PEO vs Payroll Software: Which Is Right for Your Small Business?

Managing payroll might be the most dreaded task on any small business owner's to-do list. Between calculating overtime, filing taxes across multiple states, and keeping up with ever-changing compliance requirements, it's easy to see why 40% of small businesses get penalized each year for payroll errors. But here's the real question: should you just automate what you're already doing, or hand the entire HR function to someone else?

The answer depends on whether you need payroll software or a Professional Employer Organization (PEO)—and understanding the difference could save your business thousands of dollars while freeing up hours of your time each week.

The Fundamental Difference: Tools vs Partnership

At the highest level, payroll software gives you better tools to do payroll yourself, while a PEO becomes your HR department's co-pilot, taking legal responsibility for many employment functions.

Payroll software handles calculations, automates tax filings, and generates reports—but you're still responsible for entering data, managing compliance, and resolving issues. Think of it as upgrading from a calculator to a sophisticated computer. You're more efficient, but you're still the one doing the work.

A PEO (Professional Employer Organization) enters into a co-employment relationship with your company. The PEO becomes the employer of record for certain HR functions—payroll, benefits administration, workers' compensation, and compliance—while you maintain control over day-to-day operations and business decisions.

This co-employment model is often misunderstood. You don't lose control of your employees. Instead, you share certain administrative responsibilities with an organization that has the expertise, buying power, and legal infrastructure to handle them more effectively than you could alone.

What Payroll Software Actually Does

Modern payroll software has evolved far beyond simple calculation tools. Here's what you can expect from a quality platform in 2026:

Core Functions

• Automated calculations: Gross pay, deductions, overtime, and net pay computed automatically based on your configured rules
• Tax filing: Federal, state, and local tax calculations with automatic deposits and form filing
• Direct deposit: Payments sent directly to employee bank accounts on schedule
• Reporting: W-2s, 1099s, and various compliance reports generated automatically
• Employee self-service: Staff can access pay stubs, update information, and manage their own tax withholdings

Advanced Features

• Time tracking integration: Sync with time clocks or apps to eliminate manual data entry
• Multi-state compliance: Automatic adjustment for different state tax rates and regulations
• Benefits deduction management: Coordinated deductions for health insurance, retirement, and other benefits
• New hire reporting: Automated state notifications when you bring on new employees

Typical Costs

Most payroll providers use a base-plus-per-employee pricing model:

• Base fee: $40-$150 per month
• Per-employee fee: $4-$15 per employee per month

For a 10-person company, expect to pay roughly $90-$300 monthly for payroll software.

What a PEO Provides

A PEO delivers everything payroll software does, plus significantly more:

Full HR Outsourcing

• Benefits administration: Health insurance, dental, vision, 401(k), HSA/FSA management
• Large-group benefits access: Because PEOs pool employees from multiple client companies, they can negotiate rates typically available only to enterprises with hundreds of employees
• Workers' compensation: Coverage administration and claims management
• HR support: Employee handbooks, policy creation, workplace safety programs, and HR guidance
• Compliance management: A dedicated team monitoring regulatory changes and ensuring your business stays compliant

Risk Mitigation

The co-employment relationship means the PEO shares liability for employment-related risks. This includes:

• Employment practice liability
• Workers' compensation claims
• Compliance with federal and state employment laws
• Tax liability for payroll taxes

Strategic HR Functions

Beyond administration, many PEOs provide:

• Recruiting and onboarding support
• Performance management tools
• Employee training resources
• HR consulting for difficult situations

Typical Costs

PEO pricing is straightforward per-employee:

• Basic PEO: $49-$79 per employee per month
• Comprehensive PEO (with premium benefits): $99-$149 per employee per month

For a 10-person company, expect to pay roughly $490-$1,490 monthly—but factor in the benefits cost savings before comparing directly to payroll software.

The Real Cost Comparison

Raw pricing comparisons miss the point. The real question is total cost of employment administration.

What Payroll Software Doesn't Include

When you choose payroll software, you're still responsible for:

Benefits procurement and administration: You'll negotiate directly with insurers or use a broker. Small businesses typically pay 8-18% more for health insurance than large employers because they lack bargaining power. You'll also spend time managing enrollments, terminations, and compliance.

Workers' compensation: You'll need separate coverage, and small businesses often face higher rates due to limited claims history.

Compliance monitoring: Employment law changes constantly. Without dedicated HR expertise, you risk missing updates that affect your business.

HR issues: When employee conflicts arise, you'll need to research solutions or pay for outside HR consulting.

The PEO Equation

A PEO might cost $500-1,000 more per month in direct fees—but consider:

• Benefits savings: PEO clients often see 10-20% reductions in health insurance costs
• Workers' comp savings: Master policies typically offer better rates than individual small business policies
• Time savings: Hours spent on HR administration can be redirected to revenue-generating activities
• Risk reduction: Employment lawsuits and compliance penalties can cost tens of thousands of dollars

For many businesses, the PEO premium pays for itself in benefits savings alone.

How to Decide: 7 Critical Questions

1. How Many Employees Do You Have?

Under 5 employees: Payroll software is usually sufficient. The complexity doesn't justify PEO costs, and you likely qualify for fewer regulatory requirements.

5-50 employees: This is the PEO sweet spot. You're large enough to benefit from pooled buying power but small enough that building an internal HR department isn't practical.

50+ employees: Evaluate both options carefully. You may have the scale to negotiate competitive benefits rates directly, or you might benefit from PEO services while building internal HR capacity.

2. Do You Offer Competitive Benefits?

If you're struggling to attract talent because larger competitors offer better benefits packages, a PEO levels the playing field. Access to large-group rates can transform your benefits from a weakness to a strength.

If you don't offer benefits or your industry doesn't expect them, payroll software handles your core needs without the additional cost.

3. How Complex Is Your Compliance Situation?

Businesses operating in multiple states, employing a mix of exempt and non-exempt workers, or in heavily regulated industries face significant compliance burdens. PEOs provide expertise that would otherwise require expensive legal and HR consultants.

If you operate in one state with straightforward employment situations, payroll software's built-in compliance features may suffice.

4. How Much Time Do You Spend on HR?

Track your actual hours spent on payroll, benefits questions, compliance research, and employee issues. If it's more than 5-10 hours per week, the cost of a PEO might be offset by the value of reclaimed time.

If HR takes minimal time, payroll software keeps things efficient without adding unnecessary services.

5. What's Your Growth Trajectory?

Rapid growth amplifies HR challenges exponentially. Each new hire means more onboarding, more benefits administration, and more compliance requirements. A PEO scales with you, handling increased complexity without requiring you to build HR infrastructure.

Stable headcount with minimal turnover means payroll software's predictable costs work in your favor.

6. Can You Handle an Employment Lawsuit?

A single employment lawsuit can cost $75,000-$125,000 to defend, even if you win. PEOs provide employment practices liability insurance and HR guidance that reduces lawsuit risk. If a lawsuit would devastate your business, the risk mitigation alone might justify PEO costs.

7. Do You Want to Be in the HR Business?

This is ultimately a philosophical question. Some business owners want full control over every employee interaction. Others view HR as a distraction from their core business and happily delegate it to specialists.

Neither answer is wrong—but be honest about which describes you.

Common Payroll Mistakes to Avoid (Regardless of Your Choice)

Whether you choose software or a PEO, these errors trap small businesses:

Employee Misclassification

Calling someone an independent contractor when they're legally an employee can trigger back taxes, penalties, and benefits obligations. The IRS and state agencies are actively auditing classification decisions.

Missing Tax Deadlines

Quarterly payroll tax deposits are due monthly or semi-weekly depending on your tax liability. Year-end forms have strict deadlines. Penalties accumulate quickly—and ignorance isn't a defense.

Overtime Calculation Errors

Non-exempt employees must receive overtime pay for hours over 40 per week. Miscalculating regular rate (which includes some bonuses and commissions) leads to underpayment and potential lawsuits.

Final Paycheck Failures

Many states require immediate or next-day final paychecks for terminated employees, including accrued PTO in some jurisdictions. Delays trigger penalties that often exceed the paycheck amount.

Benefit Deduction Mismatches

When benefits enrollment doesn't sync properly with payroll deductions, employees end up over- or underpaying for coverage. Neither situation ends well.

2026 Compliance Updates You Need to Know

Employment law continues evolving. Key changes for 2026:

• Minimum wage increases: 19 states raised minimum wages on January 1, with Hawaii seeing a $2/hour increase
• Retirement contribution limits: 401(k) limits increased again, requiring system updates
• ACA affordability threshold: Increased nearly a full percentage point, affecting which health plans satisfy the employer mandate
• State-specific requirements: Many states added new leave requirements, pay transparency laws, or classification rules

A PEO tracks these automatically. With payroll software, you'll need to update settings yourself or ensure your provider pushes updates automatically.

Making the Transition

Moving to Payroll Software

1. Export your data: Get complete employee records, tax ID numbers, pay rates, and deduction information from your current system
2. Set up during a quiet period: Don't switch payroll providers mid-month or during tax season
3. Run parallel payrolls: Process at least one payroll cycle through both old and new systems to verify accuracy
4. Communicate to employees: Let staff know about any changes to their pay stub access or direct deposit timing

Moving to a PEO

1. Audit your current HR situation: Document existing policies, benefits, and compliance practices
2. Plan the benefits transition: Coordinate with your current insurance carriers to avoid coverage gaps
3. Prepare employee communications: The PEO will become the employer of record on certain documents, which can confuse employees without proper explanation
4. Allow adequate onboarding time: Plan for 30-60 days of implementation before going live

Keep Your Financial Records Organized

Whether you choose payroll software or a PEO, both generate significant financial data that needs proper tracking. Every payroll run creates transactions that affect your profit and loss, tax obligations, and cash flow projections.

Beancount.io provides plain-text accounting that integrates seamlessly with your payroll data—no proprietary formats, no vendor lock-in, and complete transparency into how every dollar flows through your business. Get started for free and see why developers and finance professionals are choosing plain-text accounting for their businesses.