Understanding Payroll Costs for Small Businesses

Payroll costs for small businesses go well beyond the wages paid to employees. Accurately determining the total costs of paying employees is essential to understanding your business's financial health and pinpointing areas where you can streamline.

What Are Payroll Costs?

Payroll costs are the total expenses associated with compensating employees for their work at your business. What are typical payroll costs?

• Base pay (whether paid on an hourly, piece, salary, or other basis)
• Bonuses and commissions
• Paid time off and other employee leave
• Employer's portion of payroll taxes
• Employee benefits contributions
• Workers' compensation insurance
• Payroll administration costs

If you use payroll or accounting software, you may also have additional fees, such as payroll processing fees, payroll tax filing costs, or other add-ons. While certainly an extra expense, many businesses find that investing in a third-party payroll solution pays off in the long run since this option can help them mitigate payroll errors, provide additional tools to help them follow applicable laws and regulations, and save time each pay period.

How Much Does Payroll Cost for Small Business?

There are many options to run payroll, all of which come with associated costs of payroll services for small businesses. Here's a breakdown of some of the costs involved in the more common payroll methods, financially and otherwise.

In-House Payroll

A business owner may opt to keep payroll in-house, in which case they or dedicated members of their staff have total control over the process. Overall costs could remain relatively low and may encompass the systems and supplies needed to gather employee hours, calculate payroll, print paychecks, and pay direct deposit fees.

However, this in-house approach also involves learning the basics of properly running payroll every pay period and staying on top of changing laws related to payroll to avoid costly mistakes. As the business grows, the payroll process will become increasingly complex. This method can also make the business more vulnerable to mistakes and miscalculations due to the increased risk of human error.

While you can certainly figure out the process, running payroll can be difficult and time-consuming when you do it on your own. Even hiring a dedicated employee to handle payroll means paying that person (including benefits), providing training, and so on. Hiring a CPA for tax planning services will also come with ongoing costs for small businesses.

In-House vs. Outsourcing Payroll Costs 

Outsourcing payroll services can offer small businesses significant cost savings compared to managing payroll in-house. By outsourcing, businesses may be able to avoid the hidden costs of in-house payroll processing, such as software, employee hours, and potential penalties for errors. Outsourced payroll providers help businesses streamline processes and support compliance with tax laws, minimizing the risk of costly mistakes. Additionally, using a payroll service provider can free up valuable time for small business owners, allowing them to focus on growth rather than administrative tasks​.

Decision Matrix: In-House vs. Outsourcing Payroll

Payroll Software

Using payroll software can help streamline the process and time needed to manage payroll. Payroll software costs for small businesses include the price of the software itself and possibly installation costs, depending on the platform and pricing structure you choose. The features you opt into and the size of your workforce may also factor into the cost of payroll software.

Most accounting software offers basic payroll functions, while others have more advanced features, such as tax filing services. Consider a payroll system that can export all payroll transactions into your accounting system. This can help your books and payroll ledgers match up, which can be critical to keeping accurate tax records for payroll and business taxes.

Automated Payroll Software

Automated payroll software is an excellent choice for business owners looking to recoup time and resources. This software will generally record and calculate employee paychecks, handle tax payments and deductions, and automate other payroll-related tasks. For an additional fee, many providers will also offer employee self-service options, HR services, and time-tracking capabilities that integrate with the business's payroll system. Note that with any payroll solution, businesses are still responsible for ensuring the accuracy and compliance of their payroll.

The total cost will depend on the features and additional modules chosen, the number of employees, business location, and other factors. Consider Paychex, which has payroll plans to meet the needs of businesses of any size.

Online Payroll Providers

Depending on your business's needs, an online payroll service provider can help you save time and minimize payroll mistakes. It can also be cost-effective over the long term, especially when it can scale to meet your needs as the business grows. This option can help automate administrative tasks such as:

• Payroll processing
• Payroll-related reports
• Tax filing
• New-hire reporting
• Withholding taxes and deductions
• Preparing paper checks and direct deposits
• Filing federal, state, and local taxes
• Automating deductions for 401(k) contributions or insurance premiums

Depending on the option may have a few different fees. Some of these fees depend on how many people the business employs and the frequency of payroll periods. Other fees might be for extra services like setting up employee benefits or providing reports. Generally, businesses can expect to spend between $30 and $100 per person each month for outsourcing payroll services. Look for upfront, transparent pricing when comparing providers.

Factors Influencing Payroll Costs

Payroll costs can vary significantly depending on the business size, industry, and where you operate. Some of the main factors that affect payroll costs include:

• Payroll frequency: The pay period a business decides on can have a direct impact on its payroll costs. When it comes to payroll services pricing, some providers charge for each payroll run, while others offer an unlimited number of payroll runs. This means that the more often you pay your employees, the more it could cost. Also, consider this factor if you have different pay schedules for different kinds of employees, such as one type of pay period for salaried employees and another for hourly workers.
• Industry: Costs such as workers' compensation and state unemployment insurance vary widely depending on your industry. For example, a construction company will likely have a higher workers' compensation cost per employee per hour than a real estate business.
• Number of employees on payroll: Payroll processing services typically charge a per-employee fee per month and recurring costs for the service itself. Businesses can expect to spend between $30 and $100 per employee per month with a payroll service provider.
• Direct deposit: There may be a cost associated with the banking software you use to process your payroll transactions. However, using a third-party payroll service provider can often minimize or eliminate this cost, as these providers typically have the necessary processing software already built into their service. There may also be some minimum account balance or per-transaction fees incurred. However, these costs tend to be minor.
• Operating in multiple states or localities: Your payroll can become incredibly complex if you have employees working across the country. That's because no two states, or even localities, are alike regarding payroll tax laws, rules, and regulations. Such complications can quickly lead to avoidable errors, costly mistakes, and wasted time if you handle the process independently. Instead, many small businesses use a third-party service to help them process payroll for employees in multiple states.

Employee Benefits' Impact on Payroll Costs

Employee benefits play a significant role in shaping total payroll costs for small businesses. Benefits such as health insurance, retirement plans, and performance bonuses are critical components of employee compensation, but they also require careful payroll budgeting. For instance, offering a comprehensive health insurance plan typically adds a substantial amount to payroll costs, especially if the employer covers a large portion of premiums. Similarly, retirement contributions (like 401(k) matching) add long-term value for employees but must be factored into your payroll budget. Performance-based bonuses, while effective for employee motivation, can also cause fluctuations in payroll costs depending on business performance and employee achievements​.

Beyond traditional benefits, many businesses are turning to innovative, cost-effective options that provide high value to employees without significantly raising payroll expenses. For example, flexible working arrangements—such as remote work or flexible hours—can be offered with minimal direct cost but can substantially enhance employee satisfaction and retention. Other low-cost but high-value benefits include mental health support programs, employee wellness plans, and professional development opportunities, all of which can help reduce turnover and improve overall productivity​.

Budgeting for Employee Benefits Payroll Costs

1. Health Insurance: Typically the largest payroll-related benefit expense, often adding 10 to 20% to total payroll costs depending on employer contributions and plan options.
2. Retirement Plans: Employer matching programs add predictable long-term costs to payroll but also serve as strong retention tools.
3. Bonuses and Incentives: These can create variability in payroll costs, and they are often tied to performance metrics and business growth.
4. Innovative Benefits: Flexible work schedules, wellness programs, and mental health support offer significant value with lower upfront costs.

By strategically selecting a mix of traditional and innovative benefits, small businesses can help manage payroll expenses while offering valuable perks that enhance employee retention and satisfaction​.

Calculating and Estimating Payroll Costs for Small Business

The factors above (and many other variables) all contribute to a wide range of total employee payroll costs. As a general guideline, you can estimate payroll costs by adding up the following:

• Each employee's gross annual pay before taxes are withheld
• The total annual payroll taxes you pay on the employee's behalf
• Any additional expenses you pay on the employee's behalf, such as supplemental and statutory benefits and insurance coverage

A general rule of thumb is that once you add up the above expenses, payroll costs can be about 1.25 to 1.4 times an employee's base pay. So, if an employee is paid $30 per hour, the total payroll cost would be between $37.50 and $42 per hour.

Strategies for Managing Payroll Costs

There are concrete steps you can take to help manage day-to-day payroll costs. Beyond that, you may also be able to reduce payroll costs over the long term in the following ways:

• Outsource payroll functions: Consider outsourcing payroll to an expert payroll service provider that can help streamline processes and mitigate payroll errors. You may be surprised after getting a payroll quote that this can be a viable option versus having additional overhead.
• Classify workers correctly: Non-compliance with rules related to worker classification can lead to stiff financial penalties for an employer. If you misclassify an employee as an independent contractor, for example, you may be responsible for paying back payroll taxes for that worker and back pay.
• Invest in time tracking: It's worth evaluating your method for tracking employee time. An integrated time and attendance system can sharply decrease expenses related to the collection, management, and data entry involved in a manual system.
• Audit benefits: Even if you offer a robust employee benefits package, this could drain company expenses if some benefits are underutilized. Audit your offerings to ensure they align with your budget and employee preferences.
• Follow applicable business laws: Part of protecting your business's bottom line requires identifying potential areas of non-compliance and solving those vulnerabilities to help minimize their risk to the business. This includes staying on top of ever-changing laws, rules, and guidelines related to payroll and taxes, health and safety, employee rights, and human resources.

Future Trends in Payroll

Payroll has expanded beyond simply issuing paychecks to employees. It has become a dynamic tool for companies to accommodate various and increasing compensation agreements, support contract-based work, and meet employees' requests for faster access to funds and pay-related information. Some growing trends that could affect payroll costs in the future include:

• Immediate access to earned wages: Instant or on-demand pay allows eligible employees to access income as they earn it (typically up to a certain dollar amount each pay period) for a flat, per-transaction fee rather than waiting until their next regular pay day. For employers, pay-on-demand requires time and resources during implementation and ongoing administration. It can also quickly become complex, particularly if you're processing payroll alone.
• Increased pay: Many workers are unwavering in their quest for fair compensation. For employers, meeting increased pay demands, higher business operations costs, and the possibility of lower profits can make their businesses more vulnerable. Employers must keep a careful watch on their financial metrics and have a plan to help avoid challenges in meeting payroll obligations. Some payroll providers may provide payroll protection that extends the collection of payroll funds from your bank account.
• Timely gig worker pay: While traditional employees are typically paid weekly or bi-weekly, freelance or gig workers may have to wait weeks or months before receiving compensation. Employers who delay paying freelance or gig workers risk losing these skilled and talented individuals to competitors. Outsourcing payroll or using the most current payroll technology can help you take care of your contract-based, freelance, and gig workers with the prompt payments they depend upon and deserve.
• Emerging solutions for more accurate payroll: Rather than processing checks and finding errors after the fact, which take time to correct, building in more front-end reviews can help ensure that payroll is accurate before it goes out the door. Allowing employees to review their pay information before processing payroll is an emerging trend that is gaining traction. Paychex Pre-Check^SM allows employees to be involved in the payroll process and review their earnings and withholdings for accuracy before payday. Regular access to this information can also help them make necessary adjustments in withholdings or contributions to pre-tax accounts to take full advantage of their benefits package.

Cost Savings Through Integration and Automation in Payroll Processes

Integrating payroll software with other business functions can lead to substantial cost savings for small businesses. Tools that integrate payroll with HR, accounting, and time-tracking systems can automate manual processes, reducing the need for multiple platforms and the associated administrative costs. For example, by connecting payroll to HR software, businesses may have less administrative work, easier access to data, increased accuracy, and a higher level of regulatory compliance. This not only saves time but can also significantly reduce the risk of costly compliance errors​.

The ROI of integrated payroll systems is evident in both time saved and error reduction. Businesses that adopt software like Paychex Flex®, which offers integration with benefits, HR, and compliance systems, may see a direct reduction in hours spent on administrative tasks. Automation also helps reduce payroll errors—often a costly issue for small businesses—leading to fewer penalties and adjustments. These efficiencies translate into tangible cost savings and more predictable cash flow.