Choosing a payroll service or PEO

Before comparing tools, it helps to know the job. The IRS’s page on understanding employment taxes (opens in a new tab) explains that employers generally withhold federal income tax and the employee’s share of Social Security and Medicare taxes, pay the employer’s share, pay federal unemployment tax, deposit those taxes on a schedule, and file returns such as Form 941 and Form 940. At year end, employees get a Form W-2, and many contractors get a Form 1099-NEC.

States add their own layer: state income tax withholding in most states, state unemployment insurance, and new-hire reporting. The SBA’s hire and manage employees (opens in a new tab) guide walks through the steps of becoming an employer. Our first employee guide covers the paperwork in order.

Some very small employers run payroll by hand or with a spreadsheet. It is possible, but the deposit schedules and filings are easy to miss, which is why many owners use software.

• Payroll services (software): you enter hours and pay; the service calculates withholding, pays employees by direct deposit, makes tax deposits and files returns. Many add time tracking, benefits administration and basic HR tools.
• Accounting software with a payroll add-on: convenient if your books already live there, though features vary.
• A bookkeeper or accountant who runs payroll for you, often using one of the above.
• A professional employer organization (PEO): your workers are co-employed by the PEO for payroll, tax and benefits purposes. Owners often look at PEOs for access to group benefits and HR support, in exchange for less direct control and a longer contract.

• Pricing structure: many services charge a monthly base plus a per-employee charge. Ask what is included and what costs extra, such as year-end forms, extra pay runs or off-cycle checks.
• Tax filing: whether federal, state and local deposits and filings are all included, or only some.
• State coverage: whether the service handles every state where you have workers, including remote staff.
• Contractors: whether it can pay contractors and prepare 1099-NEC forms.
• Benefits: health, retirement and workers’ compensation options, if any, and who administers them.
• Integrations: whether it connects to your accounting software and time-tracking tool.
• Support: how to reach a person, and how quickly tax notices are handled.
• Data export: whether you can download pay history and tax filings if you switch.

• No clear answer about who pays penalties and interest if the service files late or wrong.
• Year-end, form or cancellation fees that only appear in the fine print.
• Access to your tax filings and records that ends when you leave.
• A PEO contract with a long term or exit fee you did not see up front.

The IRS reminds employers that they remain responsible for their employment taxes even when a third party handles the work. It can help to keep access to your IRS business tax account and check that deposits are actually being made.

1. Which federal, state and local filings and deposits do you make for me?
2. If you make a filing error, who pays the penalty and interest?
3. What does it cost per month and per employee, and what costs extra?
4. Can you pay contractors and prepare their year-end forms?
5. How do I get my payroll records and tax filings out if I leave?
6. Do you integrate with the accounting software I use?

A tax professional or an SBA resource partner such as SCORE or a Small Business Development Center can help you think it through (opens in a new tab) at little or no cost. If cash to cover payroll is the problem rather than the software, see our payroll financing explainer.