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What is payroll outsourcing?

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It’s rather ironic: businesses need employees to perform work, but taking on employees produces more work. Since the employer–employee relationship is heavily regulated, employers need to comply with requirements for everything from employee safety to accommodations for disabilities. Payroll processing alone can eat up significant resources. That’s why payroll outsourcing is popular, especially among small to midsize employers.

What does payroll processing involve?

Employees require a paycheck – and they expect their paychecks to be accurate and arrive on time. To achieve this, employers need to track hours worked, calculate earnings and distribute pay to employees.

Although that sounds pretty simple, payroll involves many components and can be complex. In addition to calculating the pay they owe to workers, employers need to determine what Medicare, Social Security and unemployment taxes they owe to the relevant government agencies. Employers that offer benefits may have even more calculations to carry out, including paid time off and payroll deductions or garnishments. If workers qualify for overtime pay, employers also need to calculate this. Employers with workers in multiple states need to adhere to even more rules and regulations.

Payroll Errors Can Be Costly

Employees work hard to earn their pay. So, if payroll errors occur, they may not be understanding.

A 2022 study from EY found that the payroll accuracy in the most recent fiscal year was only 80 percent. Payroll and HR services receive an average of 30 questions from employees per pay period, with each incident costing an average of $291 in direct and indirect labor costs.

When payroll errors lead to government penalties, these costs can increase substantially. According to the National Federation of Independent Businesses (NFIB), the IRS penalizes nearly one in three businesses due to payroll errors. Common errors include poor recordkeeping, falling behind on payroll taxes, withholding errors and mistakes involving worker classification.

State agencies may also become involved. According to CalChamber, California Labor Code Section 204 requires employers to pay all wages by the designated payday. Employers who underpay due to payroll errors are in violation of the law, which can result in penalties. Yeremian Law says those penalties can be as much as one day of wages for each day the employee has to wait, up to a maximum of 30 days.

What is payroll outsourcing?

Employers have two main options for payroll processing: they can handle the process in-house, or they can contract a third party to handle payroll functions. When they contract a third party, they are outsourcing their payroll.

Learn More About HR Outsourcing

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Some Payroll Outsourcing Services Go Beyond Just Handling Payroll

Payroll service providers handle tasks involved in payroll processing. In addition to the actual payment processing, this can include ensuring the company is complying with payroll-related regulations and carrying out payroll reporting. Payroll service providers may also help employers track hours by providing training and technology recommendations.

Some payroll outsourcing services provide additional HR services. Depending on the provider, this could include everything from employee benefits administration to hiring and onboarding.

The Risks of Outsourcing Payroll

Although payroll outsourcing saves time and money for many employers, there are potential risks. This is because the employer bears the ultimate responsibility for payroll, including payment of income, Social Security and Medicare taxes, meaning that if a payroll service provider makes a mistake, the employer may be liable. To mitigate risks, employers need to stay vigilant when working with payroll outsourcing providers.

  • Vet your payroll outsourcing company thoroughly. Before selecting a payroll service provider, do your research. You need a vendor with a proven track record of providing payroll services.
  • Review records periodically. The payroll service provider should be able to provide you with payroll reports. Review them to ensure everything is correct.
  • Don’t ignore problems. Although the payroll service provider will be handling payroll and fielding questions from workers, you need to stay in the loop. Communicate with employees regularly to verify they are receiving their paychecks on time and without problems. If errors occur frequently or the provider is not quickly resolving occasional mistakes, it may be time to take action.
  • Use your address as the address of record with the IRS. The IRS strongly recommends against using a payroll service provider’s address as your address of record. If the IRS discovers any issues with your account, it will send correspondence to your address of record. If this is not your address, you may not learn about the issue in a timely manner.

The Advantages of Outsourcing Payroll

While there are risks when outsourcing payroll, for many businesses, using a third-party payroll service provider can offer many benefits, particularly for small and midsize businesses that lack the resources to handle payroll management in-house. Payroll services can:

  • Help employers avoid costly errors. Payroll errors are common. Small businesses are especially at risk because they may lack experience navigating complicated payroll issues. Since payroll service providers are dedicated to payroll tasks, they have developed processes to reduce the chance of error.
  • Avoid the need to hire additional staff. To manage payroll without missing deadlines and to avoid making errors, employers may find they need to hire dedicated HR staff. But, hiring employees can eat up a lot of resources. Beyond the payroll and taxes, there’s the time needed to interview applicants and train new hires. Additionally, the more employees a company has, the greater its regulatory burden. For example, COBRA requirements kick in once a company has 20 employees, whereas FMLA and ACA reporting requirements apply to companies with 50 or more employees.
  • Scale with employers. As a company grows, it needs to hire more employees. This means payroll processing will take more time. If the workload becomes too great for the current HR professional, the company will need to hire more workers. This can make it expensive for companies to grow. Outsourced payroll services can help companies scale more efficiently.
  • Save companies money. Whether you save money will depend on the cost of the service provider and your own capabilities. However, companies that outsource payroll management will often find this is less expensive because they don’t have to hire dedicated staff.

Interested in payroll outsourcing?

Navigating payroll can be a daunting task, but with Higginbotham’s payroll outsourcing services, you can spend less time worrying about overtime rules or worker classification and more time focused on what really matters – completing core HR tasks and growing your business.

Higginbotham has 75 years of experience providing insurance, financial and HR services. Harness the power of our payroll outsourcing solutions to simplify your payroll processes and scale your business. Learn more about how our values-focused approach can add value to your business.

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