Follow Us

Like what you're reading?

Subscribe to receive periodic updates about new posts by email, or follow us via Twitter or RSS.

Please enter a valid e-mail address to subscribe.


You have subscribed.

Should You Keep Your Payroll In-house or Outsource It?


Payroll has long been one of the most outsourced functions in the business world. Titans such as Automatic Data Processing, Inc. (ADP), Paychex, Inc. and Ceridian have been responsible for cutting checks for businesses large and small for years.

But as small and medium-sized enterprises have increasingly wrested market share from big corporations, large payroll companies have had to adopt their services to meet the needs of these smaller clients. Simultaneously, technology advances have led to viable payroll software solutions, and vendors have scrambled to meet the needs of SMBs who feel underserved by the payroll behemoths.

The result? Today, SMBs have a wide spectrum of payroll options. On the one hand, you have in-house administrators who often employ payroll software to do the job. On the other, you find large, traditional payroll services—and a slew of smaller competitors vying for their piece of the outsourcing pie.

Can the big players meet the specialized needs of today's small and midsize businesses? Or is bringing payroll back in-house and using specialized software the best route for SMBs? We break down both options to help you decide whether you should outsource your organization’s payroll or keep it in-house.

Time and Money Spent on Internal vs. Outsourced Payroll

The National Small Business Association (NSBA) 2013 Small Business Taxation Survey asked 1,500 small business owners how they handle payroll. Forty percent of them reported outsourcing their payroll function; 60 percent reported handling it internally.

Time Spent on Internal Payroll Per Month

As you can see, one in three small businesses report spending more than $500 per month (more than $6,000 per year) on outsourced payroll services.

Money Spent on Outsourced Payroll Per Month

Among those businesses handling payroll internally, nearly one in four report spending more than six hours per month on payroll. That's at least 72 hours per year—nearly two full workweeks. If we use 2012 data from the Bureau of Labor Statistics to assume the hourly cost for internal payroll staff to be $36, these 72 hours translate into $2,592 per year. So the businesses doing it themselves are spending their own man-hours on payroll, while those who outsource believe it's worth paying someone else to do it.

More Than Just Cutting Checks

Tasks that typically fall to the payroll department include 401(k) and Section 125 mutual fund plans and other automatic paycheck deductions, garnishments and employee benefits. Employers are responsible for withholding federal income tax and other federal, state and local taxes from each employee’s paycheck. Payments and requisite documentation must be submitted according to strict deadlines to avoid fines and penalties. The IRS Form 941 (Employer’s Quarterly Federal Tax Return), for example, must be filed four times per year to report the tax withheld during the quarter. The end of the year requires preparing and distributing W-2s and 1099s.

Payroll is is one of the biggest expenses SMBs have. It can also be your company's biggest headache if it isn't done correctly. Whoever is doing your payroll (whether a service provider or a member of your team) must understand the relevant tax laws and regulations, all of which vary considerably from state to state. It can be an administrative headache, and mistakes could mean a phone call—or worse—from the IRS.

Benefits of Outsourcing PayrollBenefits of In-House Payroll
Improved compliance and accuracyInstant access to data
Time savingsYou may be doing most of the work anyway
Lower long-term costs for some businessesUsually cheaper

Benefits of Outsourcing Payroll

Large corporations have the resources to sustain large payroll divisions. Smaller businesses usually don't, so they look elsewhere for help. Here are some of the top reasons why SMBs outsource their payroll:

→ Compliance and accuracy. Payroll mistakes are notoriously commonplace, and many small operations find it nearly impossible to stay on top of the numerous and complicated tax code changes that can lead to these errors. According to Inc., one in three employers have been penalized for payroll errors. Outsourced payroll experts are usually less likely to make errors than an on-staff accountant or HR staffer, as they’re trained specifically in this area. When mistakes do occur, the business owner may be able to seek financial or legal restitution, depending on the specifics of the service contract.

→ Time savings. Running a business is hard enough without getting bogged down with administrative tasks. Many small business owners and their staff find it a better use of their time to focus on activities related to the core mission and leave finances and payroll to someone else.

 Lower long-term costs for some businesses. In the survey mentioned above, we saw that nearly half of small businesses report spending between $100 and $500 on outsourced payroll. T. Rod Rodriguez owns, a light manufacturing and distribution business. He says the choice between in-house and outsourced solutions is a question of what is most efficient and cost-effective for the size of the operation.

"For a small business of around 10 people, I have found that the cost of paying an outside agency to manage payroll, tax liabilities, documentation, and process the physical checks is less expensive than having an internal dedicated person," Rodriguez says.

Benefits of Keeping Payroll In-House

Payroll software has made inroads in the SMB market because it gives business owners full control over how their employees are paid. Staffing a payroll professional or simply using a program to do it yourself can offer the following benefits:

→ Instant access to your data. If you have a question about payroll or need to see payroll historicals, how quickly and easily do you need to obtain access? Outsourcing payroll means having to call your account representative for an answer that may take a few days to come. On the other hand, if all data is under your roof, you can find out what you need to know right away. And when security and privacy are a concern, many business owners simply feel better not handing over sensitive data to another company.

→ Usually cheaper. Bringing in a part-time payroll professional (or tasking someone in HR or accounting with the duties) may be cheaper for some small businesses.There are countless software options for you to explore, and while none of them run themselves (or offer the range of services provided by outsourced payroll companies), they can be a low-cost solution. For example, Paycycle by Intuit starts at $24.99 per month and is suitable for businesses operating in one state that have no more than five employees.

→ You may be doing most of the work anyway. One thing the payroll outsourcers won't tell you is this: there's no way they can really handle 100 percent of your payroll functions. You or someone on your staff will have to manually provide the data (timesheet info, paid time off, salary information, etc.). This is often done through an online interface, which can be cumbersome with the larger outsourcers. If you’re already compiling this data, it may not require many extra steps to enter it into in-house payroll software.

Other Considerations

→ Customization. Both in-house and outsourced payroll solutions can be customized to fit the specific needs of individual businesses. Still, some business owners complain that the proprietary systems of companies like ADP and Ceridian don't accommodate unique requirements or have the flexibility small businesses require. This is a niche newer, smaller outsourced companies are working to fill.

→ Scope of needs. If all you need is payroll, ZenPayroll and SurePayroll are both smaller, more affordable options than ADP. Of course, you may still have to outsource benefits and other HR and administrative tasks, and you'll still have to have someone print and distribute the checks.

“A good small payroll provider can make all the difference in the world,” says Robby Slaughter, principal at AccelaWork, a Midwest consortium of business improvement consultants. “I know [doing it in-house] seems easy right now and paying for it is a pain, but this is time that you should not be spending.”

AccelaWork outsources its payroll to Automated Payroll Service, which Slaughter describes as “a small payroll company specializing in working with small companies.” He says the service he gets comes with a personal touch, which makes going with the "little guy" worthwhile.

That's not to say the "big" payroll providers don't have their fans. Rodriguez, the business owner who uses ADP, says the "service has never been lacking," but admits his business doesn't have many unusual requirements. When he has had questions or problems (replacing an employee's lost check, for example), he says "ADP reps have always been quick to respond."

→ Cost. As with any business decision, it often simply comes down to cost. A business with 25-35 employees that uses ADP or Paychex can expect to pay anywhere from $250 to $1,500 a month. That's a huge range, but the big payroll services have a smorgasbord of additional services, plans and contract options, so getting a specific quote for your business requires filling out an online form or calling their sales staff. In-house software will almost certainly be cheaper, but then you have to factor in the salary of whoever will be handling it.

There may be "hidden" costs as well. For example, some providers keep your payroll taxes until they have to be paid to the IRS, in essence letting your money accrue interest for them in the interim. Some companies have been hit with "termination of contract" fees when they left their payroll service. As always, ask a lot of questions and read the fine print.

→ Checks and balances. Whether you choose to go with an internal staff member or software-based solution, Rodriguez recommends small businesses keep financial functions separate.

"It has been my experience that keeping bookkeeping, accounting and payroll functions separate, and performed by separate people or entities, adds a layer of checks and balances in the financial side of small business," he explains.

At Gamajato, a bookkeeping clerk handles invoices, prepares and processes payables and receivables and performs additional other front office duties. They also assist the accountant, which is an off-site service provider that handles end-of-month and end-of-year financials. The accountant can request checks, which Rodriguez then has to sign. The bookkeeper provides ADP with hours and salary information, and ADP tracks and documents payroll reporting requirements and generates and delivers checks.

The Bottom Line

There's no easy answer for small and medium businesses wondering how to handle payroll. How many employees and locations you have, what kind of benefits you offer, and how you handle accounting are all factors that must be taken into account. The large, traditional payroll service providers have the expertise to do it correctly, but they usually aren't the most affordable option. You, the business owner, will also have to meet them halfway and provide the data needed to process your payroll. Relinquishing control and handing over sensitive company information isn't easy or preferable for some organizations.

Smaller payroll outsourcers and payroll software providers are stepping in to capture the SMB market with cheap alternatives and personal customer service. If you have a handful of employees without complicated payroll needs, doing it yourself will likely be your cheapest option. You'll simply have to decide whether or not you want to spend your time (or pay someone to spend theirs) getting the paychecks out when you could be running your business instead.

Thumbnail image created by 401K (2012).

Share this post:  
Marshall Jones

About the Author

Marshall Jones is a contributor to Software Advice.

Connect with Marshall Jones via: