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Updated Jan 23, 2024

How Do PEO and Payroll Services Differ?

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Max Freedman, Business Operations Insider and Senior Analyst

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For most small businesses, gone are the days of calculating payroll by hand. Those who still manage payroll manually could benefit from digitizing the process as an increasing number of companies do today. Small businesses have several options for processing payroll online, including using a payroll service provider (PSP), which focuses solely on a business’s payroll needs, and using a professional employer organization (PEO), which handles not only payroll responsibilities but other human resources (HR)-related services too.

Choosing which of these options is right for your business depends on several factors, including the size of your company, whether you have an in-house HR team and whether you need additional HR services besides payroll processing. Before choosing which service you want to hire, you’ll need to first understand what each offers small business owners.  

Editor’s note: Looking for the right PEO for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is a PEO?

A PEO is a third-party firm that provides businesses with payroll administration and compliance assistance and other HR services as well. Through a PEO, you can access health insurance, workers’ compensation and other business insurance plans that might otherwise be unavailable to your company. That’s because a PEO is a large employer that acts as your co-employer, making it far less risky and, thus, less expensive for insurers to cover your employees.

This co-employment arrangement is what differentiates PEOs from other types of HR outsourcing services. When you choose a PEO to work with, they technically become the employer. While you still control whom you hire and fire and what your staff does each day, the PEO is in charge of paying your employees and administering their benefits.

Did You Know?Did you know
Although a PEO executes certain HR tasks for you, you'll still handle all day-to-day business affairs and employee management. If you're concerned about a PEO unfairly using its co-employer powers, choose a PEO that has been certified by the IRS or the Employer Services Assurance Corporation. This certification is a sign of the vendor's credibility.

How does a PEO work?

When you work with the best PEO services, you sign a co-employment agreement in which you assign the PEO control and responsibility for certain HR tasks, including payroll processing. As a co-employer, your PEO files and remits all taxes under its employer identification number (EIN) instead of yours, potentially saving you state unemployment (SUTA) tax costs.

What is a PSP?

A PSP takes care of your business’s payroll processing, tax compliance and administrative needs. If you hire a PSP to manage your payroll, it pays your employees according to the pay schedule you set and it includes the appropriate deductions for employee paychecks, such as taxes and benefit premiums.

PSPs can also prepare, file and pay your federal unemployment (FUTA) tax returns and quarterly business tax returns under your EIN. They can file and furnish your W-2 and W-3 forms as well. You can also designate your PSP as a reporting agent that can communicate with the IRS on your behalf to resolve any tax issues. However, unlike with PEOs, there are no co-employment agreements with a PSP and they may not handle other HR services.

While W-2 forms are for full-time employees, you’ll need W-9 and 1099 forms for contractor taxes. You’ll collect a contractor’s W-9 form when you first start working with them and, in most cases, issue their 1099 forms annually.

How does a PSP work?

When hiring a PSP, you sign an agreement that indicates how much you’ll pay per month to the PSP and what services the PSP will provide. A representative with your PSP then becomes your point of contact for all of your payroll questions and concerns. However, since PSP software is primarily automated, you may not need to contact your support representative very often.

If your employees have questions or concerns about their paychecks, benefits or time off, your employees will contact you. You’ll then contact your PSP on the employee’s behalf. With PEOs, this arrangement may differ as your PEO is your co-employer and may be in contact with your employees directly. [Are you looking for a payroll provider? Check out our recommendations for the best payroll services.]

PEOs vs. payroll providers

Given that both PEOs and PSPs can process payroll, it may be confusing at first to understand how these options differ. To help you understand the distinctions between a professional employer organization and a payroll provider, check out our side-by-side comparison.


Payroll provider

Extensive HR services provided

Limited to payroll and sometimes benefits and other HR services

Higher fees but potential overall cost savings

Lower fees but potentially higher overall costs

Co-employer arrangement may subject you to new Americans with Disabilities Act (ADA), Affordable Care Act (ACA) and employee handbook needs

No significant changes to employee contracts

Thorough risk management, compliance assistance and shared legal burden

No risk management or shared legal burden; a PSP may assist with tax and payroll compliance

Employer of record (EOR)

Contracted provider

[Read Related: PEO vs. ASO]

Below is more information about each of these comparison points.

Services provided

As your co-employer, a PEO can oversee significantly more HR tasks than a PSP can. Your PEO will likely obtain and administer your workers’ compensation insurance and it can also run your hiring and termination processes. Your PEO can also sponsor your company’s health insurance plans and offer your team high-quality large-employer plans your company might not otherwise have access to as a small business. Some PSPs also provide health insurance access but plans facilitated by PEOs typically are far superior.

A PSP is largely focused on processing your payroll and ensuring you meet your payroll tax responsibilities. However, more payroll providers today are offering additional HR services such as 401(k) employee retirement plans and HR consulting.


PEOs are often more expensive than PSPs but, in looking at the bigger picture and longer term, PEOs may cost less. For starters, the superior health insurance plans available to you through PEOs can cost you less than the insurance plans you might obtain through an insurance broker. Additionally, your PEO won’t charge you more as you add services.

Typically, PEOs charge you up to 15 percent of your gross wages per pay period or a flat but high per-employee fee each month. You may also pay a setup fee that can cost thousands of dollars. By comparison, a PSP will likely cost no more than $200 per month before per-employee fees but these fees come with none of the cost-saving HR services for which PEOs are known.

Contractual obligation

If you hire a PEO, the large employer rules that apply to PEOs now apply to you too. That means you’ll have additional ADA, ACA and employee handbook formalities with which to comply. However, alongside these added rules come tremendous time savings since the PEO can oversee a large portion of your HR needs.

If you choose a PSP, you’ll face limited regulatory and contract-based changes since your PSP is not your co-employer. It’s also important to note that you don’t lose control over your employees with either a PSP or PEO. You’ll still oversee day-to-day operations, such as employee duties, assignments and required locations.

Risk and compliance

Like most third-party firms you hire for outsourced services, a PSP does not share legal culpability for compliance errors it may make. If your PSP messes up your payroll taxes, only you bear the legal burden. In other words, hiring a PSP doesn’t do all that much to minimize your business risks and alleviate any compliance concerns.

PEOs are a different story. They’re an excellent choice for managing risk and compliance since, as your co-employer, they share legal responsibility with you. As such, PEOs have an incentive to minimize risks. They can help obtain top-tier workers’ comp plans for your company and handle your workers’ comp claims investigation, representation and management. PEOs address several additional small business risks and compliance concerns too, such as drug testing, hiring and firing and workplace security.


A PEO acts as your EOR, which means it sets the rules around your employee benefits. Although this arrangement changes little about your company’s day-to-day affairs, it may limit your employee benefits plan and carrier options.

That said, the advantages of a PEO serving as your EOR generally outweigh the cons. As the EOR, your PEO — which is a much larger company than yours — will have access to employee benefits with higher-quality plans and lower premiums than you would likely find on your own. Your EOR arrangement also delegates tax filing and remitting to the PEO under its EIN instead of yours, which can lower your SUTA and FUTA tax burdens.

Meanwhile, a PSP is neither your EOR nor your co-employer. Hiring a PSP only changes how you process your payroll and may give you access to additional HR services. You remain the EOR and all taxes are filed and remitted under your EIN.

Should you choose a PEO or PSP?

For a firmer hand in managing your payroll and additional HR operations that may keep your finances more secure in the long run, PEOs are your best bet. You can also add many types of HR services to your PEO contract and save the time and money that would be involved if you handled them in-house.

However, PEO setup fees and monthly fees can be high and PEOs can control more of your affairs than you may like, so you may prefer PSPs if these conditions concern you. PSPs may also be better if you already handle many HR services in-house and are only looking for assistance with payroll.

FYIDid you know
Many of the best payroll providers also offer PEO services. It’s often easy to move from only payroll processing to full-scale PEO services with these vendors.

The best PEOs and payroll providers

Whether you’re leaning toward a PEO or a PSP to cover your needs, we recommend considering one of the below vendors, particularly as they tend to offer both options:

  • ADP: This provider is a great choice for payroll software that scales with your company as it grows. Its PEO service, ADP TotalSource, stands out for how seamlessly it shares your data with employee benefits providers. Learn more via our full ADP payroll review and full ADP TotalSource review.
  • Paychex: If you use Paychex’s payroll services, you get automated tax calculation and filing tools that a team of more than 200 compliance experts regularly update. This compliance focus is also part and parcel of Paychex’s PEO service, which is also attractive for how it handles employee training needs. Read our full Paychex payroll review and Paychex HR software and PEO review to learn more.
  • Rippling: Unlike most payroll providers, Rippling only charges per employee per month for its payroll services, with no accompanying flat monthly fee. It should also be noted Rippling’s PEO service also excels at keeping your business compliant, especially when it comes to minimum wage laws and COBRA insurance. Learn more via our full Rippling payroll review and Rippling HR software and PEO review.
  • Papaya Global: This payroll provider is geared toward businesses that operate in more than one country, but you can use it domestically as well. It’s also the rare company that provides transparent PEO service pricing directly on its website. Read our full Papaya Global review to learn all about this vendor’s PEO and payroll services.

Payroll, benefits, compliance and more

It’s increasingly common to find payroll vendors that offer employee benefits, tax and new hire reporting and compliance, payroll services and more in one package. This combination of services offers more bang for your buck but full-scale PEO services may be even better. The extra services that come with this higher-level offering, such as employee training and COBRA compliance, can save you money in the long run. If these long-term savings don’t immediately seem worth the higher upfront costs, payroll software is a great alternative.

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Max Freedman, Business Operations Insider and Senior Analyst
Max Freedman has spent nearly a decade providing entrepreneurs and business operators with actionable advice they can use to launch and grow their businesses. Max has direct experience helping run a small business, performs hands-on reviews and has real-world experience with the categories he covers, such as accounting software and digital payroll solutions, as well as leading small business lenders and employee retirement providers. Max has written hundreds of articles for Business News Daily on a range of valuable topics, including small business funding, time and attendance, marketing and human resources.
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