount-based rate coupled with a monthly or quarterly base fee. Once more, we caught up with Brock who shares an idea of what this can cost based on his industry experience. “Under either arrangement, running payroll through an accountant can roughly cost small businesses in excess of $5,000 annually, but of course it depends on who you work with.”
You can also work with traditional payroll service provider. You get human support with these firms, “but that comes at a cost that approximates that of the accountant option,” explains Brock. “Incidentally, technological advances have shrunk the number of traditional service providers in the market, but they still have a presence.”
“In my experience, one of the most economical ways to outsource payroll is via a payroll software provider because the most competitive platforms can address all small business needs for between $100 and $300 per month. Some solutions bundle in additional human resources functions and many can help with setting up an employee benefits plan.”
— Thomas J. Brock, CFA, CPA
Does outsourcing payroll make a big difference?
It’s not uncommon for new business owners to set up shop with a limited knowledge of the actual payroll process, which includes not only paying your employees, but also actions like processing new hire forms, quarterly payroll taxes, FICA taxes, and year-end tax forms for employees (such as W-2s and 1099s).
This lack of knowledge can be costly. In fact, the IRS issued penalties to businesses in 2023 that amounted to over $4.6 billion, for late or erroneous or payroll tax payments.
In addition to messing up tax filings, there are a number of payroll errors small businesses often make. Input errors, erroneous pay amounts, and inadequate tracking of details like vacation and sick time are few of the mistakes that can lead to extra work (and unhappy employees). And payroll mistakes aren’t just limited to new businesses. In a survey conducted by Ernst & Young, 54 percent of all business owners said that their current payroll process had room for improvement.
In deciding whether to use an external payroll provider, you should also consider the fact that your time and mental bandwidth are finite resources. Even if you do everything perfectly, running payroll yourself means you’re not as involved with customers and that you don’t spend as much time dedicated to more strategic activities.
To make things simple for you, here are the big red flags that often indicate a small business is ready for outside help.
7 signs it’s time for payroll outsourcing
Sign 1: Running payroll late
Many of your employees don’t have much wiggle room when it comes to their personal finances. For example, the Federal Reserve recently found that 40% of US households can’t afford to pay for an unexpected $400 expense.
When you’re late on a pay run, that can mean really messing with the lives of your employees (not to mention the trust you’ve built with them). So if payroll ever slips off your radar — or if bank holidays regularly throw off your timing — you might want to consider a comprehensive payroll service that actively reminds you to get your paychecks out (or does them for you).
Sign 2: Making data entry errors.
Under or overpaying employees is never a good idea, but business owners who are overwhelmed by the amount of paperwork they have to deal with often make mistakes during harried late-night payroll sessions. You’ve got to pay employees on time, but you’ve also got to set the right number of allowances, deduct the right amount, and accurately enter the number of hours worked (among other things). When you get any of the numbers wrong, it means having to correct your previous payroll, and it can also mean your tax filings will include mistakes if you don’t catch them in time. Worst of all, paying employees or contractors too little can cause major friction with your team.
Outsourcing payroll reduces input errors by reducing the number of steps you have to take, and by doing all the math for you. If you still manage to mess things up, corrections are a lot easier to run, or there may even be someone to handle them for you (depending on your provider).
Sign 3: Missing tax deadlines.
In most states, a typical small business has at least eight separate payroll-related tax filings to make each year: Quarterly filings of IRS Form 941, plus analogous state filings. Getting these filings processed on time is yet another burden that can sneak up on small business owners. And making late filings or late deposits can be costly.
Most payroll services make these filings for you. Note that some will charge an extra fee for these regular filings, so make sure you understand all the costs that are included before you pick a provider. See more tips here.
Sign 4: Being late with W-2s or 1099s
In addition to the state and federal forms you file on behalf of your company, you also owe employees and contractors wage statements to help them do their annual filings. For the previous year, W-2 forms for employees and 1099 forms for contractors must be delivered by January 31. They also must be filed with the Social Security Administration and the IRS by January 31. Penalties for late W-2 filing start at $50 per form and increase the later they are filed.
Creating your W-2s and 1099s is also a service that most payroll providers handle, typically for an additional fee.
Sign 5: Experiencing cash flow issues (especially around tax time)
Even the most successful small businesses struggle with cash flow from time to time. Maybe your business has seasonal ebbs and flows, or maybe one-time expenses can throw your operating budget off-kilter. Whatever the issue, a good payroll service can help you manage cash flow in a few ways:
- Giving you good aggregate payroll data for making better cash flow projections
- Making you eligible for pay-as-you-go workers comp (which does not require budget-busting lump-sum premiums)
- Withholding the payroll taxes you owe each pay run so you don’t have to come up with all the funds at once
- Integrating with your accounting software so you can see your whole financial picture in one place
- Paying employees through direct deposit so there are no lost checks, and no lags between when a check is written and when the funds are drawn from your account
Sign 6: Struggling with deductions for benefits and garnishments
If you offer benefits, you’ll have the added complication of deducting and withholding the contributions employees make.
From time to time, you’re also likely to get notice of a court judgment (like alimony or child support) or tax levy against one of your employees. When that happens, you’ll be responsible for deducting and remitting a portion of their income to the appropriate party each pay period. It’s another little thing most small business owners would rather not deal with.
Whether you’re deducting benefits or wage garnishments, payroll outsourcing services usually make it easy to automate the process. It’ll be one less thing for you to think about (and potentially mess up).
Sign 7: If you bill hourly for professional services
Taking time to run payroll means you have to stop working on something else. If you bill hourly for the amount of time you work or the number of clients you see (like doctors, lawyers, designers, architects, or other professionals might), it means there’s a very real cost to running payroll.
For example, if you make $100 an hour and you spend four hours a month on payroll, you’re essentially giving up $400 in earnings. The math varies depending on what your billing rate is, but it should be easy to do the cost-benefit analysis by looking at how much a payroll service costs.
While payroll can be one of the trickier parts of operating a business, you can use our online payroll calculator to do most of the heavy lifting. In just a few clicks, calculate your employee’s gross pay, net pay, and federal and state withholdings (for any state) without breaking a sweat.
This list isn’t exhaustive, but it should give you a decent sense of the sorts of red flags you should be looking for. Bottom line, a good external payroll company should give you more time to do what you do best while minimizing the distractions, expenses, and mistakes that can happen when you do payroll yourself.
Outsourcing payroll pros and cons to know
There’s advantages and disadvantages to payroll outsourcing that employers will want to consider.
What are some benefits of outsourcing payroll?
- More efficient operations. If running payroll is outside your skill set, you may end up wasting valuable time figuring out a process. Outsourcing payroll eliminates time-consuming tasks that can prevent business owners from growing their businesses and achieving their strategic objectives.
- Mitigate regulatory risk. Payroll is a highly regulated aspect of business, and keeping up with the compliance for the various federal, state and local regulations can be a heavy lift. By leveraging an experienced payroll provider, this risk can be virtually eliminated (and can prevent potential unwelcome attention from Uncle Sam).
- Analytics and reporting. Many small businesses lack granular visibility into their payroll, which is typically the most significant aspect of an annual budget. It’s the type of blind spot that can limit performance analysis and hinder decision-making ability. Fortunately, payroll outsourcing can immediately enhance reporting and analytic capabilities.
- Smooth experience for workers. Getting paid accurately, on time, and in a convenient manner is likely on the minds of most employees and contractors. Some businesses are able to do this on their own, but many others take confidence in knowing a PSP has this responsibility.
Are there disadvantages to payroll outsourcing?
There are four potential disadvantages for businesses who choose to use software or a service to manage their payroll:
- Outsourced payroll costs money. Every penny matters for some small businesses — especially newer businesses that don’t have much revenue yet. If spending $40 a month (or potentially a lot more) on payroll services will literally put you into bankruptcy, then it’s best to avoid the additional expense and do things yourself.
- Loss of control. Some business owners like to sign every check and enter every field in their accounting ledger. It helps them feel in control of their business, and it also gives them have a very close relationship with their books and their employees. While most payroll services give employers the power to approve each pay run before it goes out, they don’t allow the same sense of intimacy with your books.
- Switching at the wrong time can cause headaches. Payroll providers typically make quarterly tax payments four times a year. Switching to an outside payroll provider mid-quarter (or mid-year for some providers) can result in some tricky tax issues. To make sure you have a smooth transition, your first pay run with a new provider should generally be at the beginning of a quarter or calendar year.
- Lack of trust in providers. All outsourced providers are not made equal. Some local payroll services are terrific, and some are merely terrific salesmen. Some software providers check all the boxes, and other software can come with expensive surprises. If you don’t have confidence with your provider, it’s going to slow you down, so make sure you do your homework before signing up.
User friendly with top-notch support
I’ve been in business for over 15 years and after trying several payroll providers, I highly recommend OnPay. Their platform is simple to use, fairly priced, and the customer service they provide is outstanding.
— Cesar Montalvan, MP Dental Associates DDS PC
What’s the best way to outsource your payroll?
There are a number of viable solutions available that can make payroll less of a burden. We can’t definitively say there’s a perfect solution for you (although we’d like to think nobody does payroll software better than us). But in the interest of fairness and impartiality, here are the options most businesses consider when it’s time to seek payroll help:
Increase staffing. Many new business owners, overwhelmed by mounds of paperwork, end up hiring additional staff to handle payroll and related tasks. Whether you staff up internally or hire a part-time bookkeeper on a contract basis, adding headcount can mean adding the bandwidth you need to handle payroll. This is a great choice because it means you’ll have someone new who can potentially help out with other tasks as well. But if you hire someone who’s just learning the ropes, it can wind up meaning more work for you (at least in the interim) as they get up to speed.
Sign up for payroll software. There is a lot of great payroll software on the market. You should be able to find a solution that can do anything from calculating your payroll to paying employees to filing taxes for you. Some software even handles benefits and HR or integrates with your accounting software. Once you enter employees’ and contractors’ wage information each pay period, good outsourced payroll software should do everything else automatically.
That’s the good news.
The bad news is that there’s so much payroll software to choose from that it can be hard to find the right one. Higher priced offerings may give you more features and functionality than you need. Lower priced options may have hidden costs or exclude important features like automatic tax filings and payments. Before picking a software provider, check its ratings and reviews to make sure that you’re getting what’s advertised (and that businesses like yours appear to be happy customers). It may also be helpful to use this checklist to compare payroll solutions.
Use a traditional payroll service provider. If you want the human touch, a traditional payroll service could be the way to go. Each pay period you’ll send them all your wage information, then they’ll do all the math, cut the checks, and handle your taxes. Payroll services have the disadvantage of costing a little more than payroll software with similar functionality, but some business owners feel more comfortable with having a go-to person for their payroll needs. As with any payroll-related decision, make sure to check ratings and reviews of any service you’re considering.
Go through your accountant or bookkeeper. Modern accountancies are starting to offer payroll more frequently. Working with your accountant is usually the same concept as using a payroll service: You send them your payroll information before each run and they handle everything else. Sometimes they’ll use payroll software, and sometimes they’ll perform their own calculations. The cost and service level vary dramatically from accountant to accountant.
Every business has its own needs, so don’t feel like there is any right or wrong way to do this. You just have to decide how much time you want to spend on payroll, how much money you want to spend, and how much hand-holding you need. Your goal should be to find the solution that frees you up to do your best work. Whether that means hunkering down with a calculator and a notepad or going with a payroll outsourcing solution, we hope you have the information you need to get on the right path.
