Payroll and HR – In-house, Outsource, or PEO?

One of many decisions a business owner has to make is how to handle payroll and the human resources functions.   There are a number of Federal and state laws that govern these two functions.  And, complying with the laws is not optional.  So the question for most business owners is this; what is the best and most cost effective way to ensure that my company is in compliance with the law?  The following comments will shed light on the topic but business owners are encouraged to seek the advice of an HR professional and a Chief Financial Officer.

To begin the discussion, here are a few things you should be aware of.

  1. Both the payroll and the HR function are processes that are defined by multiple Federal and state laws and regulatory agencies.  Non-compliance with the law can result in stiff penalties, e.g. if a company doesn’t have the correct employee files it could be exposed to a fine of $10,000 PER EMPLOYEE.
  2. The processes represent an expense over and above actual payroll but are essential.  The functions can be performed by existing staff or outsourced.   Which approach is best for a company is not always obvious and depends in large part on the size of the company, the skills of existing employees and the amount of time a business owner is willing to make available for those employees to perform either or both functions.
  3. Payroll is governed by Federal and state wage and hour laws.  There are also several employment related laws, many of which apply to companies with a prescribed minimum number of employees.  So, it is important to know which apply to your company.  An HR professional can make that determination.   Here is a list of the primary employment related laws: the Fair Labor Standards Act (FLSA), the Occupational Safety and Health Act (OSHA), the Americans with Disabilities Act (ADA), the Civil Rights Act, the Age Discrimination Employment Act, the Consolidated Omnibus Budget Reconciliation Act (COBRA), the Immigration Reform and Control Act (IRCA) and, the Family Medical Leave Act (FMLA).  Additionally, employers may be required to report new hire information to a state directory as part of Federal legislation on welfare reform.
  4. Companies that are Federal contractors will also need to comply with the Rehabilitation Act of 1973 and the Vietnam Era Veterans Readjustment Assistance Act of 1974.
  5. There are also other governmental entities that have rules and regulations that companies must abide by. These include; the Department of Labor (DOL), the National Labor Relations Board (NLRB), the Equal Employment Opportunity Commission (EEOC) and, the Department of Revenue (or similar) in the various states.  All of these organizations are busy ensuring that their rules and regulations are being followed.  They are especially motivated by the current economic climate where tax revenues are down and fines to companies can supplement those low tax revenues – so, BEWARE!   As a side note, you may have seen a recent article in The Wall Street Journal that discusses how the NLRB is currently seeking ways to make it easier for unions to be formed.  This is an example of a potential change in the law that an HR professional and a CFO could provide advice on.

So, what are the options for business owners?   Briefly there are three: (a) handle all payroll and HR functions in-house, (b) outsource one or both functions while keeping your employees on your payroll or, (c) utilize the services of a Professional Employer Organization (PEO).  The following paragraphs briefly describe each option.

Performing both functions in-house is a viable option if a business has one or more people with the knowledge, experience and aptitude to perform the functions.  It will typically require a payroll software program and possibly other software for the HR function.  Doing it in-house means that the employer is responsible for complying with all provisions of the laws mentioned above including making timely payroll tax payments.  It also means that the cost of benefits and worker’s compensation is based on the employer’s pool of employees and its historical claims experience.  Note that, in general, companies with a larger employee pool get better rates.

Either the payroll or HR functions can be outsourced to experts for a fee.  This is a good option for companies that don’t have the in-house expertise or technology to keep up with the laws and regulations mentioned earlier.  Of course, the company is still responsible for compliance and for making timely tax payments but the task is made much easier with the help of these outsourced professionals.   By going to an outsource provider, a company pays only for these services to the extent they are needed.   This may be the best option for most companies for a long time or until a company grows to a point where it might make sense to bring one or both functions in-house.   And, even many of the country’s largest companies still rely on outsourced payroll in particular because of its complexity.

A PEO, or professional employer organization, is a company that is in the business of providing payroll and HR services to other companies that either do not have the resources or desire to perform the payroll and HR functions in house or, that want to take advantage of lower rates for benefits and/or workman’s compensation that are available through the PEO.  With a PEO, a company’s employees are hired by the PEO and become employees of the PEO.  They are then leased back to the original company.  Because PEOs have a larger overall pool of employees than do their clients they are usually able to obtain lower rates for benefits and workman’s comp for their clients than their clients could get on their own.  In this scenario, because the staff members are employees of the PEO, the PEO must comply with all Federal and state payroll and employment laws including making timely payroll tax payments.  But, the company who is leasing the employees also shares in that responsibility.

Before deciding which option is best, consult with an HR expert and a Chief Financial Officer.  They can help you evaluate the options in the context of your company and recommend the best course of action.  Because every company is unique, there is no one “right” way to do it.  But here are some thoughts:

  1. Teresa Buelow who operates a payroll service and is an HR consultant in Glendale, AZ, has this to say: “When conducting a needs analysis for a client, I normally look at the number of employees and the cost involved to resource those functions.  If the company has no interest or a lack of ability or reach to manage their employees then I would recommend a PEO.”
  2. She also says that using outsourced resources rather than a PEO might make more sense if the employer can get better rates for benefits and workman’s compensation than a PEO because of its historical experience rating.

Lastly, if you decide to explore outsourced providers and PEOs, look for these things:

  1. Clear, unambiguous and competitive fees
  2. Billing statements that clearly show all fees  (transparency)
  3. A good reputation in your business community
  4. A good legal track record
  5. Responsive customer service

Please let me know what you think of this article and if I can be of help to you in determining your company’s next steps in the payroll and HR arenas.


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