What to look for in a payroll provider's banking practices

Given its scale and complexity, payroll is one of the largest recurring cash outflows for many organizations. That’s exactly why many businesses, particularly larger ones, outsource payroll to managed payroll services. But before you outsource, it helps to know how to find payroll providers that can help your organization reduce risk while meeting your business needs. 

A provider with strong banking practices helps keep your payroll funds and tax payments secure and supports compliance. So, instead of focusing solely on payroll processing software features, make sure to evaluate how providers move and safeguard your money. 

The six practices below cover essential things to look for when choosing a payroll partner based on guidance from the Internal Revenue Service (IRS), Federal Deposit Insurance Corporation (FDIC), and National Automated Clearing House Association (Nacha). Each provides a practical way to explore the vetting process, and a trustworthy provider should be able to give clear, direct answers. 

Key takeaways

• Besides comparing features, choosing a payroll provider requires evaluating the provider’s banking practices to help reduce financial and operational risk. 
• Outsourcing payroll doesn’t transfer responsibility for federal employment taxes unless you outsource to a certified professional employer organization (CPEO). 
• If the bank holding your payroll funds fails, FDIC pass-through coverage may protect up to $250,000 per depositor, per insured bank, per ownership category, as long as the account is properly titled and documented. 
• Under Nacha operating rules, payroll providers that perform Automated Clearing House (ACH) transactions on behalf of employers are third-party senders with annual audit and risk-assessment obligations. 
• Payroll providers that keep funds in one bank could be more vulnerable to banking disruptions than providers with multiple banking partners. 

Why a payroll provider's banking practices matter

A payroll provider’s banking practices decide how securely and accurately it manages the three critical financial flows that pass through it every pay cycle: wages, tax deposits, and benefit contributions. They also help determine your company’s risk exposure, because the funds remain your responsibility even when someone else processes payroll. 

If the provider’s bank fails, you can lose access to the payroll funds. That can delay paychecks, tax deposits, and benefit contributions. Errors or fraud can cause the same kind of damage if a provider misroutes or misappropriates funds. Either way, you’re the one left explaining late wages to employees and missed deadlines to the IRS. 

Knowing how to find a payroll provider with transparent banking practices helps you choose one that reduces your exposure and protects your interests. The six practices below are ones your provider should be able to explain (and prove) without hesitation. 

Practice 1: Confirm the provider's third-party payer classification

The IRS recognizes four third-party payroll provider arrangements, each with a different liability profile:  

• Payroll service provider (PSP) 
• Reporting agent (RA) 
• Section 3504 agent 
• CPEO 

Employers generally remain responsible for both payroll funds and federal employment taxes when they use PSP or RA payroll tax filing services.  

Section 3504 agents share joint liability with the employer for certain employment taxes, but the employer remains responsible for funding payroll and making sure employees get paid. And only a CPEO can assume certain federal employment tax liabilities from an employer under Internal Revenue Code Section 3511.  

So, before choosing a payroll provider, ask which third-party payer arrangement they operate and request supporting documentation. Depending on the arrangement, they should be able to provide one of the following forms:  

• Form 8655 (Reporting Agent Authorization) 
• Form 2678 (Employer/Payer Appointment of Agent) 
• Form 8973 (Certified Professional Employer Organization/Customer Reporting Agreement) 

Practice 2: Check FDIC pass-through insurance on client-funds accounts

FDIC insurance protects bank customers by covering their deposits if an FDIC-insured bank fails. In most cases, it covers up to $250,000 per depositor, per FDIC-insured bank, and per ownership category (for example, individual accounts or business accounts).  

However, a payroll provider using an FDIC-insured bank isn’t enough. Deposited payroll funds must also qualify for FDIC pass-through insurance, which lets each client or employer receive separate FDIC coverage for its share of the funds. 

Before choosing a provider, ask which bank holds the funds and whether it is FDIC-insured. Also, confirm whether client funds will be held in a custodial or fiduciary account properly titled to reflect that relationship. Proper account titling is one of the requirements for pass-through insurance.  

Next, ask whether both the provider’s and the bank’s records identify the beneficial owners. Without proper recordkeeping, the FDIC may treat payroll funds as deposits owned by the provider rather than the individual employers. If that happens, multiple employers could end up sharing a single $250,000 insurance limit instead of each employer’s funds being separately eligible for FDIC coverage. 

Practice 3: Ask about CPEO certification and the bond

A certified professional employer organization is the only third-party payroll arrangement the IRS recognizes as capable of transferring certain federal employment tax liabilities from the employer to the provider. If liability protection is a priority when researching how to find a payroll provider, verifying a provider’s CPEO status should be part of your evaluation. 

Start by asking whether the provider is a CPEO and when its certification became effective. Since the IRS maintains a public online list of certified CPEOs, confirming a provider’s certification independently is straightforward. 

Next, ask the provider for its current Form 14751 bond documentation. To stay certified, a CPEO must maintain the Form 14751 surety bond and submit annual audited financial statements.  

Practice 4: Verify Nacha Third-Party Sender compliance

ACH is an electronic network for transferring funds between U.S. bank accounts. It’s commonly used for direct deposits and payroll transactions, and Nacha develops and enforces the rules governing the ACH network. Under those rules, payroll providers that originate ACH payments on behalf of employers are third-party senders. 

Before choosing a provider, ask whether it’s a third-party sender under the Nacha operating rules. If it is, the provider must comply with Nacha requirements that help reduce fraud and improve the reliability of payroll payments.  

Follow up by asking whether the provider is registered with its originating depository financial institution (ODFI) as a third-party sender. ODFIs are required to identify and register third-party senders, making registration another important indicator of Nacha compliance. 

Lastly, request the provider’s most recent rules compliance audit and audit attestation as supporting documentation. Third-party senders must complete this audit annually to verify compliance with Nacha’s rules.  

Practice 5: Ask about bank concentration and continuity

If your payroll funds are all in one bank, that bank’s failure can delay employee wages, tax payments, and benefit contributions, leaving your organization to deal with the consequences. When Silicon Valley Bank collapsed in March 2023, it trapped the payroll funds of companies and third-party providers that used the bank exclusively. 

Dayforce wasn’t impacted by the Silicon Valley Bank failure. The company had no deposits with or direct relationship with SVB, so the failure had no material effect on its operations. That’s the argument against concentration. If your provider's fate is tied to one bank, your payroll is tied to that bank’s fate, too. 

When evaluating payroll providers based on their banking practices, ask which bank holds client funds and whether the provider uses multiple banking partners. Also, ask if the provider has a documented continuity plan for bank outages or failures, and how quickly payroll can be routed through an alternate bank if the primary bank becomes unavailable.  

A tested continuity plan helps a provider keep payroll running with minimal disruption, even when banking issues occur. 

Practice 6: Review the provider’s fraud controls

While banks have their own fraud prevention controls, a third-party payroll provider should also have its own. That’s because payroll diversion fraud often starts with phishing attacks that trick employees or administrators into changing direct deposit details, redirecting wages to fraudulent bank accounts.  

A payroll service provider with strong fraud controls can help detect suspicious changes and reduce the risk of unauthorized payments. That’s crucial because payroll diversion is much easier to stop before funds are transferred. Once an ACH payment settles, recovering the funds can be difficult or even impossible. 

When evaluating a provider’s fraud controls, ask whether it uses multi-factor authentication (MFA) to protect payroll system access. Also, confirm that it offers direct-deposit change approvals and bank account change alerts. The former helps prevent unauthorized users from accessing payroll systems and making fraudulent changes, while the latter helps identify suspicious account updates that could lead to unauthorized payments. 

Finding the right payroll provider

Finding a payroll provider that fits your organization requires more than comparing features and prices. Vetting a provider’s banking practices is just as critical. These practices determine how securely your money moves and how much risk you take on if something goes wrong. 

Due diligence should cover:  

• Third-party payer classification 
• FDIC pass-through insurance 
• CPEO certification and bonding 
• Nacha third-party sender compliance 
• Bank concentration and continuity planning 
• Fraud controls  

Skipping these during due diligence could mean entrusting your payroll funds to a provider that may not have the safeguards to protect your business and employees. 

Frequently asked questions

How do I find the right payroll provider for my business?

Evaluate the provider's banking practices, including third-party payer classification, FDIC pass-through insurance, CPEO status, Nacha compliance, bank continuity, and fraud controls. Also, compare service model, platform structure, pricing, and reporting, and request documentation that supports practice claims. 

What banking practices should I check before choosing a payroll provider?

Before choosing a payroll provider, confirm its third-party payer classification and FDIC pass-through insurance, and review its Nacha compliance. Also assess its bank concentration, continuity planning, and fraud controls. If liability protection is a priority, verify whether the provider is a certified CPEO. 

What happens to payroll if a payroll provider's bank fails?

If a payroll provider's bank fails, payroll processing may be delayed until funds are transferred to another bank. While FDIC pass-through insurance helps protect eligible payroll funds when an FDIC-insured bank fails, providers with multiple banking partners and tested continuity plans can minimize delays by routing payroll through alternate banks. 

What is a payroll provider's continuity plan and why should I ask about it?

A payroll provider’s continuity plan explains how it will keep payroll running during disruptions like bank outages or cyberattacks. Asking how the plan works and how long it takes to restore payroll processing is crucial because it indicates how quickly a provider can recover from an incident. 

How does Dayforce support payroll reliability and banking resilience for its clients?

Dayforce Payroll supports payroll reliability and banking resilience through documented banking, ACH, and continuity controls. Even though Dayforce wasn’t a Silicon Valley Bank customer during the 2023 bank failure, it helped affected clients transition their banking information to alternative banking platforms, reducing payroll delays.