Payroll processing is undergoing a renaissance of sorts, as more players enter the field, the processing options grow more diverse, and the compliance issues become more critical.

Once relegated to an administrative assistant or bookkeeper, rather than being treated as a real discipline for professionals, payroll was used by many accounting firms as a loss leader. It was a service provided for clients that was not necessarily profitable in itself, but rather a means of maintaining the professional relationship with the client in order to capture the more profitable engagements in audit, tax and business management.

But things have changed.

As the economy has declined, the nation's 11,000-plus taxing authorities have become much more aggressive about the collection of payroll taxes. This has led to higher penalties for non-compliance, as well as a substantive increase in the changes made each year to the payroll tax codes.

CompuPay noted that in 2011 alone there were over 4,000 regulation changes nationwide affecting federal, state and local payroll taxes. This magnitude of change is simply too much for the average small-business owner to keep pace with.

This growing regulatory attention has: created a reduction in the number of companies that want to do payroll on their own; created a resurgence in the use of payroll processing service bureaus; and brought a new generation of competitors -- including private companies, banks and financial services firms -- into the field. The American Payroll Association, which provides education and professional certification for in-house payroll professionals, has more than 24,000 members in the U.S., with growing memberships in Canada and Mexico as well. And the Independent Payroll Processors Association, which represents the outside processing vendors, currently claims more than 240 companies as members.

"The complexity of payroll compliance is what makes payroll profitable," said Stephanie Salavejus, vice president and chief operating officer for PenSoft, a payroll and employee management software solution company headquartered in Newport News, Va. "With the legislative changes in the last decade, payroll is no longer a task that can be accomplished by just anybody -- it takes specialized training and professional certification. We see a strong trend toward accounting firms seeking payroll managers for their clients who have these certifications, in order to ensure the highest-quality service to clients and the lowest risk for the firm."

There is no question that accounting clients are looking to professionals to help reduce the risks inherent in processing payroll and filing the appropriate taxes. The question is, in an era of higher risk, higher competition and lower fees for the service, is payroll a profitable venture for an accounting firm?

"There are very few CPA firms that would find payroll to be a profit center," said Mark Strippy, executive director of payroll services for Heartland Payment Systems. "When you take a look at the technology investment required, the tax compliance issues, the cost of maintenance and forms, even the cost of printing and distributing paper checks, it makes little economic sense."

"CPAs want the opportunity to expand other services for clients, and for them what does make sense is to bundle payroll as part of a total service concept, but to avoid the cost and risk of doing it themselves," he added. "The successful CPA firm will offer payroll as part of the bundle by partnering with somebody who does it for a living."

"One of the strongest trends in payroll has been the move to Software-as-a-Service-based platforms," explained Michael Alter, president and CEO of SurePayroll. "The change has caused accountants who already offered payroll to rethink the business and take advantage of the growth potential here. Additionally, many accountants who never considered payroll are now offering payroll services for the first time. SurePayroll has seen the number of accountants who get into the payroll business grow by more than 50 percent each year for the past three years. The SaaS model makes the payroll business more profitable because the model is infinitely scalable. This enables payroll to be profitable even for a relatively small number of payroll clients."

 

THE FOUR MODELS

"In terms of a small accounting firm performing payroll services ourselves for our clients, the answer has to be, 'Absolutely not,'" said Randy Crews, the owner of a South Texas accounting practice that serves a diverse client base. "If you plan to do it yourself, even with the best software and systems, we calculated that we would need more than 80 payroll clients just to break even. That's because of the necessary investment in the system, in one or more trained professionals, and in tax liabilities and the increased risk to the practice, all of which have to be factored into the overhead of the firm."

Lisa McMahon, a member of Warren Averett, a Birmingham, Ala.-based accounting firm, has referred the firm's clients to an outsourced payroll company for the past eight years. "Keeping up and complying with all the federal, state and local rules and regulations requires a lot of time and effort. Many clients have limited resources to use for processing their payroll and filing all the necessary returns timely. By outsourcing their payroll, our clients can get out of the payroll business and have more time to spend on revenue-generating activities for their business."

The numbers vary, but most payroll professionals agree that performing payroll services completely in-house will require a large client base just for those services. The estimates vary, but the minimum seems to be in the range of 80 to 130 payroll clients to break even. And even with those numbers, direct processing by the accounting firm may not represent the best way to serve the clients.

There are actually four models for how to offer payroll services:

Offer no services. Instead, establish a relationship with a reliable payroll service to which clients can be referred, with the firm having virtually no interaction.

"Payroll can be a very profitable service, but you have to make a strategic decision either to get all the way in or get all the way out," said Jack LaRue, senior vice president of MyPay Solutions for Thomson Reuters. "If you are going to perform the service, you have to dedicate the resources and keep pace with the changes in tax law. The days of offering payroll to a few clients in order to gain larger or more profitable engagements are over."

MyPay currently does more than $5 million a year in payroll processing in all 50 states, providing services and support to accountants who choose to be involved with payroll without having to process it. "You have to make a clear and conscious decision to do payroll, because it is one of the 'stickiest' of services. It is one of the ways that an accountant secures his position as a trusted business advisor," said LaRue.

Refer the service, but maintain oversight. This is a solution in which the accounting firm is not involved in the preparation of the payroll, but does review the payroll figures and validates the filing of the payroll taxes. This generally may also involve assisting the client with payroll decisions and ensuring the correct transfer of payroll information to the general ledger.

"Business owners virtually have to outsource their payrolls," said Lori Loridon, director of payroll and tax compliance for Sage Employer Solutions, which includes Sage HRMS. "Payroll is not their highest priority, and in a small company the owner may not have the knowledge and experience to do payroll. So it becomes essential for a knowledgeable professional to be watching over the payroll and the compliance process. And it makes sense for that professional to be at the accounting firm, because that is who will have to deal with the issue if there is ever a tax compliance problem."

Partner with a processor. This is the model in which the firm offers payroll services and actively works to expand its practice, but partners with an external processor. Offered by a number of vendors, in this option the accounting firm is integrally involved in the payroll processes, but does not need an internal staff to complete the mechanical process to input data and output payroll or tax forms. This is the most common model in use by accounting firms today, with the exception of sole-practitioner firms.

"Only a small number of accounting firms take a hands-off approach to payroll," said Andy Childs, vice president of marketing for Paychex Payroll Processing, one of the major national firms that offer specific tools for accountants, and the exclusive payroll partner for the American Institute of CPAs. "And even these want access to the payroll data for accounting purposes. Likewise, only a small percentage wants to perform the payroll themselves."

"We have found that there has not been a major change in dynamics, in terms of CPAs that do or do not do payroll. Where the changes have been seen is in the tools that are available, with technology taking a larger role with the advent of online access, mobility, and other technologies for easier, faster, better access through multiple channels," he said.

Perform the payroll in-house. This is the option favored by major national and global accounting firms, which have the resources to commit both to the specialists to perform payroll and those needed to stay abreast of a rapidly changing tax market. And surprisingly, it is a popular option for many accounting firms seeking greater control over a payroll market whose risks are increasing. Professionals point to the need to personally keep abreast of the changes in compliance. An example: In the past year, the Commonwealth of Pennsylvania has recalculated all of its taxes and compliance rules.

"Payroll can be a profitable practice in its own right," said Scott Hess, a partner with Top 100 Firm CliftonLarsonAllen, in Racine, Wis. "We have upwards of 1,000 payroll clients in the new firm, and we use that practice as a part of the total service concept for our clients. Our overhead is already covered by traditional accounting services, so the gross profit from add-on services like payroll falls directly to the bottom line. We staff it with our own people, so that we maintain a personalized level of service with our clients. That's the way we do business, and it is successful for both us and our clients."

The path to profitability in payroll lies through any of these four models, if the firm assesses its service mix and the needs of its clients, then commits to a specific course of action and commits the necessary resources.

But in the 21st century, payroll is expanding beyond its traditional boundaries that encompass other services related to employees. In this emerging model, payroll is part of a continuum of services that begins with time clock or time and billing management, through payroll and benefits, and on to higher-end human resources services that may include employee policies, investment advice and retirement services.

 

THE HR COMPONENT

On the surface, the introduction of human resources management services as a companion to payroll seemed to make only marginal sense. After all, HR is a discipline in its own right, requiring a substantial body of education and experience beyond accounting.

But accounting firms that are offering both as bundled services see them as a natural extension of one another.

"The evolving nature of 'full-time,' together with the need to comply with the broader spectrum of increasingly complex employment rules and regulations, creates a greater need for small-business owners to use formal time and attendance systems," said Sal Hazday, vice president and general manager of specialty products for ADP's Small Business Services division.

"Another trend we see is the increased tracking of HR information through HRIS, or human resource information systems. For example, our research shows 75 percent of small businesses today track HR and benefits information, up from approximately half of small businesses tracking such data just a few years ago. By tracking employee data, payroll processors are better able to effectively and efficiently comply with changing regulations and initiatives launched by the Equal Employment Opportunity Commission and other federal, state and local agencies," Hazday added.

"The idea is to help firms maximize their return on investment," said Sage's Loridon, "as well as optimizing their human resources and payroll business processes. We offer an integrated HR and payroll system to assist accountants and their clients in automating and streamlining their day-to-day HR and payroll business processes. You can't treat the two as separate processes any longer, given the health care mandates that are impacting payroll decisions, the need for benefits administration, and an increasingly complicated retirement planning environment. You have to look at a tight integration of the entire stream of processes, from the moment an employee arrives at work or clocks in, to the day when they move into retirement."

 

A 'FULL-TIME' FUTURE

Payroll is an evolving practice for most firms. In the past five years, that evolution has included increasing use of social media, self-directed data management for employees, the use of "payroll portals" and the use of mobile applications to enable business owners and their accountants to manage the payroll and collaborate from anywhere, at any time.

But the future of payroll services may be less about technology than about compliance, and in particular new changes in payroll and benefits that will dramatically affect how "full-time" is defined for employees.

"The definition of 'full-time' is going to get a lot of attention over the next two years, but not necessarily only for labor or Fair Labor Standards Act overtime purposes," said Peter Isberg, vice president of government affairs for ADP. "The Patient Protection and Affordable Care Act (also known as health care reform) defines full-time as 30 hours a week on average, and requires all large employers to carefully track, record and report to the IRS annually whether each employee worked full-time during each month starting in 2014. This will, in turn, drive which employees must be offered health benefits to avoid an IRS shared responsibility penalty. It also factors in to new automatic enrollment requirements and waiting period limitations, among other important details."

"Accounting professionals processing payroll for their clients should keep an eye on how 'full-time' will be defined and become familiar with the new IRS proposed guidance defining different ways in which employers will track the full-time status of each employee," Isberg said.

 

Dave McClure is the president of Kent Associates, in Alexandria, Va., an independent testing laboratory and evaluation service.

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