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Outsourcing Payroll: Pros and Cons for Businesses

Payroll management can be a time-consuming job. While many companies handle this duty in-house, others choose to outsource it to third-party companies. Payroll outsourcing is a common practice that has a number of advantages and disadvantages to consider. Learn what the practice of outsourcing payroll is, understand the benefits of outsourcing payroll, review the downsides of outsourcing payroll, know how outsourcing payroll works and assess the services typically included by a payroll outsourcing company.

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What is the practice of outsourcing payroll?

Outsourcing payroll is the practice of hiring a third-party payroll firm to manage your company’s salaries and wages. Some payroll outsourcing companies exclusively manage payroll responsibilities, while others perform a number of HR-related tasks in addition to payroll.

Related:How to Write a Payroll Clerk Job Description Sample

Benefits of outsourcing payroll

Outsourcing payroll to a third-party company does offer a number of benefits to companies who use this practice. A few of the top advantages include:

Saving time

Manual payroll takes a lot of time. Payroll officers have to track or find information regarding:

  • Benefit deductions
  • Wage garnishments
  • Paid time off
  • Unpaid time off
  • State taxes
  • Federal taxes

This can be a challenge for a single employee to handle for an entire company, particularly if they have other job responsibilities beyond payroll. Outsourcing payroll removes all of those responsibilities from your team and saves you time.

Reducing costs

Often, particularly for small or medium businesses, outsourcing payroll saves money. The time and resource cost of performing payroll in-house is almost always more expensive than the monthly cost of having a dedicated payroll company handle the process.

Maintaining tax accuracy

Tax regulations are often quite complicated. These laws also change regularly, and without proper education and training, employees can make unintentional, but costly, payroll tax errors. Outsourcing payroll to a dedicated company ensures those handling your payroll are well-trained and qualified to handle the tax aspects of payroll.

Ensuring compliance

Aside from taxes, using a payroll company with experienced and trained payroll professionals ensures that your payroll processes will meet all state and federal rules and regulations.

Providing security

Computer security is costly. Many small businesses don’t have the resources to properly encrypt and store sensitive data, like employee bank account information, properly. Most payroll companies have sophisticated security measures in place to protect their clients’ data.

Eliminating software concerns

Those who manage their own in-house payroll often use software programs to help them track hours and calculate earnings. However, these programs can be expensive and may require regular updates or patches to function properly. Using a payroll company eliminates this expense.

Spreading out support

For small businesses in particular, there’s usually a single employee who manages the payroll process. If that person falls ill or takes a vacation, managing payroll can pose a big challenge for the company. When you use a payroll company instead, you don’t have to worry about one person managing the process, since the company has a team in place to ensure your payroll gets processed.

Offering direct deposit

Despite the ubiquity of online banking, offering direct deposit is not easy for most small businesses who perform their own in-house payroll processing. Third-party payroll companies have the resources to set up direct deposit for your employees.

Related:How to Write a Payroll Manager Job Description Sample

Downsides of outsourcing payroll

Despite the many advantages of outsourcing payroll to a dedicated company, it’s important to consider the downsides of the practice before making a decision about outsourcing. Common complaints about outsourced payroll include:

Errors and time

While trained payroll professionals are less likely to make mistakes than less experienced in-house employees, errors can still happen. When payroll companies make a mistake on an employee’s paycheck it can often take longer to correct than it would if you managed payroll in-house.


Ultimately, you are responsible for any tax filing mistakes or other errors the payroll company may make, which can cause substantial expense and be challenging to resolve.

Unused benefits

Some payroll companies offer additional services or perks as part of the cost of their payroll services that your company doesn’t really need or use. In these cases, you could end up spending more money than you need to on outsourcing your payroll.

Data protection

While most payroll companies have exceptional digital security protocols in place, breaches can still happen. Using an external payroll processor is not a guarantee of data protection.

Missing information

Since there’s the added step of sharing wage and employee information with the payroll processing company, if you forget to share an important detail or the company loses the information, it can delay your payroll processing and leave your employees without their checks.

Related:How to Write a Payroll Specialist Job Description Sample

How does outsourcing payroll work?

Whether you complete your payroll processing in-house or outsource the process to a third-party company, the steps are similar. Here’s a step-by-step guide to the outsourced payroll process:

1. Select a company

The first step when outsourcing your payroll is to select a company. Some companies exclusively perform payroll processing, while others also manage additional human resources tasks and responsibilities. Find a company that you trust and that offers the services you’re looking for.

2. Provide information

In order to process your payroll, you’ll need to provide the payroll company with initial information to set up your account and ongoing information like hours, time off and bonuses so the company can accurately calculate and distribute paychecks to you and your employees. Most payroll companies will ask for the following information for all employees:

  • W-4 tax forms
  • Any state-specific tax withholding forms
  • W-9 tax forms for any independent contractors
  • I-9 forms
  • Job application
  • Bank information for direct deposit
  • Medical insurance information if applicable
  • Retirement plan information if applicable

3. Track time

Depending on whether employees are salaried or hourly, you’ll need to track and submit timesheets to your payroll company. Many external payroll processors use digital time tracking software that they, you and your employees can access to make time tracking easy for everyone.

4. Approve pay amounts

Once the payroll processing company has all the information they need, you’ll provide any wage garnishment information or bonus payment information and approve paycheck totals for your employees.

5. Manage taxes and withholding

Before the payroll processor can write the checks, they must deduct the appropriate employee selected withholdings and required state and federal withholdings from the net pay amount.

6. Administer checks

The payroll processing company submits payment to your employees, either through physical checks or direct deposit straight into their bank accounts.

7. Provide reports

Payroll reporting is an integral part of the payroll process. The external payroll company will manage all the necessary record keeping and submit the necessary reports to the appropriate parties or organizations on your behalf.

Related:What Are ER Taxes? A Guide to Employer Taxes

What do payroll services typically include?

Payroll companies can vary dramatically in terms of the services they include. While some offer only the necessary payroll processes, others can perform a number of other human resources and finance-related tasks. Review this list of potential services you might use from an external payroll processor:

  • Maintaining payroll records
  • Calculating the appropriate pay amount after withholding and taxes
  • Mailing the checks or managing direct deposit
  • Providing W-2 forms and other annual tax documents to employees
  • Submitting necessary tax reports and information to the IRS and state tax offices
  • Managing unemployment reporting and taxation
  • Handling withholding payments to retirement plans and other entities

Considerations before you outsource your payroll

If you’re ready to outsource your payroll, it’s wise to vet potential companies before committing to work with them. Use these considerations to help you make a final determination about payroll outsourcing and to select the best company for your needs:

  • Security:Ensure the company’s data security system is strong. Ask if they’ve ever experienced any data breaches.
  • System:Learn how they manage and store data and whether they’ve had a system crash that resulted in deleted information.
  • Taxes:Know how their employees are trained on tax law and how frequently they receive continuing education to stay abreast of changes.
  • Longevity:Ask how long the company has been in business and how many clients they support.
  • Customer service:Understand how their customer service and support teams function, so you’ll know what to expect if you call in with a problem.
  • Corrections:Know how long it will take them to correct payroll errors should they happen.
  • Evidence:Learn how they’ll communicate submission of tax reports and other necessary documents to you for your own record keeping.

The outsourcing of payroll can provide you with several worthwhile benefits. However, it’s important to consider the potential risks and downsides before committing to an external payroll processor.

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