Never Do Your Payroll In-House

You run a small $20 million ecommerce business with about 40 employees, and your taxable earnings are generally around $1.5 million. Would you like to do your own income taxes?

I know the answer. Why not? If that’s the case, why do you want to do your payroll in-house? You think it’s easy? Do you think nothing will ever go wrong? Is it because you are an expert in all aspects of labor law and payroll compliance?

Outsourced payroll is affordable, and while never 100% foolproof, the compliance risks of a payroll firm are far lower than doing payroll in-house.

In this discussion, I’ll answer the following questions:

1. Why do small business owners do in-house payroll to begin with?
2. What are the risks of doing in-house payroll?
3. The alternative to in-house payroll, and how to choose a payroll firm?
4. When is the only time to do in-house payroll?

What’s Up with Small Businesses Doing Their Own Payroll?

Sharon owns a small boutique coaching firm focused on CEOs with revenue under $5 million. She has a staff of 13 employees. She uses a freelance bookkeeper with no certifications or a college degree, but Sharon does not know that. When she met Ed, he was friendly and outgoing, and he seemed to know what he was talking about when it came to accounting.

Ed swears by QuickBooks payroll because that’s all he knows. Therefore, Sharon’s firm handles payroll in-house because she trusts that a third party knows what they are talking about.

The example above resembles many of the small companies I’ve worked with since 2003. In short, small business owners handle payroll in-house because they do not know that better, safer options exist for their payroll needs.

The other reasons small business owners will roll with in-house payroll are as follows:

• It’s seemingly effortless (which is not entirely accurate)
• It’s convenient (this is true)
• It’s ostensibly low-risk and reliable (no, this is far from the truth)

More than 90 percent of the battle is moving these small companies away from in-house payroll. The small business CEO becomes complacent, thinking and questioning, “Why change?”

The simple answer is that most small business accounting teams are not knowledgeable about payroll. Show me a great controller, and I’ll show you a person who loathes payroll processing. As a rule, accountants generally hate payroll because it’s an albatross on limited resources.

Experienced accountants view payroll in the same way they view income taxes. Income taxes are farmed out to CPA firms. The reason seasoned accountants prefer outsourcing payroll is that payroll firms are experts in this highly tax-compliant role.

If you have a third-party or an internal bookkeeper doing payroll in-house, it’s probably because they like clerical work and administration. Don’t let that reason be the deciding factor for doing your own payroll.

What Are the Risks of Doing In-House Payroll?

I am not a payroll expert, nor do I want to be. However, I’ve heard Bob Jennings (aka, The Seminar Speaker) share numerous horror stories about payroll non-compliance.

While somewhat tongue-in-cheek, just be perfect. Don’t make mistakes. Never. Is that possible?

I’ve already stated I’m no payroll expert, but I do know about the following risks:

1. The risk of mis-filling a 941 with errors (just because you are using QuickBooks payroll does not mean you’re risk-free). In these cases, the penalties are substantial and unforgiving.
2. Misclassifying contractors when they should be statutory employees (good luck on an audit if you are ever caught).
3. I’ve said it earlier, but payroll requires expertise in payroll tax law. If you have someone handling in-house payroll, they should have one or more HR/payroll certifications and complete upwards of 40 hours of CPE annually. That’s even true if using QuickBooks payroll.
4. Theft. Yes, it’s true. Ask me about Erin, who was a one-person accounting department for a $13 million temp staffing company. It happens.

While it’s not a risk, payroll places a high burden on the accounting team. Remember, good accountants generally loathe payroll. It’s a significant distraction from what they should be doing.

Now that you know the risks, are you sure you want to keep doing payroll in-house?

How to Find a Payroll Firm

I learned a key insight about payroll firms when I started my consulting practice more than twenty years ago. Payroll firms are excellent and affordable at handling the mundane, routine tasks of payroll when nothing goes wrong. When issues appear, that’s when you find out if you have a good firm or not.

I’ve experienced frustrations with the national firms. I’ve never been a fan of ADP, and there are a couple of others whose pricing baffles me. So who does that leave?

Most cities have payroll firms that handle from 500 to 2000 clients in any given month. I’d start there. Obviously, you want to interview a few of their customers.

I’m also a fan of CPA firms that use CS Payroll by Thomson Reuters. First and foremost, these firms are tax and accounting-centric. If they use CS Payroll, it means they are serious about payroll and run the operation like a business. However, I’m also open to any other CPA firm that has a fully dedicated payroll arm separate from its tax and auditing services.

While a CPA firm offering payroll services might be slightly pricer than, say, Paycor, expect far better and faster customer service.

While I may appear to be dismissing the Paycors and the Ghustos of the payroll world, know the type of customer service you’ll be receiving if you select a national firm.

On the other hand, do not automatically default to your current CPA firm if they offer payroll services. I’ve been to enough CPE events where I’ve heard many firm owners express their dislike for payroll. They provide the service because they feel as though they need to. Please stay away from them. If you go the local route, find the firm that runs payroll as a dedicated business.

The Only Time In-house Payroll is Acceptable

I’m going to break up my answer into two parts. My first answer pertains to an industry where tight integration is beneficial, but not strictly required.

Imagine a large specialty or general contractor with 50 or more contracts in process at any given time. If an outside payroll firm is used, the journal entry to record payroll could easily be 100 lines or more. While the journal entry can be automatically uploaded to the accounting system, the process is still laborious.

In those cases, if the contractor has a seasoned accountant who thoroughly understands labor law and stays up to date on state and federal regulations, I lean toward handling payroll in-house. This approach allows payroll to be tightly integrated with the project management system.

And that leads to the second part of my answer. I only want a person doing payroll with the following background:

• At least five years of public accounting experience, with much of that work in taxes
• They complete at least 80 CPE hours in payroll-related topics annually
• They insist on hiring a third-party firm that they can use for Q&A on an anytime-anywhere basis
• They also possess one of the SHRM certifications

Many of the outsourced bookkeepers and clerks I’ve experienced since 2001 do not meet any of these qualifications, but the majority will tell their clients they are payroll experts. They think that because they seemingly know QuickBooks, they can handle any payroll need for those they serve. That’s not a true statement.

Suppose you have an outsourced bookkeeper who uses QuickBooks Payroll. In that case, my first recommendation is to find a local payroll expert who can review your practices and procedures and identify areas of compliance risk that can be significantly reduced. Keep that person in place for your outsourced bookkeeper until you ultimately decide to move on to a payroll firm.

Also, make sure your bookkeeper has a complete checklist—from setting up payroll items in the accounting system to actual payroll processing to auditing/reconciling liabilities after each pay period. While I still don’t like the idea of your bookkeeper doing payroll, at least that third-party local payroll expert can be a resource on demand.

Am I being harsh in stating you shouldn’t do payroll in-house? If so, let’s reframe the question: Which solution offers the lowest risk backed by the most significant compliance expertise? I think you’ll get the answer right on this one.