Payroll describes the entirety of a company’s processes, reporting, and standards for paying its employees. Not only does payroll include the actual procedures for distributing money to employees via checks or direct deposits, but it also includes keeping accurate and detailed records of all payments and paying employment taxes.
Payroll process for employees
The payroll process for employees begins when they are hired and fill out a W-4 form. This form gives details about their tax status and how much income tax they want the employer to withhold. Whether an employee is paid hourly or on an annual salary, they must complete and submit a W-4 to their employer.
After submitting a W-4 and beginning work, the employee receives a paycheck regularly (usually every two weeks, sometimes every week). The employer must withhold certain taxes from that employee’s pay, including federal and state income taxes, as well as Medicare and Social Security. The government puts this requirement on employers to reduce the number of individuals who fail to contribute enough to their taxes throughout the year and face large tax bills when they file their returns.
This process is generally known as payroll processing, and it includes calculating employee pay and withholdings and scheduling and distributing payments. The process can also include special circumstances that affect paychecks like time off, overtime requests, and more. We’ll discuss these in greater detail later.
How to manage payroll
Payroll management is one of the important tasks a business must handle. It not only affects the direct ability to pay employee salaries, but it’s also directly connected to employee loyalty and morale and a company’s overall reputation as an honest and on-the-ball organization. Late paychecks or improperly managed payroll are some of the fastest ways to erode employee trust and motivation.
Payroll management is also essential for compliance with federal regulations. The IRS, the Department of Labor, and other regulatory bodies carefully monitor how a company pays its employees, withholds taxes, and remits those payments to the government.
Payroll management is the process for managing a company’s payroll, including paying employee salaries or hourly wages, and paying taxes relating to payroll. It also includes administering bonuses and other special circumstances relating to payments made to employees.
Companies can manage payroll one of three ways:
- Completing it in-house
- Outsourcing payroll processing to a third-party firm or individual
- Using automated payroll software to streamline the process and save time and money
There are advantages and disadvantages to each of these three methods for payroll management, so let’s dig into how each one will affect the company in both the short- and long-term.
In-house payroll
Completing payroll manually requires a business owner to learn how to process payroll themselves or have an internal team manage it. Unfortunately, this approach is time-consuming and requires a certain level of expertise in labor laws and tax withholding so the business can avoid penalties.
Third-party payroll accounting
Many companies outsource payroll processing to a third-party firm or individual. While this means the company doesn’t need to spend internal resources (time) to process payroll, there is a monetary cost associated with paying an outside firm.
Payroll software
As payroll processing software becomes more powerful and inexpensive (sometimes free), using software to automate nearly every part of the payroll process has grown increasingly popular.
Automation leads to fewer hours spent processing payroll, less risk of user error, and a less expensive process overall. Payroll software is capable of automatically calculating wages and necessary tax withholdings, generating checks or deposits, and even filing required tax forms.
Information needed to manage payroll
Paying employees isn’t as simple as writing a check. Here’s a list of information you need to manage your payroll process.
Employee info
A company must have a W-4 form on file for each of its employees. The W-4 form gives the employer information about how much federal tax to withhold from the employee’s paycheck. The company can’t process payroll or distribute paychecks to employees until it has this information on file.
Hours worked
For hourly employees, properly tracking hours worked is vital for payroll processing. Some companies also track the hours of salaried employees, simply to ensure they’re putting in enough work hours to justify their salary.
Time off
Many companies track information about paid time off (PTO) for vacations, sick days, holidays, etc. in their payroll records. This is particularly important for companies that give employees a set amount of PTO days each year.
Salaries and wages
Your payroll records should include information about how much you pay each employee and when you pay them. For salaried employees, this includes their annual salary and payment periods. For example: a $64,000 salary split into 26 two-week periods equates to $2,462 in gross salary every two weeks before deducting taxes.
Companies must also track and record hourly wage rates for each hourly employee.
Overtime
Companies must provide overtime pay when non-exempt employees work more than 40 hours in a single week. Pay for overtime hours must be at least 1.5x their normal hourly wage.
Fringe benefits
Non-salary or wage benefits can also fall under payroll processing. These benefits can include things like health insurance, retirement contributions, and other incentives. Companies must track these benefits as part of the payroll process.
Other pay
Other sources of pay include tips, commissions, and bonuses. Companies must record and process these sources of pay through payroll, as well. While customers pay tips directly to employees, employees must still report their tips to their employer so that they can be properly taxed via payroll taxes.
Any employee who receives more than $20 in tips per month must report those tips to their employer on Form 4070, unless the employer tracks employee tips in its point of sale (POS) system.
Deductions
Anything the employer withholds or subtracts from an employee’s pay is known as a deduction. This can include payroll taxes like federal income tax, state income tax, Medicare tax and social security tax. It can also include contributions to a workplace retirement plan and the employee’s health insurance premiums.
Garnishments
When an individual owes significant back taxes or back child support, the federal government may garnish their wages. The employer must withhold a portion of the employee’s paycheck until the debt is repaid.
What type of payroll records do I need to keep?
A company’s overall record of all calculations for employee pay is known as its payroll register.
Federal and state government agencies regulate payroll processing. For example, the IRS and the Department of Labor requires companies to maintain payroll tax records for at least four years after the tax is due or is paid (whichever is later).
In fact, there are 20 total unique payroll-related records companies must maintain to meet the federal government’s requirements. They generally fall under three umbrellas: income tax withholding records, Social Security and Medicare (FICA) tax records, and Federal Unemployment Tax (FUTA) records.
Income tax withholding records
Income tax withholding records include anything relating to calculating and withholding federal or state income taxes from employee paychecks.
Because each employee owes taxes to the federal government (and sometimes state and local governments) on their wages, businesses usually have to withhold some taxes and submit them directly to the government after each pay date.
Keeping careful records of these tax withholdings is essential. Some related records to keep include:
- Name, address, and Social Security number of each employee
- Amount and date of each payment for compensation
- Amount of wages subject to withholding in each payment
- Amount of withholding tax collected from each payment
- The reason the taxable amount is less than the total payment
- Statements relating to employees' nonresident alien status
- Market value and date of non-cash compensation
- Information about payments made under sick-pay plans
- Withholding exemption certificates
- Agreements regarding the voluntary withholding of extra taxes
- Dates and payments to employees for non-business services
- Statements of tips received by employees
- Requests for different computation of withholding taxes
Social Security and Medicare (FICA) tax records
Every employee’s paycheck includes a deduction designed to be paid into Social Security and Medicare, funds designed to provide for former workers after they retire or become disabled. Companies must keep records of Social Security and Medicare taxes, including the amount of each payment subject to these taxes, the amount and date of FICA tax collected from each payment, and an explanation of any differences or areas where the figures don’t align. Related records include:
- Amount of each payment subject to FICA tax
- Amount and date of FICA tax collected from each payment
- Explanation for any difference
Federal Unemployment Tax (FUTA) Records
Federal unemployment tax records are payroll records relating to a company’s unemployment tax payments. The federal government requires companies to maintain records relating to federal unemployment tax, including the total unemployment tax paid during a calendar year, the amount of payroll subject to unemployment tax, the amount of contributions paid into the state unemployment fund, and any other information necessary to file an unemployment tax return. Related records include:
- Total amount paid during the calendar year
- Amount subject to unemployment tax
- Amount of contributions paid into the state unemployment fund
- Any other information requested on the unemployment tax return
Keeping proper payroll records
Keeping correct, up-to-date, and compliant payroll records is essential. The Fair Labor Standards Act (FLSA) established many of the regulatory standards relating to payroll record keeping. This law addresses the requirements for employers to keep accurate records for every non-exempt worker.
How to control employee accessibility
In addition to ensuring that financial information relating to payroll is accessible to regulatory bodies, employers are also legally required to give employees access to specific information relating to their payroll. These include benefits summaries, 401(k) summaries, check history and deduction totals, direct deposit details, time clocks, and paid time off information.
Other employee accessibility features for payroll might include the ability to access and download relevant documents, like tax withholding info and W-2s, change their individual withholding settings, make inquiries, and ask questions relating to their pay.
The more transparent and easily accessible this information is for employees, the more satisfied they’ll be with their payroll experience at a company.
FAQs
How do you process paychecks?
Processing paychecks accurately, effectively, and on time isn’t just a legal requirement, it’s also essential for keeping employees happy. Nothing makes employees feel more quickly disconnected from their employer’s leadership than late paychecks, incorrect payments, and other issues. Companies should verify and include salaries, hourly wages, overtime payments, bonuses, and necessary tax deductions in paychecks where necessary. This helps the company avoid getting in hot water with the IRS.
How do you handle payroll taxes?
Generally, many companies have a specific role that oversees payroll management—fittingly, the position is usually called the Payroll Manager. Payroll managers are in charge of determining tax deductions and other elements of payroll, including completing forms to document payroll taxes and filing W-2s for each employee. Juggling required documents, filing deadlines, and more requires an organized and focused skillset, making payroll tax managers a valuable addition to a business.
Is payroll part of HR or accounting?
Payroll typically falls under human resources, since it deals with employee compensation. However, because it’s essentially an accounting function, some companies place payroll within the finance or accounting division.
