How to Avoid Payroll Mistakes

Updated: April 30, 2009

It's no secret among HR professionals or small-business owners that payroll processing is a headache they're more than willing to offload. But just because a third-party outsourced provider takes over the cumbersome work of handling tax filings and cutting paychecks, there are still plenty of details to iron out to ensure the outsourced relationship — not to mention, the payroll runs — are a success.

In fact, the biggest mistake that small- and medium-sized companies make when outsourcing the payroll function is thinking it's a turnkey situation — that they'll simply hand over the file and presto: Checks are issued instantaneously the next pay period. "Most companies don't consider what needs to happen," noted Dawn O'Callaghan, senior HRMS consultant for Dresser & Associates Inc ., a Scarborough, Maine certified reseller of the Sage Software Enterprise Suite, which includes payroll software amongst its modules. "They think that magically someone is going to do payroll for them, and yes, they are, but there's a lot of information that has to be shared somehow," said O'Callaghan.

Payroll is tricky for small companies with limited HR resources for a number of reasons. Just because a company is small doesn't mean that it isn't subject to the same federal and state regulations that govern larger businesses. That means someone in the firm needs to be up on changes to withholding tables; the rules governing how and when to deposit Social Security and Medicare taxes; and how to calculate payroll deductions for health care, 401(k) , or other benefits. Security is another big issue. HR files contain tons of personal information about employees, from salaries to bonus structures, and small businesses handling their own payroll need to be sure there are proper safeguards and security technologies in place to protect the privacy of their employees.

Hosted Solutions

With all of these requirements, it's no wonder that many small- and medium-sized companies earmark payroll processing as the first HR function to outsource. The choices for payroll outsourcers range from large service provider giants like ADP Inc. and Ceridian Corp . to dozens of smaller providers like CheckPoint HR and Paychex Inc ., which offer hosted payroll-processing solutions and services.

Prior to selecting one of these or another payroll-processing partner, companies need to do their due diligence in identifying the true cost and benefits of outsourcing this function versus trying to handle it in house. For companies with fewer than a couple of hundred employees, the decision to outsource typically makes sense because of the cost savings associated with not having to hire dedicated HR professionals versed in all of the payroll regulations. Once the evaluation is done, the next step is to clearly identify the scope of the services required and to ensure the provider is up to the task. Of utmost importance is being clear about the terms of the agreement related to what is covered by the outsourcing fees and what is not.

Specifying in writing who is responsible for what function and who owns the payroll information is another area that many companies gloss over when entering into these kinds of outsourcing relationships. Here's where attention to detail is paramount. For example, if the outsourcing arrangement culminates midyear, who is responsible for issuing W-2 forms to employees?

Also, knowing what reports are covered under the basic contract is another critical part of covering the bases, said Dresser & Associates' O'Callaghan. For example, if a company regularly produces a report to track employee attendance, establish whether that same report will be delivered under the outsourcing relationship or if it will come at an additional charge. The same level of detail applies for the ability to issue on-demand checks outside of the standard pay period. "When you're doing payroll in house and you need an on-demand check, it's no big deal," she explained. That's not necessarily the case when you're relying on an outsource vendor to do it for you, she added, so be clear about the details of the arrangement up front.

Pacing is Key

Finally, companies considering the move need to provide ample time for the data conversion and auditing that's necessary to move to an outsourced system. Getting IT and HR people involved in the decision will ensure the process goes smoothly, as will drilling down on details such as what the file requirements are for transmitting and receiving the data.

"HR professionals have to be very thorough upfront with the terms of the agreement," O'Callaghan said. "Don't assume because it worked this way in house that it will work the same way with an outsourcer. Take the time to review and understand the terms of your service agreement."

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