Many employers outsource some or all of their payroll and related tax duties to third-party payroll service providers.
These providers can help you:
- Administer payroll and employment taxes; and
- Report, collect, and deposit employment taxes with state and federal authorities.
- However, it is important to understand that you are still ultimately responsible for the payment of income tax and Social Security and Medicare taxes.
Employers who outsource payroll should consider the following:
- Remember that you are ultimately the party responsible for the payment of income tax withheld and both employer and employee portions of Social Security and Medicare taxes. If the third party fails to make the federal tax payments, the IRS may assess penalties and interest on your employer account. You may also be held personally liable for certain unpaid federal taxes.
- If there are any issues with an account, the IRS will send correspondence to the employer's address of record. The IRS strongly suggests that you do not change your address of record to that of the payroll service provider, as it may leave you uninformed of tax matters.
- You should ensure that your payroll service provider is using the Electronic Federal Tax Payment System (EFTPS) so you can confirm that payments are being made on your behalf.
As part of the outsourcing process, employers may enter into an agreement in which the third party agrees to take over some or all of the employer’s federal employment tax withholding, reporting, and payment responsibilities. Depending on the arrangement, an employer who uses a third party to perform federal tax functions on its behalf may remain solely liable for taxes, or may become jointly and severally liable.
The following are common third-party arrangements:
- Payroll Service Provider (PSP). A PSP typically prepares employment tax returns for your signature and processes the withholding, deposit, and payment of the associated taxes. A PSP may also be authorized to prepare employee paychecks and Forms W-2.
- Reporting Agent (RA). Generally, a reporting agent is a PSP that is authorized to perform certain acts on behalf of an employer. You can use IRS Form 8655, Reporting Agent Authorization, to designate a PSP as a reporting agent for things like payroll services and depositing and paying taxes on your behalf.
- Section 3504 (Form 2678) Agent. You may appoint an agent (under section 3504 of the Internal Revenue Code) to perform acts such as withholding, reporting, and paying federal employment taxes. A significant difference from a PSP or RA is that the section 3504 agent agrees to assume liability along with you for your Social Security, Medicare, and federal income tax withholding responsibilities.
The chart below illustrates the most significant differences among these third-party arrangements:
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