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How Do PEO and Payroll Services Differ?

Max Freedman
Max Freedman

PEOs and payroll services both streamline payroll processing, but they do so in vastly different ways.

  • A professional employer organization (PEO) provides payroll administration and compliance support, as well as additional HR services.
  • A payroll service provider (PSP) handles your payroll administration and compliance without any shared legal burden.
  • Two factors that will influence your decision are whether you want additional HR services beyond payroll processing and what type of in-house HR team you have in place.
  • This article is for small business owners who are trying to decide whether it's best to outsource their payroll to a PEO or a payroll service.

For most small businesses, gone are the days of calculating payroll by hand. Those who still use this method could benefit from digitizing the process. To do that, small businesses have several options, and among those options are using a payroll service provider (PSP), which focuses solely on a business's payroll needs, or using a professional employer organization (PEO), which handles payroll responsibilities but other HR-related services, too.

Choosing which service is right for your business depends on several factors, including the size of your business, whether you have an in-house HR team and whether you need additional services besides payroll processing. Before making a choice as to which service you want to hire, it is important to first understand what each offers small business owners.  

What is a PEO?

A PEO is a third-party firm that provides payroll administration and compliance, plus other human resources (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 you. That's because a PEO is a large employer – making it far less risky and thus less expensive for insurers to cover – that acts as your co-employer.

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

Did you know?Did you know? Although it handles certain HR tasks, you still handle all day-to-day business affairs and employee management. If, though, you are 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 (ESAC).

How does a PEO work?

When you work with a top PEO, you sign a co-employment agreement in which you assign the PEO control and responsibility for certain HR tasks. 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.

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 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 PEOs, there are no co-employment agreements with a PSP.

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 – and you use a PSP for payroll – 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 thus be in contact with your employees. [Looking for a payroll provider? Check out our recommendations for the best payroll services.]

To help you understand the distinctions between a PEO versus a payroll provider, this table of side-by-side comparisons may help:

PEO Payroll provider
Extensive 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 ADA, ACA and employee handbook needs No significant changes to 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 Contracted provider

PEOs vs. payroll providers

Although PEOs and payroll providers both oversee your payroll, they'll do so in different ways. These differences include additional services, varying prices and different contractual obligations. Here's how it breaks down:

Services provided

As your co-employer, your PEO can oversee significantly more 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 you high-quality large-employer plans you might not otherwise have access to. Some PSPs offer health insurance, but PEO plans are typically far superior.

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

Cost

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.

PEOs typically charge you up to 15% 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 employee per year, 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 your PEO apply to you. You'll have additional Americans with Disabilities Act (ADA), Affordable Care Act (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 few regulatory and contract-based changes, since your PSP is not your co-employer. It's also important to note that with neither a PSP nor a PEO do you lose control over your employees. You'll still control day-to-day operations such as employee tasks, assignments and required locations.

Risk and compliance

Like any third-party firm that you hire to outsource certain services, a PSP does not share legal culpability for compliance errors that it may make. In other words, if your PSP messes up your payroll taxes, only you bear the legal burden. As such, 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. PEOs have an incentive to minimize risks. They can help obtain top-tier workers' comp plans for your company. They'll also handle your workers' comp claims investigation, representation and management. PEOs address several additional small business risks and compliance concerns such as drug testing, hiring and firing, and workplace security.

Employer of record

A PEO acts as your employer of record (EOR), which means it sets the rules around your benefits. Although this arrangement changes little about your day-to-day affairs, it may limit your benefits plan and carrier options.

That said, the benefits of a PEO serving as your EOR generally outweigh the cons. As the EOR, your PEO – which is a much larger company than yours – has access to benefits with higher quality 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.

A PSP, on the other hand, is neither your EOR nor your co-employer. Hiring a PSP only changes how you process your payroll and perhaps any additional HR services your PSP offers. You remain the employer of record, and all taxes are filed and remitted under your EIN.

Which one should you choose?

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 thus 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 can most external companies, 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.

Image Credit: Sanja Radin / Getty Images
Max Freedman
Max Freedman
Business News Daily Contributing Writer
Max Freedman is a content writer who has written hundreds of articles about small business strategy and operations, with a focus on finance and HR topics. He's also published articles on payroll, small business funding, and content marketing. In addition to covering these business fundamentals, Max also writes about improving company culture, optimizing business social media pages, and choosing appropriate organizational structures for small businesses.