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Many different businesses want to outsource some of their HR functions for various reasons. They may be startups or very small enterprises with so few employees that they can’t justify hiring even a single HR generalist, let alone an experienced team of specialists. They may want to provide more services and benefits than their current HR staff can handle. Some organizations have run into issues in the past and want to improve their compliance with labor and tax laws. Others are looking to save money and streamline their businesses by leveraging the experience and knowledge of professional service providers.
Whatever the motivations for using them, both Professional Employer Organizations (PEOs) and payroll outsourcing providers offer businesses solutions to streamline HR and payroll processes. Here, we compare both models to inform you and help you choose the best type of service provider for your organization’s specific needs.
What is a PEO?
A Professional Employer Organization (PEO) is a service provider that takes over responsibility for a client company’s HR functions like handling payroll, benefits, compliance, and employee administration. It does this through a co-employment arrangement in which it essentially behaves like the employer for HR purposes. At the same time, the company retains control of day-to-day operations like managing employees’ tasks and work schedules.
PEOs also take on the responsibility of managing compliance with labor and tax laws in the country or state where they support employees. This includes monitoring federal and state laws for changes, helping to create legally compliant contracts, and helping to maintain working conditions following these laws. The PEO’s client acts as the workplace employer and also has responsibilities like maintaining a safe and compliant workplace. As the third but crucial part of this tripartite relationship, employees are contracted by the client but receive their HR support from the PEO.
Different PEOs offer different services and in most locations, these companies are not strictly controlled. However, in the US, they can apply for certification from the IRS to demonstrate a strong financial responsibility, organizational integrity, and tax compliance. They may also be accredited by the Employer Services Assurance Corporation (ESAC) to show high standards of quality and financial stability.
PEOs may offer many services, including:
- Recruitment
- Hiring
- Onboarding and offboarding
- Payroll management and tax filing
- Benefits administration
- Risk management
- Training and development
- Talent management
- Compliance management
- Worker’s compensation support
What is Payroll Outsourcing?
A payroll outsourcing service provider is a third-party company that manages wage calculations, tax withholdings, and payments to employees and government bodies. Payroll outsourcing focuses specifically on handling payroll processing, tax filings, contributions to benefits programs, and compliance. However, these companies do not provide broader HR services beyond payroll.
To manage payroll, a service provider must first onboard all of a client’s employees to its platform so that it can set up automatic calculations for each individual. From there, time tracking and attendance data from the client for each pay period need to be collected. Using this data, it calculates each employee’s gross salary, taxes, benefits contributions, and other deductions, leaving net pay. The payroll is normally shown to the client for review and approval and is then run. The payroll company pays the employees and remits tax withholdings and deductions to the appropriate government agencies. It also submits necessary forms and files reports to comply with state and federal regulations. Importantly, payroll companies can provide their services across multiple states or sometimes different countries.
Payroll outsourcing can include the following specific services:
- Calculating wages
- Payroll reporting
- Administering benefits
- Filing taxes
- Tracking time and attendance
- Expenses and budgeting consultation
Key Differences Between PEO and Payroll Outsourcing
Scope of Services
PEO: PEOs provide full HR services that include payroll management as well as benefits administration and compliance. They help to manage employees’ paid time off (PTO) and offer support for their HR-related questions and concerns.
Payroll Outsourcing: These service providers focus solely on payroll-related tasks without managing HR compliance. These days, most payroll providers offer additional benefits administration, but this is not a standard payroll service and is considered an add-on.
Co-Employment Relationship
PEO: A PEO acts as the administrative employer, sharing legal responsibilities with the client company which is the workplace employer in this co-employment relationship. The client manages its employees’ daily tasks while the PEO manages their HR concerns.
Payroll Outsourcing: There is no co-employment responsibility in the payroll outsourcing relationship. The client retains full employer responsibilities, while the service provider only handles the specific duties related to payroll processing.
Compliance Management
PEO: A PEO manages both HR and payroll compliance, including compliance with labor laws, tax regulations, and mandatory benefits. It has to have expert knowledge of federal law as well as specific regulations in each state where it manages employees for its clients.
Payroll Outsourcing: Payroll providers only handle payroll compliance, leaving HR compliance to the client. They need to have expertise in tax law and constantly be aware of changes to state or federal regulations that may affect how payroll is calculated.
Benefits of Using a PEO
For many organizations, using a PEO is a good option to help streamline their business and manage their employees effectively. The benefits specific to using a PEO include:
- Comprehensive HR Support: A PEO will provide a wide range of HR services, including employee benefits, tax compliance, and regulatory updates. Many PEOs offer special consultation services which allow clients to leverage the knowledge and experience of experts in payroll, hiring, employee management, and even business planning. PEOs also provide support for employees by acting as their go-to HR contact for any concerns or questions they might have.
- Cost Efficiency for Small Businesses: Working with a PEO can help small businesses manage their employees’ needs without the administrative burden of hiring HR staff. A typically efficient ratio of HR staff to total employees is around 2.5, meaning a company should have 2.5 HR staff for every 100 employees it employs. A small startup with just ten employees can’t follow this ratio and hire 0.25 HR staff. Instead, it can work with a PEO to manage its staff and leverage that provider’s expertise without having to hire its own HR personnel.
- Employee Benefits: Nearly all PEOs provide access to group insurance plans, retirement benefits, and wellness programs, which are either mandatory or optional for employers to add to their employees’ compensation packages. Because they co-employ so many workers, they can access extensive benefits products and offer them to their clients at below-market rates.
- Compliance Expertise: It’s the role of the PEO to maintain compliance with local, state, and federal employment laws. To this end, these providers need to retain both HR and legal experts in order to manage employees fairly and correctly in the eyes of the law.
Benefits of Payroll Outsourcing
Payroll outsourcing handles different needs than the full-service model of a PEO. The main benefits of engaging this kind of service provider include:
- Focus on Core Payroll Functions: Outsourcing payroll simplifies payroll management with specialized services for accurate wage calculations and tax filing. Modern payroll companies have online platforms that provide complex calculations quickly and effectively without making errors. These providers specialize in calculating payroll, submitting tax filings and forms, managing benefits contributions, and paying employees correctly and on time.
- Cost-Effective for Limited HR Needs: Payroll outsourcing is ideal for companies that don’t require full HR support but need payroll processing. These companies may already have one or more HR staff who are able to handle other HR functions but who may not have the extra time or specific skills to manage payroll as well. Instead of paying providers for services they don’t require, they can hire payroll outsourcing providers for only the help they need.
- Flexibility: Most payroll outsourcing providers can be scaled as needed to fit the business size and employee base of any expanding organization. All modern providers base their services on online platforms that can accept thousands or even millions of employees. Their calculations are automated so that payroll runs can be done nearly instantaneously.
Cost Comparison: PEO vs Payroll Outsourcing
| Service Type | Cost Structure |
|---|---|
| PEO Costs | May charge a percentage of overall payroll but more frequently assess a flat fee per employee. They may include bundled services for payroll, benefits, and HR compliance or assess each service separately. |
| Payroll Outsourcing Costs | Typically charge a flat fee per employee or a fee per payroll run. As it’s limited to payroll-related services, this service is less expensive than a PEO. |
HR Support: PEO vs Payroll Outsourcing
| Service Type | HR Support |
|---|---|
| PEO | Offer comprehensive support, including employee benefits, onboarding, compliance, HR consulting, and sometimes recruitment as well. |
| Payroll Outsourcing | Normally focused solely on ensuring employees are paid correctly, and taxes are filed on time. They don’t normally offer additional support for HR functions like recruitment, hiring, or training. However, many payroll companies offer benefits administration as an optional add-on. |
When to Choose a PEO
Opting to engage a PEO depends on several factors, including your company’s size and employees’ needs. It’s also crucial to shop around and select a PEO partner that’s the best fit for your specific needs. Important considerations include:
- Business Size: PEO service is best suited for small and medium-sized businesses that need comprehensive HR support but don’t have the necessary internal resources.
- Growth and Expansion: This service is also ideal for businesses expanding into new markets or growing their workforce, as PEOs handle multi-state compliance and may support international hiring.
- Employee Benefits Needs: Companies that want to offer competitive benefits packages but lack the size to negotiate group plans directly can find much better prices through PEO providers.
When to Choose Payroll Outsourcing
At times, it’s more advantageous to simply outsource payroll to a service provider rather than performing this function in-house. Payroll outsourcing is a good option for:
- Small Businesses with Limited HR Needs: This service is best for businesses that only need help with payroll processing and tax filings and don’t require HR support.
- Cost-Sensitive Companies: Payroll outsourcing is ideal for companies that want to reduce costs and don’t require a full HR service.
- Companies with In-House HR Teams: Payroll outsourcing works well for companies that already handle HR internally but need assistance with payroll. The HR staff at these companies may be overworked or lack the specific skills and knowledge to manage multi-state or even global payrolls.
Legal and Compliance Considerations
Professional Employer Organizations (PEOs)
When you engage a PEO, it acts as a co-employer and assumes responsibility for employment law compliance. In many cases, it will even file taxes under its own taxpayer identification numbers so that if there are any errors, it is the party liable for them and not your company.
This shared liability, combined with the PEO’s professional expertise, increases compliance and reduces liability for your business.
Payroll Outsourcing
Working with a payroll outsourcing provider ensures payroll tax compliance. The provider’s software will perform all calculations accurately and manage the timing of payments to employees and tax authorities.
Most providers are highly certified and work to high standards to maintain high-quality financial management. This ensures a high level of compliance with tax and employment laws relating to payroll. At the same time, these providers leave all other elements of HR compliance for your company to manage.
PEO vs Payroll Outsourcing: A Crucial Business Decision
Choosing between a PEO and payroll outsourcing depends on your company’s size, HR needs, and budget. PEOs provide comprehensive HR and benefits support and also include payroll management. On the other hand, payroll outsourcing focuses on simplifying payroll management and doesn’t include any other HR services that your company may not need or want to pay extra for.
In order to find the best solution for your business, be sure to evaluate your current needs effectively and look carefully at the differences between these types of service providers. This will help you make the right decision for long-term success.