When people hear the words “payroll processing,” the first thing that comes to mind is a slew of numbers.
There’s a lot of number crunching involved when you process payroll, but there are many other factors that make up the process of paying people’s salaries.
Calculations for payroll may mean that you need the help of a payroll accountant, as they specialize in that process. However, payroll processing does not always mean large, complex computations and the hiring of accountants. Many organizations, especially small businesses, just need an effective payroll process.
What Is Payroll Processing?
In any business enterprise, there are people who work behind the scenes as well as those who are client-facing. They contribute to keeping the business profits coming into the company.
There are also other departments within a business, such as the accounting department, that take care of the financial aspects. And of course, the human resources department that makes sure employees at all levels of the company adhere to labor regulations in their country of operations. No matter how big or small the business is, all employees are entitled to a salary and other benefits. This is where payroll processing comes into play.
To process payroll means paying the employees in a business organization. This covers the whole process of paying employees, from calculating how much they earned, and any deductions, to the time they receive their payments. Specifically, payroll processing involves the following:
- Calculation of employee’s gross pay for the payroll period (weekly, bi-weekly, monthly)
- Withholding deductions, such as loan payments and social security payments
- Filing of payroll taxes
- Distribution of net pay to employees
Payroll processing is an important aspect of any business because regular, smooth payment is a huge factor in employee retention.
Depending on the size of the business, the payroll process can be done manually or with an automated system. A business can also outsource payroll processing and hire independent third parties to process their payroll. Regardless of the method, payroll should comply with the labor and salary regulations of the business’s country of operations. Here are eight easy steps in processing your company’s payroll:
Before you are allowed to employ individuals for your business, you first must be recognized by your state and country as an employer. You must secure the essential paperwork that proves your qualification as an employer. The following paperwork is required to process payroll:
- Federal employer ID number (EIN)
- Tax identification number. You can verify if your federal and state tax IDs match. If not, you can also check if you need to apply for your federal tax ID, or if it can be assigned
- An account with the Electronic Federal Tax Payment System
- Bank account for payroll transactions. It is highly advisable that this account is solely for payroll
- State electronic tax payment accounts if your state requires it
- Workers compensation insurance
Securing these important documents is proof of your compliance with local and federal regulations regarding employment and is necessary to process payroll.
Employment and payroll are not always straightforward. Here are some questions you should ask yourself when setting up a payroll policy:
- How often would you pay your employees? There are various frequencies on when employers pay their employees. Some pay weekly, bi-weekly, semi-monthly, or monthly and will therefore need to process payroll depending on this frequency .
- What kind of employees are you hiring? Employees can be hired to do full-time or part-time work. Some employees are also exempt from doing overtime work, while some are not.
- How will you track your employees’ work time? Think of whether your employees’ salaries will be based on the number of hours they worked or on a fixed pay rate. If based on hours, decide on how you or your employees can track the total hours worked over a pay period.
- Will you provide your employees with benefits such as health insurance? Aside from the federally mandated benefits, you can offer your employees other benefits deductible from their gross pay. For example, some corporations have employee stock purchase plans which allow employees to purchase company stock at a discounted price. The purchase price of the stock is deducted from the participating employee’s gross salary.
- Which employees are required to pay taxes, and which are not? Since salaries are not equal, some employees are required to pay taxes, and some are not. You must determine which employees are required to pay and how often you need to pay those taxes.
- How will you pay your employees? There are various ways you can distribute payroll to your employees. You can pay them through checks, cash, or do a direct deposit into their bank account.
- How will you calculate employee and process payroll along with its breakdowns? As we mentioned before, payroll processes vary depending on the size of the business. In the next three sections, you’ll discover the three methods of payroll processing.
To process payroll manually, you have to calculate gross pay, deductions, and the net pay without the help of software. Usually, businesses process payroll manually on paper or using a digital spreadsheet. If you are a small business with a small number of employees, there is a high chance that you will adopt a manual payroll processing system, since it’s cheaper than payroll plans or outsourcing.
Nowadays, many companies outsource some of their business processes, including payroll processing. You can hire an independent payroll accountant, or even outsource to companies providing payroll processing services. This can decrease your stress and leave you to focus on other aspects of your business.
For companies that would like to process payroll in-house, implementing payroll software is the best route. You can purchase payroll processing software from various tech companies, all of which cover a wide range of services, from basic payroll assistance to HR services and work-time tracking.
Now that you have established your business as an employer, it is time for you to find the people who can add value to your organization. Before your newly hired employees can start working, you need to collect documents that are essential to process payroll that meet federal government compliance. These documents include the following:
This form contains employee tax information. It tells you the tax rate to use for your employee, helping you to deduct the correct amount of federal income tax from their gross pay. Keep in mind that you should ask your employees to fill out a new form whenever their personal or financial circumstances change. Some states have their own W-4 forms which you can collect and store for your employees.
Although the labor market is huge, not all applicants are eligible for work. For you to verify whether your newly acquired talent is legally qualified for work, you must ask them to fill out Form I-9. Your potential employee must fill out the form on their first working day. As an employer, you must also fill out the form’s Section 2 within three business days. You are not obliged to send a duly filled Form I-9 to the government unless an authorized representative requests that you do so.
If your payroll policy includes a direct deposit as a mode of payment, you will need your employees’ bank information. Some companies also ask their employees to open a payroll account with a preferred bank. You can also get your employees’ bank information through a voided check. However, this may only apply to specific cases.
Some businesses offer health insurance benefits to their employees. However, you cannot deduct any amount for insurance premiums from their gross pay without their written authorization. Once you can get these documents, you must register your
Now that you have secured all the pre-employment paperwork, it’s time for the actual job. The need for a timesheet will depend on your basis of paying your employees. Some jobs have a fixed salary for each payroll period. In these cases, timesheets are simply for visibility. However, if your payroll policy indicates an hourly rate, reviewing and approving employees’ timesheets are crucial to how you process payroll.
Reviewing and approving timesheets also depend on the type of payroll processing your business is implementing. If you opt to process payroll manually, your employees typically use paper timecards where they can write down their start time, any breaks taken within the day, including the lunch break, and their end time. Lunch breaks, however, are not counted and not paid. When it’s the end of the payroll period, your payroll team must add up the hours and check if there are any mistakes. Once you have verified that the timecards are correct, you can transcribe them to your payroll records.
On the other hand, if your business uses an automated payroll system, your timecards will most likely be digital and ready to be uploaded to your payroll software. No matter what type of payroll processing service you use, it is important to keep employee timecards accurate and verified.
Now that you know how many hours your employees worked, it is time for you to calculate your employees’ gross pay and deductions.
Gross pay is your employees’ total earnings for the payroll period before any deductions. This means that this is the equivalent monetary amount that your employees worked for the whole payroll period.
You simply add up the time your employees worked and multiply the answer by their hourly rates when calculating the gross pay. Straight time hours will vary, but the usual is up to 40 work hours in a week. Take note that overtime pay is also included in the gross pay and is usually 1.5 times more than your employees’ regular hourly pay rate.
Employees will not receive 100% of their total earnings in a payroll period. This is because there are benefits and expenses attributed to their earnings, which are deductible from their total earnings. Here is a list of the common deductions:
- Government-mandated benefits such as Social Security and Medicare
- Federal unemployment tax
- Deductions based on the benefits you offer your employees such as stock purchase plans and health insurance
- Tax deductions on employee tips and incentives, if applicable
- Miscellaneous deductions such as uniform expenses and expenses for your employees’ work equipment
In payroll computation, you must add all these deductions to calculate the gross deductions for the payroll period. However, you can still show a breakdown of these deductions to your employees so that they know what benefits they are getting.
Now that you know your employees’ gross pay and gross deductions for the pay period, it is time to calculate the amount they are actually going to receive. This is called net pay and is simply calculated by subtracting the gross deductions from the gross pay.
Once you can determine your employees’ net pay as well as their gross deductions for the payroll period, you should now pay your employees, tax agencies, and benefit providers.
Payment of payroll taxes and employee benefits usually have a specified schedule. For example, insurance premiums and social security contributions are usually paid monthly. On the other hand, payroll taxes are usually paid on a quarterly basis. In paying tax agencies and benefit providers, you will pay out the amounts you withheld from your employees’ gross earnings. Some benefit payments have an employer’s share, so you must pay those as well.
When paying your employees, it is important to stick to your designated payment schedule. This schedule is determined in Step 2 when you set up a payroll policy. Here are some common ways of distributing employees’ net pay for each pay period:
- Checks sent to your employees’ homes or distributed at the office
- Direct deposits
- Prepaid cards loaded solely for their take-home pay
- Mobile wallets that you can deposit their net pay into
Some states require a pay statement or pay slip to be given to your employees every payday. This can be either in print or electronic format. These pay statements contain information on how your employees’ net pay or take-home pay was calculated. Meaning, that you must provide details as to what affected their take-home pay, including their hourly rate, total hours worked including overtime, and their deductible benefits.
Work is never-ending, and so is your payroll. Tax regulations require you to prepare year-end payroll tax reports as well as distribute them to your employees. Each employee’s year-end payroll report or Form W-2 must show their total earnings and taxes paid for the period. They also must receive their W-2 forms by January 31 the following year according to tax laws.
Once you have paid your employees for the payroll period, you must update your payroll records. These records must reflect all the important details regarding your most recent payroll and tax transactions which include some, if not all, of the following:
- Amount withheld for federal payroll taxes
- Amount withheld for social security contributions
- Medicare taxes from employee pay
- Any tax contributions you made
Updating your payroll records is important as it means compliance with federal labor laws as well as tax laws. In addition, it is highly advisable that you retain your payroll documents in case of pay disputes with employees or an IRS review. Payroll documents you should retain include, but are not limited to, the following:
- Pay stubs
- Documentation on pay increases, as well as other details regarding the increase.
The duration for payroll processing varies from one business to another, depending on the number of employees and the type of payroll method they adopt. Usually, payroll processing takes a few hours, but if your business is processing payroll manually, this will take longer.
If your business is using payroll services and software from tech companies, you’ll save time. Most payroll software already includes payroll tax calculations which can take up a huge chunk of time if done manually.
It only takes a short time – three days at most – for employees to receive their pay once you’ve submitted your finished payroll.
Payroll processing is no easy task. You must keep in mind different labor laws as well as tax laws to keep your business compliant. However, there are steps you can take to make your payroll processing easier, which we’ll list again below:
- Establish your business as an employer
- Set up a payroll policy
- Collect payroll documents from newly hired employees
- Collect, review, and approve timesheets
- Calculate employee gross pay, gross deductions, and net pay
- Pay of salaries and wages to employees and pay tax agencies and benefit providers
- Prepare the year-end payroll tax reports
- Update payroll records and retain payroll documents
All these steps help you in remaining compliant with certain payroll regulations set by the Internal Revenue Services (IRS) and the Department of Labor (DOL).
You can also outsource payroll services providers to make your payroll processing less time consuming and easier. You can find software and solutions providers who also offer payroll services. Once purchased, your payroll software will be tailored according to your payroll policy and business type.
Redefine your payroll processing with these steps and see how easy it can be!
Frequently Asked Questions (FAQs) On How to Process Payroll
Q: How often should you process payroll?
This will depend on how often you intend to pay your employees – depending on whether you pay weekly, bi-weekly, bi-monthly or monthly. Basically you have to process payroll based on what your agreed payroll schedule is.
Q: What are my options for paying my employees?
You have numerous options. The most common ones include distributing payroll via check, direct bank deposits, or via a pay card. Take note however that there are stringent rules surrounding electronic money transfers and other alternative forms of payment, which must always be followed.
Q: Are there any tax forms needed to process payroll?
This largely varies depending on where you’re located and the size of your business. However, in a lot of cases, there are basic paperwork and documentation needed to process payroll that employers should comply with.
Q: How long should I maintain payroll records?
The FLSA requires employers to maintain records for at least three years, including documents, time sheets, and wage calculations. The IRS requires businesses to keep payroll tax records for at least four years.