By Stephen J. Dunn
Payroll service providers are a big deal for small business─an estimated 41% of American small businesses use them.
The services provided by PSPs range from payroll processing to taking custody of an employer’s payroll cash. Payroll processing includes computing employees’ gross pay, withholdings, and net pay; printing payroll checks (for employees not electing direct deposit); preparing payroll reports for management; and preparing payroll tax returns. PSPs make valuable expertise available to employers unable to develop it on their own.
PSPs taking custody of employers’ payroll cash assume responsibility for paying for payroll taxes on employees’ wages, and for paying net pay to employees. Professional employer organizations (“PEOs”) go further and purport to hire an employer’s employees and lease them back to their erstwhile employer. PEOs assume responsibility for paying employees’ net pay and all payroll taxes, and for funding all employee benefits.
The problem is that a PSP taking custody of employers’ payroll cash may not use it for its intended purpose. Employees must be paid their net wages, as surely they will be heard from if they are not. But the taxing authorities are not at the PSP’s door demanding remittance of payroll taxes. The PSP principals can embezzle the funds earmarked for payroll taxes, perhaps covering them later with other amounts withheld from employees’ wages.
The taxing authorities will eventually demand payment of payroll taxes. When they do the employer may have to pay the taxes a second time. Even an employer using a PEO is not off the hook, as taxing authorities may regard a purported lessee as employees’ true employer.
In an infamous case here in southeast Michigan, principals of PSP Simplified Employment Systems embezzled tens of millions of dollars of its customers’ employment tax funds.
An employer should never allow a PSP to take custody of its payroll cash. The employer should maintain custody of its payroll cash, funding the payroll bank account, making direct deposits of net pay to employees’ bank accounts, distributing payroll checks to employees not electing the direct deposit option, and remitting all payroll taxes. If the employer does not prepare its payroll tax returns, it should review the PSP-prepared returns, reconcile them to its books, sign them, and file them.
Upon receiving payroll account bank statements, an employer should reconcile them to its books, promptly notifying the depositary bank of any forged or altered checks. Under the law of most states, a customer cannot hold a depositary bank liable for paying a forged or altered check unless the customer notifies the bank of the defalcation “within a reasonable period of time, not exceeding 30 days,” after the customer first receives a bank statement reporting it.
In sum, computing employees’ gross pay and withholdings, printing payroll checks, preparing payroll reports, and preparing payroll tax returns are appropriate uses of a PSP. But an employer should never allow a PSP to take custody of its payroll cash.