In today's challenging economic environment, companies are increasingly looking for ways to bolster revenues, and for some accounting firms that means offering payroll services for clients.

But the reality is that payroll is facing a storm of legislative uncertainties, economic aftershocks and ongoing technology changes, so commitment will be key in order for accounting firms to churn a profit and survive the swells.

"Some firms are getting into [payroll services] for a profit, but it takes a high commitment. You need to be all in or all out," said Jack LaRue, senior vice president of Thomson Reuters' myPay Solutions.

The consensus is that more and more accounting firms are providing payroll services to their clients. LaRue noted that an informal online poll taken in the spring indicated that most firms were looking to grow their payroll services business versus e-filing, tax planning or consulting. Meanwhile, a November 2008 PayCycle survey provided by Intuit found that 79 percent of the 456 respondents planned to grow their payroll business in 2009.

Payroll, however, is a complex market that has had its share of unrest over the years.

For example, Sage Software partnered with CompuPay in 2008 to provide outsourced payroll services so it could re-invest resources into other areas, and in February 2007, ADP announced that it had signed an agreement to acquire Intuit's outsourced payroll business. Such developments likely left some industry observers wondering if payroll is actually harder than it seems.

More recently, legislative uncertainties, such as health care reform, and the effects of the economic downturn have many on the edge of their seats, as changes are most certainly afoot for payroll.

"From a legislative or regulatory point of view, health care is on everybody's mind, and if some version or another of health care reform is eventually enacted into law, there are going to be some ramifications for payroll," said Mike O'Toole, senior director of publications and government relations for the American Payroll Association.

The bills that are currently floating around contain provisions that would require employers to report on an employee's W-2 how much the employer contributed to their health insurance during the year, explained O'Toole. This has actually been proposed off and on over the years, and O'Toole believes that this provision will be part of any bill.

"That would certainly involve payroll or at least a new interface between a company's benefits department and the payroll system," he said.

There are also proposals to cap the amount allowed in a flexible spending account for a year, which would involve payroll tracking a new cap on what employees can have taken out of their pay for their FSA. O'Toole said that he also saw a draft version that would narrow the definition of qualified medical expenses that could be reimbursed from a flexible spending account to not include non-prescription medications, such as aspirin, unless they are prescribed by a physician.

"So there are different things in health care reform that could affect payroll legislatively or regulatory-wise," O'Toole said.

The turbulent economy has certainly impacted payroll, as evidenced by the most recent quarterly results at Paychex, which offers a variety of payroll and human resource products and services. For the first quarter ended Aug. 31, Paychex saw its payroll service revenue decrease 6 percent, to $354.4 million compared with the year-ago period. Weak economic conditions negatively impacted its client growth, check volume, and revenue per check, as checks per client decreased 5 percent for the first quarter compared with the same period last year.

The American Recovery and Reinvestment Act that was passed by Congress in February to jump-start the economy will continue to impact payroll through next year, said O'Toole, given a reduction in employees' withholding. "The ramifications of that are going to come back to payroll people next year when people file their tax returns, because there's a fairly large segment of the population that was going to have their withholding reduced by more than their tax credit, and they may get a surprise when they file their income tax return next year," he said.

For example, married couples who file jointly and are each employed full time would each get about $600 worth of reduced withholding, or $1,200 total, but would be entitled to an $800 tax credit, so they may be under-withheld and have a surprise when they file their tax return next year. Then there are those situations where certain people aren't entitled to the tax credit or may fall under special withholding rules, such as those for non-resident aliens.

"So what is going to happen is when people start filing their tax returns next year they may be calling up the payroll person and say, 'So how come I was under-withheld? Did you do something wrong?'" O'Toole asked.

Another component of ARRA that could turn around and bite payroll is the COBRA subsidy premium. Under this subsidy, eligible workers pay 35 percent of the premium to their former employers.

"The employer pays the other 65 percent but gets that amount back as a tax credit when they file their employment tax return, so that is an extra administrative burden to payroll to then collect information from the employees and find out who is paying the reduced premiums and then getting the credit back when they file their employment tax return or subtracting it from their payroll tax deposits. It's another level of administrative burden for employers, especially this year when a lot of employers were involuntarily laying off or terminating quite a few people," O'Toole added.

 

FUELING THE FIRE

"On the unemployment compensation side, there's been a lot in the news about states that, when their funding for unemployment benefits gets low and they are in danger of running out, they can borrow money from the U.S. Treasury to help pay benefits, and they are obligated to repay that money back within a certain period of time," said O'Toole. "If they don't, then the employers who operate in those states have to pay more in federal unemployment tax."

A key example is Michigan, which was hard-hit by unemployment largely due to the downward spiral of the auto industry, and in 2007 borrowed money from the U.S Treasury to pay benefits. The state was unable to repay the money in 2008, as required, so in 2009 it became a credit-reduction state.

What this means is that all Michigan employers must submit federal unemployment at a higher rate each year that the state has an outstanding loan balance. Generally, an employer would submit federal unemployment at a rate of 0.8 percent on the first $7,000 of wages for each employee. Under the credit reduction, an employer must increase their rate 0.3 percent each year. Therefore, for 2009, all Michigan employers will be paying FUTA at a rate of 1.1 percent, and for 2010 at 1.4 percent.

The problem is that Michigan ended up being far from alone. O'Toole said that he is aware of 18 other states that borrowed money in 2008 and will be unable to repay in 2009, meaning that by the end of 2010 employers in those states could be paying higher federal unemployment tax.

"The economy does affect payroll in several ways, whether it is legislative or regulatory or just the sheer fact of job losses and unemployment compensation," O'Toole said.

 

THE UPSIDES

The good news is that there appears to be a great deal of opportunity for accounting firms interested in payroll services, and technology - namely Web-based solutions - has made payroll easier and more cost-effective.

Over the years, London, Ky.-based Greene, McCowan & Co. has built a solid payroll service business and today offers payroll services for about 100 clients, many of whom have more than 400 employees. Managing member Ryan McCowan said that the firm uses Thomson Reuters' Payroll CS for its payroll services, in conjunction with NetClient CS portals. On a time basis, payroll services account for about half of the firm's business.

McCowan's firm may have a robust payroll business today, but it didn't happen overnight. Several years ago, the firm didn't have the luxury of today's technology, as the software was too expensive. It would take the firm all day to do an 800-person payroll manually, but now, with the technology in place, it can be done in about an hour.

The firm packages payroll with its write-up services, a move that it believes lessens the likelihood of a client pulling its business and going to a competitor. "If you have [payroll] separate, they view it as just a charge if it is billed separately," said McCowan. "I think it adds value to the services."

Today, the firm is at a point where it is bringing in just payroll clients, which is a good way to build a relationship with that client and perhaps provide additional services.

"They see us as a trusted advisor, so we have that relationship if something goes wrong with their accountant," McCowan said.

This is in line with the findings of Intuit's PayCycle survey, which found that 82 percent of respondents said that they are able to sell accounting services to payroll clients.

R. Sean Manning, manager member of Manning & Co. PC's sister company, Payroll Vault, also uses Payroll CS to service its 100 payroll clients. He views payroll as "a profit center." It currently accounts for about 10 percent of gross revenue for the Littleton, Colo.-based firm, but the firm is hoping to see that number double next year and double again in the next three years.

Manning, like many industry members, believes a Web-based solution is key. In fact, Web-based payroll services and paperless solutions - such as private portals for clients, direct deposit, the electronic transmission of checks to be printed by the clients, and electronic pay stubs accessible via intranets - continue to be a strong trend within payroll.

Julie Lubetkin, accountant marketing leader for Intuit's Employee Management Solutions Group, said that online payroll has been a bright spot and is changing the perception of payroll to being "easy, profitable and convenient."

"Accountants are worried about revenues, and one way they are growing is by starting to provide online payroll," Lubetkin said.

Intuit's offering includes Intuit Online Payroll for Accounting Professionals (formerly PayCycle), which is designed for accounting professionals looking to offer payroll services. According to a 2007 PayCycle survey, 37 percent of accountants did not run client payroll before using Intuit Online Payroll for Accounting Professionals.

In July, Intuit completed its $170 million acquisition of PayCycle, a move it expects to expand the online capability of its payroll offering and strengthen the company's position as a provider of Software-as-a-Service for small businesses.

"It is doing all of the hard work for you," said James C. Cavalaris, CPA, who processes payroll for about 20 to 25 of his tax clients using Intuit Online Payroll for Accounting Professionals. Processing payroll for the small number of clients with Intuit's offering works well for Cavalaris, but he acknowledges that, if dealing with larger clients, payroll could "be very messy" and "very cumbersome."

LaRue of Thomson Reuters, whose offerings include Payroll CS, Service Bureau Payroll CS and myPay Solutions, agrees that more companies are moving toward paperless payroll, and he urges those firms that are serious about payroll to be committed and to have a dedicated staff, like two or three associates, if they want to turn a profit. Those firms that have a successful payroll business stand to benefit. "We know that payroll is one of the stickiest services because it is difficult for the client to leave the accounting firm," he said.

Thomson Reuters research has found that 38 percent of accountants prefer to process the payrolls for their clients, while 32 percent said that they prefer to outsource their clients' payrolls to a service bureau. The remaining 30 percent said that they prefer their clients to do their own payroll.

Waco, Texas-based Jaynes, Reitmeier, Boyd & Therrell PC has been processing payroll for clients for about 12 years, but roughly 10 years ago it decided to tackle the market head-on with a dedicated three-person staff handling just payroll processing.

"We decided there was a niche for it and we wanted to develop it - and it worked," said Paula Moerbe, senior manager of the firm.

The firm has a payroll division called Payroll Systems of Texas LLC that handles about 225 payroll clients. Payroll is currently a "small percentage" of the firm's revenues, but it is hoping to change that by beefing up advertising. The company processes payroll and bills it separately using Payroll CS, but is looking to migrate some of its larger clients to the Service Bureau Payroll CS solution.

Moerbe said that a key benefit to providing payroll services is the relationship that it builds with clients. "I think it is a great way to retain clients. We have good tax clients and they may have household employees. If you have a payroll bureau you can roll that into it. You want that relationship, and the tax information is available."

 

A CLOUDY FUTURE

As mentioned above, Sage Software announced in August 2008 that it had entered an agreement with CompuPay to provide co-branded outsourced payroll services to Sage Software customers. For accountants interested in offering online payroll processing services, this could mean using CompuPay on the back-end to handle the work, said Kathey Palmer, senior vice president of business development.

"We are seeing a heightened interest in accountants doing hosting solutions - accountants doing the front end and using us on the back end," said Palmer. "They are seeing payroll as a value-added service."

In 2006, NetSuite launched its Premium Payroll Service, a full-service solution to manage payroll whereby NetSuite handles all filings and deposits for federal, state and local jurisdictions.

Barinder Saini, director of payroll development for NetSuite, said that cloud-based systems are a trend and noted that if a CPA wanted to set up payroll for an existing customer they could buy a NetSuite subscription to meet that need.

Meanwhile, Joel Benzel, a senior product manager at Paychex, believes that accountants can further promote their value to clients looking to manage costs by being aware of solutions like time and attendance. The benefits could be significant. "If you are an average-size business with 50 hourly employees and had each person being paid for five minutes more a day without a time and attendance application, you'd be paying more than 1,000 hours over the course of a year, and if they are getting $15 an hour that could be $16,000 a year," Benzel said.

While payroll is undoubtedly facing several uncertainties in light of health care reform, recently enacted legislation and a wobbly economy, what does seem to be certain is that it is migrating to the Web - and that it can pay. "It will start as a value-added service because you have to have a lot of payrolls to make money on it," said McCowan. "I would look at my client base and see if clients will transfer that payroll to me."

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