Payroll refers to a list of employees paid by a company. The term encompasses both the process of paying employees, and a specific list of a company’s employees that shows who is entitled to receive payments and how much is owed. If you’re a business with its fair share of employees, it can be tricky to keep track of who is owed what amount of money.

As tricky as payroll may be, it’s still crucial to get it right. Underpaying your employees is obviously a problem, and messing up on any tax will bring the full brunt of the IRS upon your business.

Most companies use an accountant, or payroll software. Both of these can calculate any taxes or deductions that are involved in the payroll process, allowing you to be sure that you won’t have any outstanding fees or taxes falling through the cracks.

If you're eager to master the art of the payroll for your business, then read on.

How Does Payroll Work?

There are a few steps to payroll processing – it’s not just pushing a button and distributing money to your employees. Here are the steps you need to take to pay your employees, and ensure you can avoid any legal problems.

1. Ensure employee information is accurate

This should happen before you even hire the employee, let alone pay them. It’s important to make sure their banking and personal information (eg. address) is accurate, but equally important is the W-4 form.

The W-4 Form is an IRS form that employees must complete to let their employer know how much money to withhold from their paycheck for federal taxes. Missing out on information here can be a big problem, as it could get you in legal hot water, so it might be worth setting up a consultation with an accountant to go over your records (even if you don’t intend on using one full time).

2. Set up payroll schedule

Some companies pay on a weekly basis, like every Tuesday, while others pay on the last day of the month. You’ll need to create a consistent payment schedule so that payroll calculations are accurate, as these calculations are based on consistent pay periods. It also allows employees to plan their outgoings and bills around when they get paid.

3. Calculate gross pay

If your employees are salaried, you’ll simply need to break their yearly salary into the appropriate pay period. If they’re paid by the hour, you need to make sure that you pay them accurately for the time they’ve worked. When calculating hourly employees, you’ll need to add up all the time they’ve clocked in, as well as calculate any overtime.

If you’re not looking forward to calculating by hand, some payroll systems or dedicated time-tracking systems can help with hourly-paid employees, as they track hours and do the calculations automatically.

4. Make necessary deductions

There are some permitted reasons to deduct money from your employees’ paychecks, like company-wide healthcare, pensions, FICA taxes (Social Security and Medicare taxes), state taxes, or employee debt. These are all done before the employee gets their paycheck. Payroll systems will perform salary deductions automatically. All users need to do is ensure their employees' tax and benefit details are correct.

5. Pay your employees

That’s what this is all about! Finally, your loyal employees get their payment. Once the deductions are done from the previous step, all you need to do is finish the transfers. It’s important to note that payments must be made either by direct deposit or a paper check. Direct deposit can take a couple of days to clear, however, so make sure to run your payroll ahead of payday if you’re using direct deposit.

6. Keep tidy records

Once the dust has settled and everyone’s got their money, you need to make sure that everything is properly recorded. If you’re using an accountant or payroll software, this will be done automatically, but if you’re managing it by your own hand, you should keep extensive records of all calculations and payments.

These records are kept for W-2 forms. These forms are used for end-of-year reports, and for documentation of any changes in pay. Legally, you must keep track of any employee payment from your business.

Key Payroll Components

We’ve looked at payrolls in a broad sense, but let’s look at the individual components that make up an entire payroll system.

Employee Details

The bread and butter of the system – you’ll need to know who you’re paying, after all. The employee details section will contain a collection of the personal information of all the employees you need to pay, as well as their banking details, role in the company, amount they’re owed, and any court ordered wage garnishment to effectively and fairly pay each employee.

Hours Worked

Employees are typically either hourly or salaried. Salaried means they earn a fixed amount per pay period, as opposed to hourly workers, who are paid based solely on the amount of time they have clocked into the system. If your company pays workers hourly, payroll software will be able to keep track of how much your employees are owed, based on how much time they’ve amassed.

To do this, you’d just need to keep track of all the hours that your employees have clocked in over the course of a single pay period, then add up their hourly wages to cover each hour (factoring in any overtime). If you don’t want to do all of these calculations for each employee, payroll software can calculate this for you.

Salary

If your business employs salaried workers, you’ll be paying them a flat rate every time payday rolls around. People usually talk about their salaries in terms of the amount they make in a year, but it can be helpful to break a yearly salary into pay periods.

For example, if you pay an employee a yearly salary of $28,600 with weekly pay periods, their weekly paycheck will be $550 before deductions.

Overtime

If your employees are hourly, it’s possible that you might need them to put in time outside of their normal 40 hour shift. If that’s the case, you need to pay them the pay rate outlined by the FLSA, unless a different overtime rate was agreed upon in a contract. Anyone earning over $684 a week ($35,568 a year) is exempt from government-enforced overtime payments.

Annual Leave

Whether it’s the mandated two week vacation or a spell of compassionate leave, you’ll still need to make sure your employees are getting what they’re owed. You’ll need to do the necessary calculations to ensure employees are still paid correctly for paid leave. This can be done by hand, or calculated automatically using software.

Benefits, Reimbursements, and Bonuses

Salary and hourly wages are always going to be calculated in the system, but every company will have one-time payments that you also need to make sure are included in the financial statements. These can include:

• Benefits: Money that goes towards any company-wide benefits, like health insurance or a retirement plan
• Reimbursements: If an employee pays for something that benefits their roles in the company, such as a class or seminar, they can receive the money they spent back
• Bonuses: Outside of salary or wages, employees might receive additional payment, like commissions or end-of-year bonuses

Payroll software can help you generate and keep track of any unscheduled payments.

Payroll Deductions – What Are They?

A payroll deduction is when a percentage of an employee’s wage is removed from their payment. There are a lot of reasons why this could happen, but by law, you must calculate this accurately. Here are a few major types of payroll deductions:

Taxes

We all owe our fair share to Uncle Sam, so you need to ensure the correct amount of federal and state income taxes are removed from your employees’ paychecks and sent to the government.

Taxes are the most common payroll deductions, and are made up of income taxes and payroll taxes. Income taxes include both federal and state taxes that go straight to the government’s general funds. While the federal income tax rate is standard across the country, state income taxes vary from state to state.

Payroll taxes cover two purposes – Social Security and Medicare. These are collectively known as FICA taxes. The Social Security tax rate is 6.2%, while the Medicare tax rate is 1.45% (or 2.35% if the employee earns more than $200,000/year), adding up to 7.65% (or 8.55% for the higher wage bracket).

There are also FUTA taxes, which are paid by the employer, not the employee. This is 6% of the first $7,000 an employee makes, and goes towards unemployment programs.

Benefit Deductions

If your company offers any kind of benefits, like healthcare or a dental program, your employees will make payments to remain eligible for these benefits. These payments are taken from their wages via the payroll system.

Pension and 401(k)

Everyone’s favorite long-term rainy day fund, a pension is a retirement fund run by an external company that an employer can opt into. A pension plan takes a small sum based on the employee’s paycheck, and invests it into a long term savings plan.

Your employee may also opt to put money into a 401(k). While pensions and 401(k)s are often spoken of in the same breath, there is a key difference. A pension is paid for by the employer, while a 401(k) is funded by the employee – meaning that part of the employee’s salary is held back by the employer and funneled into a 401(k). Pension payments, on the other hand, come from the company’s pockets.

Wage Garnishment

If an employee has some kind of debt – be it medical, student, or otherwise – a court order can be established to set up a system in which a percentage of their wage is deducted before they receive it, and sent straight to their debtor. This is known as wage garnishment. Along with complying with a court order, this can save your employee time, as well as the heartache of having to part with the money.

Ways to Run Payroll

Payroll can be handled one of three ways: by hand, with software, or through an accountant.

You may choose to go the classic route and tackle it by hand. If you run a small business with only a few employees, you probably wouldn’t need to pay for payroll software or for an accountant’s help, as long as you’re confident in doing it yourself.

But if you're not confident about doing it yourself, you could use the help of a hired accountant. Rather than having to juggle payroll as well as any other business-related responsibilities, you can hire an external accountant whose entire job it is to make sure your financials are all accurate and clean.

While people still absolutely hire accountants, it’s definitely a job that has been somewhat sidelined due to the genesis of payroll software. Back in the days before widespread computer usage, you’d need an accountant to manage all the papers and calculations, but payroll software can take a lot of the weight off your shoulders.

Payroll software can be a huge help for a business looking to manage the finances of multiple employees. If you’re running a business yourself, there are enough things on your plate, so to be able to easily remove one of the more complicated and important aspects is a great help.

If you're interested in looking at one of the cheapest payroll software options on the market, check out Square Payroll. Otherwise, there are plenty of payroll software platforms that are worth your consideration.

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Duncan (BA in English Textual Studies and Game Design) is an Australian-born writer for Tech.Co. His articles focus on website builders, and business software that allows small businesses to improve their efficiency or reach, with an emphasis on digital marketing or accounting. He has written for Website Builder Expert and MarTech Series, and has been featured in Forbes. In his free time, Duncan loves to deconstruct video games, which means that his loved ones are keenly concerned about he amount of time he spends looking at screens.