What is a Payroll Service Agreement?
Payroll service agreements are essential documents used by companies that have outgrown their in-house payroll and human resource capabilities. Generally, payroll service agreements document an agreement between a human resources outsourcing company ("HRSO") and its client(s) regarding the HRSO’s provision of payroll services over a group of employees or contingent workers in exchange for certain fees.
In essence, a payroll service agreement is an agreement to pay someone else to do what many businesses used to do themselves. However, payroll service agreements are important documents that in addition to memorializing an agreement to provide payroll services, should also address licensure and registration requirements, intellectual property rights, confidentiality of information, obligations with regard to information technology security, compliance with applicable laws, indemnification and other legal considerations .
Companies contracting with HRSOs may offer such companies peace of mind by assuring them that compliance with payroll, tax and human resources obligations will be handled by experts in the field while providing them with the financial flexibility to focus on their core businesses, rather than on administrative tasks. In the case where a panel (or multiple panels) of HRSOs have been approved by the company, the panel HRSO should be required to enter into a detailed payroll service agreement with the company, spelling out as many details regarding the relationship as possible, while leaving certain implementation details to be handled through statements of work and/or the HRSO’s standard form of engagement and other agreement(s) with the company.
Key Components of a Payroll Service Agreement
Payroll service agreement usually will contain the following: Scope of Service, Fees, Ownership of Data and Security, Termination and Limitation of Liability. Scope of Services. The scope of services section is where you will find both parties’ obligations clearly laid out (at least that is the goal). If the payroll company is responsible for reporting employees’ wages to state and federal authorities, this will be the section that sets forth what those duties are. You may find that the payroll company will limit their obligation in providing guidance on tax law and amendments. Sometimes a one line statement is included to the effect that the payroll company is not responsible for ensuring compliance with ever-changing tax law. It is also important to know whether the payroll company will provide services as to employees or as to independent contractors whose salaries are reported on IRS Form 1099. Before you sign an agreement, you will want to ensure that the scope of services is what you expected and that there are no other fees that will be charged in addition to the fees you expect to be charged.
Fees. You will want to confirm the specific fees to be charged for the services and whether the fees may be increased after a certain point in time. Another key consideration are the fees that the vendor will charge if you terminate your relationship before the contract expires. For example, the vendor may charge a fee to process the final payroll or a fee in lieu of a monthly service fee for a portion of the unfulfilled portion of the contract.
Ownership of the Data and Security Provisions. It is critical that you understand whether the company will own the data that it processes on your behalf. Generally, you will want to own the data. Security provisions are also critical and you want to ensure that they address whether or not a third party vendor will have access to the data. For example, if the vendor employs off-shore employees that work with the data, you will want to ensure that you are comfortable with this access and that these employees are under contract as well.
Termination. Like all termination rights and notice provisions, it is important to understand when the vendor can terminate the contract and what the notice provisions are. These can vary from three (3) days to thirty (30), although a 30-day provision is fairly standard and common.
Limitation of Liability. The limitation of liability provisions limit both parties’ liability for breach of contract or otherwise and may limit the amount of damages recoverable for breach of contract. There are two important points to remember about these provisions. First, generally speaking, courts will not enforce provisions that limit liability for reckless or willful injury. Second, the law in that particular jurisdiction governs the language unless the parties agree to be governed by another jurisdiction’s laws.
How to Select a Payroll Service Provider
When it comes to choosing a payroll service provider, businesses should consider several factors, as not all payroll companies are created equal. Reputation and experience in the industry are important factors to consider as well as experience with companies of similar size. This may seem like an obvious consideration, but keep in mind that many payroll service providers still prefer to do business in batches and by capacity and this can create real problems for companies with unique needs or requirements. For example, if a provider does not have experience with executive compensation packages, stock options or various incentive compensation plans, you may find yourself needing to enter into a service agreement with a second provider lured by a low price for services. Price is always an important consideration, but companies must also be wary of pricing based on hourly rates or surcharges for services. Surcharges are frequently charged for more labor-intensive services such as year-end processing, and they can add up quickly. A company’s representative should review the pricing structure with the services representative to ensure there are no surprises. Hourly charges can be an indication of an inefficient staff at the payroll provider. Hourly charges may not include an estimate for the amount of time it will take to process year end information or to set up the payroll. In addition, businesses should inquire as to the level of technology the payroll provider offers for its clients, particularly with regard to record keeping, certificates and configuration. While outsourcing these functions may seem like a tempting shortcut, off location processing and storage can bring a number of hidden risks. For example, if a computer system crashes and information is lost, the payroll provider may charge extra for re-creating the information or it may not be able to be re-created at all. If salaries are being held at the payroll provider for any period of time, the provider could run into liquidity issues that can cause checks and drafts to bounce. With the right technology, payroll providers should be able to electronically maintain paystubs, tax withholding statements and other documents. Payroll service providers may also have different criteria for processing and error adjustments. Some payroll service providers will be happy to make changes to W-2s, but others may charge for their services. In some cases, clients may end up choosing between getting their request done quickly and paying significantly more for the service.
Common Issues with Payroll Service Agreements
When signing up with a payroll service company, you may sign an acceptance form to begin using their services, as well as a service agreement or contract. There may also be additional exhibits—sometimes confusing—containing other materials, such as Privacy and Security Statements, Data Use Agreements, State Notices, etc.
The problem for many businesses is that they simply sign the forms without reading everything and, if they do manage to read everything, they may not fully understand the implications. Again, legal counsel can be a valuable resource for analyzing any such agreements.
Here are some common issues that arise when working with payroll service providers. Note that these are merely examples of some common pitfalls, so they are not exhaustive nor do they cover all the issues that may arise.
Unclear Terms and Conditions—Service providers use boilerplate forms and can insert any number of legal terms in the agreement itself or on other forms. It is up to the business to ensure that they fully understand the terms, how the agreement works, and what is meant by certain terms.
Monitoring and Auditing Terms—Some agreements contain clauses or provisions that require the customer to audit, monitor or otherwise review information provided by the service provider. Depending on the wording, such terms can be very onerous.
Inconsistent Terms – Inconsistency in terms or clauses across multiple documents that constitute the agreement (what is free or paid, who has rights to what, etc.) can lead to problems between businesses and their providers.
Hidden Fees – A frequent source of disputes, hidden fees can start off small and before you know it, you could be paying double what you thought you were.
Service Interruptions – When things go wrong with programming, system transitions or updates, service interruptions can cost businesses lost sales or even lost customers. Not all payroll service providers make themselves available during all hours (e.g., weekends).
Security Breaches – And this is not limited to service providers. Although few things are immune to today’s hackers, over the past few years, a number of major breaches have been perpetrated against companies that perform payroll services.
Negotiating a Payroll Service Agreement
The beginning point in negotiating a payroll service agreement is to identify your company’s priorities as well as the questions you want the vendor to answer. It is important to identify which items concern you most. For example, if your company offers a 401(k) plan, then missing a scheduled deposit deadline can have serious ramifications. On the other hand, if you haven’t converted to an electronic timekeeping solution, timing on payment of payroll taxes each month might not be as high a priority. Priorities will very likely be different from one company to the next.
While assembling your list of priorities, you should certainly be asking at least the following questions: First, what precisely is included? You want to be certain that all of your needs are being met. A payroll service agreement should set forth all of the services that your vendor will provide. Some vendors focus on time and attendance systems or payroll services and may not be able to help you with other payroll-related services like drug testing, background or social security verification. If these are services that you’d like , you want to be certain that the payroll company either provides them or has an arrangement with another provider to ensure a seamless experience for your employees.
Second, how does the vendor keep my information secure? Physically, how is the data stored? Is it stored in a password-protected system and backed up each day? Is the payroll service provider software that only it has access to? If you ever have a dispute with the vendor, can it delete your data or back-up files to retaliate against you? Cybersecurity is an increasing concern in all industries. A payroll service company has large amounts of personal information about your employees. You want to verify that the vendor is protecting that information by taking steps that will minimize any potential cyberattacks.
Third, what happens when problems arise? Does the vendor have a process for when something goes wrong? What is the company’s policy with regard to penalties and late fees? Are employees reimbursed for bank fees incurred due to failure to deposit payroll funds on time? All of these questions should be addressed in the agreement, so it is important to obtain a negotiated agreement that includes answers to those questions. Failure to address them up front can result in costly penalties down the road.
Legal Challenges with Payroll Service Agreements
When you’re looking at signing a payroll service agreement, there are some legal considerations to keep in mind.
What is "the Law" When You Are Hiring a Payroll Service?
A payroll service may be liable for criminal prosecution if employees are mistreated on the job. You can also be liable under certain circumstances. The way to control the exposure of this issue is to make sure in the agreement that the payroll service is warranting that they’re in compliance with the state and federal labor laws and that you are complying as well. The payroll service can also agree to indemnify you if there is any liability under the law. The payroll companies also have insurance to protect them and you from claims or lawsuits arising out of employment.
Taxes are another area of liability. You are liable for all taxes, including withholding taxes. The easiest way to limit your liability is to make it the sole responsibility of the payroll service to make sure that all taxes are reported and paid on time and that they are in compliance with the IRS.
There can also be liability under the Fair Labor Standards Act. If the worker is being misclassified as an independent contractor, you may be liable for his overtime and any other consequences of being classified incorrectly. This is an area where you absolutely want to be protected and cannot over-protect yourself.
Workers’ compensation insurance can be protected under this agreement. There are two ways to make the payroll company responsible for workers compensation. First, you can be responsible and shift the cost for workers’ compensation to the payroll company. If you want to pay less, you can choose to retain responsibility for workers’ compensation insurance and have the payroll company "check" on people’s hours to make sure that the correct amount is being contributed. If you’re a landscape company, fires, or something else that has high claims for workers compensation, you should make the payroll company responsible for workers’ compensation.
Insurance coverage for the payroll company must also be made available to you. If the payroll company has errors and emissions insurance, or general liability insurance, you may be able to come after them if there’s a problem.
Say you hire a payroll company, and they go out of business. The bankruptcy trustee may take a big chunk out of any claim you have. Therefore, you want the entity signing the agreement to be a corporation or an LLC, so the bankruptcy trustee does not have access to the owner’s personal assets. You want to make sure that whoever the payroll company hires to do the payroll for you has enough experience and is appropriately trained. It is a good idea to verify that the payroll company provides training. Another good idea is requiring that the payroll company indemnify you for any loss that occurs if they use someone who is not trained to carry out the payroll function. Also make sure that the individual who executes the contract on behalf of the payroll company has authority to do that, (and be sure to get a corporate or LLC resolution).
The Future of Payroll Service Agreements
Technological innovations and regulatory developments will continue to shape the future of payroll service agreements. For example, the IRS has embraced new technology by implementing an online system for submitting the Form 941, Employer’s Quarterly Federal Tax Return. Employers can begin using Form 941 Online to submit for the current quarter. The IRS has announced that it will eventually eliminate its submissions of Form 941 on paper. While the online system does not yet accept copies of Schedule B (Form 941), Employer’s Monthly Federal Tax Return, the IRS expects to have that capability within the next year . We expect that, in the future, payroll services will issue forms such as the Form 941 to the IRS electronically rather than submitting paper forms.
In addition to new technology, data collection may be affected by regulatory changes. For example, the Department of Labor’s proposed overtime pay regulations would require most employees who will be affected by the regulations to record all hours worked. Employers that use payroll services will have to modify their current procedures or adopt new procedures to ensure that their payroll service providers collect the required data. Federal and state laws that take effect on or after January 1, 2016 could also affect the data collected once those laws are implemented.