What is payroll?

What payroll entails

The key purpose of payroll is to make sure your employees are paid accurately and on time while complying with various legal requirements. More specifically, that means:

Calculating wages

Determine the correct amount of pay for each employee based on their hours worked, salary, wage, or commission structure. This also includes accounting for overtime, bonuses, and any other compensation.

Calculating and filing taxes

Calculate, withhold, and remit the correct taxes, which can include federal, state, and local taxes, depending on where your business and your employee(s) are located. Employers are required to file payroll taxes with the appropriate agencies and provide employees with the necessary tax documents by the correct deadlines.

Compliance

Adhere to federal, state, and local labor and employment laws, including minimum wage requirements, overtime pay regulations, workers’ compensation enrollment, and proper classification of employees and independent contractors. It’s up to employers to stay up-to-date on these laws and any changes to legislation to avoid potential penalties.

Recordkeeping

Maintain accurate records of employee hours, wages, tax withholdings, and other payroll-related information. These records are important to have on hand for tax filings and in case you get audited or need to resolve any payroll disputes.

Running payroll: 2 methods

There are two primary methods for running payroll: manually calculating payroll or using a payroll system. Each method has its own benefits and considerations, which we’ll explore in more detail below.

Calculating payroll manually

Calculating payroll manually involves using spreadsheets or other manual methods to track employee hours, calculate wages, and determine tax withholdings. This method is most often used by small businesses with a limited number of employees.

How to run payroll manually

1. Gather employee information. Collect necessary payroll information such as hours worked, salary rates, and any bonuses or commissions.
2. Review and approve time sheets. If your employees are paid hourly and not salaried, review their time sheets and compare them to employee schedules to check for errors.
3. Calculate gross pay. Multiply the hours worked by the hourly rate, or use the salary amount, adding any bonuses or commissions.
4. Calculate and withhold income taxes. Calculate income tax withholdings (federal, state, and local, if applicable based on where the employee lives and their allowances. You can use the IRS Withholding Estimator to determine how much to withhold for federal income tax, and check with your employee’s state tax assessor’s office for the correct state income tax withholding rate, if they have a state income tax.
5. Calculate other deductions. Calculate Social Security taxes, Medicare, federal and state unemployment taxes, and any other payroll deductions (e.g., retirement plan contributions, health insurance).
6. Calculate net pay. Subtract the total deductions from the gross pay to determine the net pay.
7. Pay employees. Issue payments to employees each payday. You can pay them via paper checks, by direct deposit into their bank accounts, or by whatever payment method you mutually agree upon.
8. Recordkeeping. Maintain accurate records of all payroll calculations and payments, and give pay stubs to employees for their own records.

Using a payroll system

A payroll system automates the payroll process, reducing the risk of errors and saving time. Payroll systems can handle calculations, tax filings, direct deposits, and recordkeeping. Some even have time tracking, employee benefits like PTO and sick time, integrations with accounting software, garnishments, and other convenient features that make payroll easier for everyone from startups to small business owners to enterprise companies.

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Types of payroll systems

There are several different types of payroll systems businesses can choose from, based on their needs and resources.

Professional payroll services

Professional payroll services provide full-service solutions for managing payroll, which can be a good choice for businesses that either don’t have a full human resources team, or have limited in-house HR resources.

By outsourcing payroll to a professional service, businesses can have a complete hands-off experience that includes all aspects of payroll processing: wage calculations, deductions, direct deposits, and generating payroll reports. Additionally, full-service payroll providers often offer HR support, such as managing employee benefits, handling workers' comp, and assisting with compliance, giving your business more flexibility to focus on its core operations.

Payroll software

Payroll software allows businesses to manage payroll in-house using automated tools. These modern payroll solutions can typically handle calculations, tax filings, and direct deposits, giving businesses flexibility and control while saving them time and effort.

Hybrid payroll systems

Hybrid payroll systems combine elements of both professional services and payroll software. Businesses can use software for routine tasks while relying on professional services for complex issues or compliance support.

How to choose a payroll system

When choosing a payroll system, consider factors such as the size of your business, your budget, the complexity of your payroll needs, and the level of expertise you need to manage your payroll. Carefully evaluate the features, costs, and support options of different systems to find the best fit for your business.

What to consider when selecting a payroll system

1. Your business needs

• Size of your business: Small businesses might benefit from simple, self-service payroll solutions, while larger organizations may require comprehensive, full-service options.
• Complexity of your payroll needs: Consider the complexity of your payroll needs, such as multiple pay rates, bonuses, commissions, and overtime calculations.

2. Payroll providers

• Reputation and reliability: Research payroll providers and read reviews to make sure they have a good track record of reliability and customer satisfaction.
• Services offered: Look for providers that offer the payroll management features you need, like tax filing, compliance, or human resources support.

3. Pricing

• Cost structure: Understand the pricing model of each payroll provider or software. Some charge a flat fee per month, while others may charge per payroll run or per employee you onboard.
• Hidden fees: Be aware of any additional costs, such as fees for tax filing, direct deposits, or customer support.

4. Integrations

• Accounting software: Does the payroll system integrate with your existing accounting software?
• Time tracking systems: If the payroll software doesn’t offer time tracking as a feature, make sure it integrates with a time tracking system to automate the process of calculating hours worked.

5. User experience

• Intuitive interface: The payroll system should have an intuitive and user-friendly interface, making it easy for your HR team to navigate and use.
• Self-service options: Self-service features, like an app or employee dashboard, allow employees to access their pay stubs and tax forms, and update personal information without needing HR intervention.

6. Customer support

• Availability: See if the payroll provider offers reliable customer support to assist with any issues or questions that may arise.
• Resources: Look for additional resources such as training materials, webinars, and tutorials to help your team get the most out of the system.

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Payroll taxes

Payroll taxes are the mandatory contributions that employers and employees make to fund various government programs. It’s usually up to employers to deduct them from employees’ paychecks and file and pay them on employees’ behalf. Here’s a breakdown of the different types of payroll taxes you’ll need to know.

FICA taxes

FICA, a type of federal tax, includes Social Security and Medicare. Both employers and employees contribute to these taxes. The current rates are 6.2% for Social Security and 1.45% for Medicare, with employers matching these contributions.

Unemployment taxes

Unemployment taxes fund state and federal unemployment insurance programs. Employers are responsible for paying these taxes, which vary based on the state and the employer's experience rating.

Income taxes

Income taxes are withheld from employees' wages and paid to federal, state, and local tax authorities. Employers must accurately calculate and withhold these taxes based on employees' earnings and tax withholdings.

Frequently asked questions about payroll

Still have questions about payroll? Learn more in the FAQs below.

What is the difference between gross pay and net pay?

Gross pay is the total amount of money earned by an employee before any deductions, such as taxes, health insurance, and retirement contributions. Net pay is the amount of money an employee takes home after all deductions have been subtracted from the gross pay.

How often should payroll be processed?

Payroll can be processed on various schedules, including weekly, biweekly, semimonthly, or monthly. The frequency depends on the employer's policies and the nature of the business. Consistency in payroll runs helps ensure timely payment to employees and compliance with labor laws.

What are the benefits of using a payroll service provider?

Using a payroll service provider can save time and reduce errors by automating payroll calculations, tax filings, and compliance tasks. It also ensures that payroll is processed accurately and on time, helps maintain compliance with labor laws, and provides support for human resources functions.

How do payroll systems integrate with accounting software?

Payroll systems can integrate with accounting software to streamline financial management. This integration allows for automatic synchronization of payroll data with the company's general ledger, reducing the need for manual data entry and minimizing the risk of errors.

Why is payroll tax compliance important?

Payroll tax compliance is crucial to avoid legal penalties and fines. Employers must accurately calculate, withhold, and remit federal, state, and local taxes. Compliance with tax regulations ensures that employees receive accurate tax forms and that the business adheres to legal requirements.

What are the potential penalties for payroll errors?

Penalties for payroll errors can include fines, interest on unpaid taxes, and legal action. Errors such as incorrect tax withholdings, late tax payments, or misclassification of employees can result in significant financial and legal consequences for the business.

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