Exploring Outsourcing in HR and Payroll: Insights from Industry Experts

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The COVID-19 pandemic prompted significant changes to tax and labor laws, creating more compliance challenges for employers. Even after the pandemic, HR and payroll functions are rapidly evolving, particularly with the integration of generative artificial intelligence (AI).

A new presidential administration is also implementing changes across key agencies like the IRS and the Department of Labor, with potential rollbacks of certain regulations. Meanwhile, states are increasingly focusing on laws related to pay transparency and minimum wage.

In a recent discussion, experts from a top 10 advisory tax and assurance firm examined the benefits and complexities of outsourcing HR and payroll functions. They highlighted why many companies are opting for this approach amid ongoing regulatory changes, expansions, and other evolving needs.

Reasons and benefits

Gillian Florentine, a director with Baker Tilly’s Human Resources consulting team, explained that when outsourcing HR and payroll functions, there are generally two main approaches: project-based outsourcing and recurring support. She said that recurring outsourcing involves ongoing support for HR and payroll functions which can be more cost-effective for small to mid-sized businesses (SMB) that do not have the capacity to hire full-time staff for these roles.

Florentine added that outsourcing also offers reliable backup support. If a full-time HR or payroll employee is on leave, the outsourcing firm can provide another expert to fill in, ensuring continuity. “The backup nature of outsourcing is pretty desirable…especially in the SMB demographic,” she said.

Deanna Kempinski, a senior manager with Baker Tilly’s Human Resources consulting team, noted that project-based outsourcing has a definitive start and stop period involving tasks such as updating or creating employee handbooks, refreshing job descriptions, or conducting compensation studies. She said that there are many reasons a business might outsource HR and payroll projects, including lacking the bandwidth internally to do the work themselves.

Kempinski added that a fair amount of project work is in the compensation space. “A lot of times, organizations just don’t have the expertise in-house to do a full-out compensation study with access to market data,” she said.

Challenges and solutions

Outsourcing HR and payroll functions present benefits for organizations, but challenges may also arise. Florentine explained that one common challenge is the difficulty leaders face in envisioning how remote support will work with their staff, especially since many have been operating in remote or hybrid modes since COVID-19. “How do you actually support the people if you’re not co-located with them…physically?” she questioned.

To address this, Florentine suggested outsourcing providers offer virtual office hours through platforms like Zoom or Webex, simulating in-office interactions and ensuring accessibility.

Another challenge Florentine stressed is the hesitation employees may feel when approaching HR due to existing relationships within the organization. However, she said that a significant benefit of outsourcing is the neutrality of third-party providers. As external entities, they remain impartial, which helps in resolving issues fairly and is appreciated by both employees and management.

“We really are a neutral third party to come and help resolve issues that might not otherwise be uncovered in the business,” Florentine said.

Kempinski noted that the nature of project-based work often involves addressing specific needs, which can differ from recurring tasks. She said that challenges may arise when a leader engages in a project without securing buy-in from other stakeholders, leading to delays in obtaining necessary information, completing requests, or general responsiveness, which can extend timelines and complicate project completion.

“But generally, we’re not seeing too much pushback on the project side…because it’s…a different thing that they’re looking for,” Kempinski said.

Assessing the need for outsourcing

When it comes to determining the need for outsourcing, Florentine stated that payroll becomes a necessity after the first employee is hired. She said that business owners must decide whether to manage payroll internally or outsource it, considering factors like organizational size and complexity. Expanding business operations is also a factor since multi-state hiring adds further complications due to varying state regulations.

Florentine advised businesses to evaluate their size, complexity, and growth trajectory to determine if outsourcing is appropriate. Also, consider their internal expertise and resources. A cost-benefit analysis should factor in potential savings, compliance improvements, and a strategic focus on core activities.

On the project side, Kempinski said organizations may need to outsource due to anticipated staff changes, such as retirements, or to enhance skills and technology. Taking advantage of these third-party services can provide greater expertise and connectivity, helping businesses adapt and advance.

“So, I think that trajectory of your business and…where you want to take it could influence the decision too,” she said.

“And you can find that sometimes…outsourcing the project, or complete functions altogether, better solve long-term for where the company wants to go,” Florentine added.

Selecting an outsourcing partner

Choosing an outsourcing partner can be a challenging process. Both Florentine and Kempinski emphasize that companies should evaluate factors such as expertise, responsiveness, having a single point of contact, and cultural fit to ensure success. Florentine compared business partnerships to marriage, stressing the significance of considering long-term compatibility instead of rushing into a decision.

She explained that businesses typically seek partners who understand their needs, are responsive, and offer technical expertise at a reasonable price. The goal is to find a vendor that provides good value and service. “Those are the things that, if I’m sitting in the C-suite or executive or business owner seat that I’m thinking about, if I’m going to buy those services,” Florentine reasoned.

Kempinski highlighted the importance of choosing partners who provide innovative solutions instead of simply replicating existing processes. “Think about ways to improve,” she advised.

During the request for proposal (RFP) process, she suggested looking for vendors who propose enhancements to processes, such as streamlined payroll and increased employee engagement. Additionally, Kempinski emphasized the need to ask vendors how they would tackle specific problems or pain points during the vetting process to ensure they can offer effective solutions.

Florentine noted that large firms typically have an RFP process to define their needs, but many SMBs do not, which can lead to unclear expectations and challenges in defining the scope of work. Whether formalized or not, critically assessing what is needed before engaging with vendors is a crucial first step.

Implementation and transition

The initial steps transitioning to outsourcing can vary depending on whether the company is starting from scratch or already has existing operations. For new setups, Florentine suggested prioritizing tasks like establishing payroll accounts and onboarding paperwork. For existing operations, she advised assessing the current state of HR and payroll, identifying vendors, and planning the transition to avoid service gaps.

“Make sure there’s plenty of coverage so that the business doesn’t feel any gap in service or experience,” Florentine said, noting the importance of facilitating a smooth transition process.

For projects, Kempinski urged to ensure full agreement on the scope of work and customize the plan to meet client needs. She explained that flexibility is key, allowing for a phased implementation, if necessary, which should begin with a clear understanding of the client’s requirements and adjust as needed based on discussions.

Managing the outsourcing relationship

Florentine and Kempinski explained that effective communication is key to managing a successful outsourcing partnership, especially when working remotely. Florentine suggested regular meetings, clear documentation, and proactive updates to help maintain alignment. She also said that monitoring performance involves setting expectations and reviewing outcomes against metrics.

Florentine emphasized the advantage of making a phone call to communicate an issue, which may take more time to resolve through multiple emails. “Sometimes, you can resolve things in just two minutes,” she said. She added that a personal touch is often more appreciated and can lead to a better outcome.

On the project side, Kempinski said that weekly or biweekly check-ins help manage complexity. She explained that once the necessary information is gathered, the team can proceed independently, providing drafts and final deliverables for client feedback.

Legal and compliance considerations

When outsourcing HR and payroll functions, Florentine stated that companies must be aware of legal compliance considerations. She stressed that engaging with a third party does not eliminate employer responsibilities and circled back to the importance of communication between the business and the third party to ensure both parties are aligned.

Florentine also took the time to explain a key distinction between outsourcing to a Professional Employer Organization (PEO) and other third-party firms. She noted that PEOs enter into a co-employer relationship, issuing W-2 forms under their Employer Identification Number (EIN), while non-PEO firms allow companies to retain control over their staff and issue W-2 forms under their own EIN.

Florentine cautioned that this difference could impact customization and flexibility in HR and payroll processes.

Data security when working with a third party

Data security is a critical factor to consider when outsourcing HR and payroll functions because of the sensitive personal and health-related information involved. To ensure data protection, Florentine mentioned that companies use secure platforms like Huddle for information exchange, restricting access to authorized personnel only. She also recommended using secure email protocols to protect communications.

Additionally, Kempinski highlighted that firms prioritize confidentiality in proposals and engagement letters, and that employees receive extensive training on data security to safeguard sensitive information. She also encouraged organizations collaborating with third parties to utilize secure servers for information sharing and to verify that providers have similar security measures in place.

Emerging trends in 2025

Florentine and Kempinski discussed a few trends that emerged in HR and payroll outsourcing in 2025. Florentine said that business leaders are increasingly focused on workforce planning, upskilling, and reskilling employees to adapt to automation and AI. They seek cost-effective solutions for day-to-day tasks while reconfiguring existing roles to meet new demands.

Kempinski stated that compensation remains a significant topic, with a broader focus on total rewards, including time off, leave options, and flexible work schedules. Pay transparency legislation is prompting organizations to reassess their compensation structures and philosophies, leading to more questions from employees.