Why Year-End Transitions Are Preferable
Whenever possible, switching payroll providers at the end of the calendar year is strongly recommended. Since payroll data and reporting requirements reset on January 1 each year, switching at year-end avoids nearly all integration and compliance complexities and eliminates risk of avoidable expenses. For example, switching at year end instead of mid-year:
- Avoids complex reconciliation and reporting requirements across multiple providers.
- Reduces the risk of duplicate payroll tax liabilities and unnecessary, unrecoverable payroll tax expense.
- Prevents complications in quarterly and annual filings (W-2s, 941s, state returns) and reduces the risk of state notices and penalties.
- Prevents employees from losing progress toward benefit deductibles and out of pocket maximums.
Risks of Mid-Year Switch Between PEO and Non-PEO (or between different PEOs)
- Duplicate Tax Withholding
- Employees may exceed FICA and FUTA/SUTA limits, leading to over-withholding.
- Employees may reclaim excess FICA via their tax return.
- Employers, however, cannot recover their duplicate match.
- FICA cost to employer: up to 6.2% of wages over the threshold
- FUTA cost to employer: up to 6% on the first $7,000 per employee
- Payroll Tax Reporting and W-2 Complexities
- Employees will receive two W-2s, likely causing confusion and questions.
- Mismatched or partial-year data often results in IRS or state notices to companies which may result in penalties and correction efforts.
- Benefit Plan Impacts
- Benefits Plans will change, resulting in necessary employee communication, an extra plan enrollment and COBRA notices for previous plan.
- Plan deductibles and out-of-pocket maximums reset, potentially increasing employee expenses.
- If staying with the same carrier, carryover arrangements may be able to be negotiated but will take extra effort.
- The company could consider temporary HRAs to offset duplicated costs for employees, but this will add to employer expenses.
- The company will need to manually monitor HSA and 401(k) contributions by employees to prevent exceeding annual contribution limits.
- Administrative & Compliance Implications
- New payroll tax registrations and workers’ compensation coverage may be required (if moving from PEO to Non-PEO).
- Employees may need to re-complete onboarding forms (tax, direct deposit, benefits).
- Employees will receive two W2s and 1095s, adding potential confusion.
- Financial reporting may be disrupted if GL mappings or pay periods do not align.
- Employee communication is critical to avoid confusion and build trust.
Risks of Mid-Year Switch Between Non-PEO Payroll Providers
- Year-to-Date Data Accuracy
- Ensure complete and accurate YTD compensation, tax, and benefit data transfers.
- Incomplete cutovers can result in misreported W-2s, incorrect tax filings, and audit risk.
- Tax Filing & Compliance
- Avoid mid-quarter transitions; instead, change providers on the first day of a new quarter if a mid-year change is necessary.
- Misaligned filings can trigger IRS and state notices, penalties, and manual corrections.
- To avoid confusion, extra expense, and extra work at year-end, be sure to clarify in advance which provider will issue year-end W-2s.
- Duplicate Withholding Risk
- Incomplete YTD imports may result in duplicate FICA/FUTA/SUTA withholding.
- Employees may recover excess FICA through their tax return, but employers cannot reclaim their match.
- Assure that YTD HSA and 401(k) contributions by employee are captured in new system to prevent exceeding annual contribution limits.
- Administrative Considerations
- Assure pay period alignment between systems to avoid gaps or overlaps that could result in employee pay being off.
- Confirm GL mapping alignment between systems.
- Set clear expectations with employees—especially regarding timelines and any benefit impacts.
The Bottom Line
Whenever the calendar allows, schedule your provider change for the first payroll of the new year. The reset on January 1 wipes away cumulative tax caps, benefit accruals, and multi-system reconciliations—saving you hours of cleanup and thousands in duplicate taxes.
