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What Is Payroll: Your Complete Guide

QUICK SUMMARY

Payroll is a core business function. Use this guide to help you understand what it is, the laws the govern it, and best practices for ensuring timely and accurate payroll.

TABLE OF CONTENTS What Is Payroll? Why Is Payroll Important? Payroll Regulations Payroll Deductions Payroll Documents Processing Payroll Who’s Responsible For Payroll Processing? Payroll Process Best Practices

What Is Payroll?

Payroll is a fundamental aspect of business operations that covers the process of paying employees for their work. It encompasses various tasks, including calculating wages, withholding deductions, submitting payroll reports, and issuing payments to workers.

Effective payroll management is crucial for ensuring that employees are compensated accurately and on time while also complying with legal and regulatory requirements.

Why Is Payroll Important?

Accurate and efficient payroll management is essential for several reasons. Firstly, it ensures that employees receive the correct compensation for their work, which I’m sure you’ll agree is of vital importance!

Additionally, proper payroll management helps businesses comply with payroll tax laws and regulations, avoiding penalties and legal issues. Moreover, it provides valuable insights into labor costs and employee productivity, enabling informed decision-making by management.

Payroll Regulations

In the United States, payroll regulations are governed by various federal, state, and local laws designed to protect workers' rights and ensure fair compensation practices. Some key payroll regulations in the US include:

Fair Labor Standards Act (FLSA): The FLSA establishes minimum wage, overtime pay eligibility, recordkeeping, and child labor standards for employees in both the private and public sectors.
Federal income tax withholding: Employers are required to withhold federal income tax from employees' wages based on their withholding allowances, filing status, and income levels.
Social Security and Medicare taxes: Employers must withhold Social Security and Medicare taxes, collectively known as Federal Insurance Contributions Act (FICA) taxes, from employees' wages. The current rates are 6.2% for Social Security and 1.45% for Medicare, with additional Medicare taxes for high-income earners.
Federal Unemployment Tax Act (FUTA): Employers are subject to FUTA tax, which funds unemployment benefits for workers who have lost their jobs. The current FUTA tax rate is 6% on the first $7,000 of wages paid to each employee annually.
State Income Tax Withholding: Many states impose income taxes on employees' wages, which employers are required to withhold and remit to the appropriate state tax authorities. State income tax rates and withholding requirements vary by state.
State Unemployment Insurance (SUI): Employers are required to pay state unemployment insurance taxes to fund unemployment benefits for eligible workers who are unemployed through no fault of their own. SUI tax rates and wage bases vary by state.
Workers' Compensation Insurance: Employers are typically required to carry workers' compensation insurance to provide medical benefits and wage replacement for employees who suffer work-related injuries or illnesses.
Employment Tax Reporting: Employers must file various tax forms with the IRS, such as Form 941 (Employer's Quarterly Federal Tax Return) to report income taxes, Social Security, and Medicare taxes withheld from employees' wages, as well as the employer's portion of these taxes.
Wage and Hour Laws: In addition to federal regulations, many states have their own wage and hour laws governing minimum wage rates, overtime pay, meal and rest breaks, and other aspects of employment compensation.
Employee Classification: Employers must correctly classify workers as employees or independent contractors based on factors such as the degree of control over the work performed and the nature of the employment relationship. Misclassification can result in penalties and legal liabilities.

These are just some of the payroll regulations that employers in the US must comply with to ensure legal and regulatory compliance in their payroll practices.

It's essential that businesses stay informed about changes in payroll laws and regulations to avoid potential penalties and legal risks.

Payroll Deductions

In the United States, there are several common payroll deductions that employers withhold from employees' wages as required by law or as part of voluntary benefit programs. Some of the most common payroll deductions in the US include:

Federal Income Tax: This deduction represents the amount of federal income tax that employees owe based on their earnings and tax filing status. The withholding amount is calculated using the information provided on the employee's Form W-4.
State Income Tax: Many states impose income taxes on residents, and employers are required to withhold state income tax from employees' wages if applicable. The withholding amount is based on the employee's state of residence and tax filing status.
Social Security Tax: Employees contribute a portion of their wages to fund the Social Security program, which provides retirement, disability, and survivor benefits
Medicare Tax: This deduction funds the Medicare program, which provides healthcare benefits to eligible individuals aged 65 and older, as well as certain younger individuals with disabilities.
401(k) or Retirement Plan Contributions: Many employers offer retirement savings plans, such as 401(k) plans, where employees can contribute a portion of their wages on a pre-tax basis. These contributions are deducted from employees' paychecks before taxes are withheld, reducing their taxable income.
Health Insurance Premiums: Employees may elect to participate in employer-sponsored health insurance plans and have their premiums deducted from their paychecks. These premiums typically cover medical, dental, and vision insurance coverage.
Flexible Spending Account (FSA) Contributions: FSAs allow employees to set aside pre-tax dollars to pay for eligible healthcare or dependent care expenses. Contributions to FSAs are deducted from employees' wages on a pre-tax basis.
Union Dues: Employees who are members of labor unions may have union dues deducted from their paychecks to support union activities and representation.
Garnishments: Employers may be required to withhold a portion of an employee's wages to satisfy court-ordered garnishments, such as child support payments or tax debts.
Voluntary Benefits: Employees may choose to participate in voluntary benefit programs, such as life insurance, disability insurance, or commuter benefits, with premiums deducted from their paychecks.

These are some of the most common payroll deductions in the US, but the specific deductions may vary depending on factors such as employer policies, state laws, and individual employee elections. Employers are responsible for accurately calculating and withholding the appropriate deductions from employees' wages in compliance with applicable laws and regulations.

Payroll Documents

Running payroll is serious admin. Here’s a list of documents you’re gonna need.

Personnel documents

Employee information form: A comprehensive employee information form collects basic details about each employee, such as their full name, address, Social Security number (SSN), date of birth, contact information, emergency contacts, and employment status (e.g., full-time, part-time, temporary).
Form W-4 (Employee's Withholding Certificate): The IRS Form W-4 is completed by each employee to indicate their tax filing status, withholding allowances, and any additional withholding amounts for federal income tax purposes.
Form I-9 (Employment Eligibility Verification): The Form I-9 verifies the identity and employment eligibility of employees hired to work in the US.
Offer letters or employment contracts: Document the terms and conditions of employment for each employee in an offer letter or employment contract, including details such as job title, compensation, benefits, work hours, employment status, and any applicable probationary periods or conditions.
Benefit enrollment forms: If offering employee benefits such as health insurance, retirement plans, or other voluntary benefits, collect completed benefit enrollment forms from employees indicating their benefit elections, coverage levels, and any required contribution amounts.
Direct deposit authorization form: Obtain authorization from employees to deposit their wages directly into their bank accounts by completing a direct deposit authorization form. Employees provide their bank account information, including bank name, account number, and routing number, to facilitate electronic wage payments.
Payroll authorization form: Some employers may require employees to complete a payroll authorization form authorizing deductions from their wages for items such as uniform expenses, equipment purchases, or voluntary deductions for charitable contributions.
Performance evaluations or reviews: Maintain records of employee performance evaluations or reviews documenting performance feedback, goals, achievements, areas for improvement, and any salary increases or bonuses awarded based on performance.
Termination documentation: Document the details of employee terminations, including the date of termination, reason for termination, final wages or compensation owed, benefits continuation options, and any required notices or agreements.
Employee handbook or policies: Provide employees with an employee handbook or access to company policies outlining their rights, responsibilities, and expectations regarding employment, compensation, benefits, leave policies, workplace conduct, and other relevant matters.

Payroll tax forms

In the United States, employers are required to file various payroll tax forms to report wages, taxes withheld, and other payroll-related information to the Internal Revenue Service (IRS), state tax agencies, and other government entities. Some common payroll tax forms in the US include:

Form W-2 (Wage and Tax Statement): Employers must provide Form W-2 to each employee and submit copies to the Social Security Administration (SSA) annually. Form W-2 reports employees' wages, tips, and other compensation, as well as taxes withheld, such as federal income tax, Social Security tax, and Medicare tax.
Form W-3 (Transmittal of Wage and Tax Statements): Form W-3 is a summary transmittal form that accompanies Form W-2 when submitted to the Social Security Administration. Employers use Form W-3 to report total wages, tips, and other compensation, as well as total taxes withheld for all employees.
Form WH-347: Used to submit certified payroll—a specific type of weekly payroll report required in the United States for contractors and subcontractors working on federally financed or assisted construction projects worth $2000 or more.
Form 941 (Employer's Quarterly Federal Tax Return): Employers use Form 941 to report federal income tax withheld from employees' wages, as well as Social Security and Medicare taxes (FICA taxes) withheld from employees and the employer's portion of FICA taxes. Form 941 is filed quarterly by most employers to reconcile payroll taxes for each quarter.
Form 940 (Employer's Annual Federal Unemployment (FUTA) Tax Return): Employers use Form 940 to report and pay federal unemployment tax (FUTA) owed on wages paid to employees. Form 940 is filed annually to report FUTA tax liability for the previous calendar year and reconcile any FUTA taxes paid during the year.
State Quarterly Wage and Tax Reporting Forms: Many states require employers to file quarterly wage and tax reports to report state income tax withheld from employees' wages, as well as state unemployment taxes (SUTA) and other state payroll taxes. The specific form and filing requirements vary by state.
State Unemployment Insurance (SUI) Reports: Employers may be required to file separate reports to report state unemployment insurance (SUI) taxes and provide information on wages paid to employees, unemployment claims, and other relevant data. These reports help determine the employer's SUI tax rate and eligibility for unemployment benefits.
Form 1099 Series: While not strictly payroll tax forms, Form 1099 series includes various information return forms used to report payments made to independent contractors, freelancers, and other non-employee workers. Examples include Form 1099-MISC for miscellaneous income and Form 1099-NEC for nonemployee compensation.

Processing Payroll

Payroll processing can be time-consuming with little to no margin for error. Luckily, there are a few options available when it comes to actually running payroll.

Manual processing: Employers can manually calculate employees' wages, taxes, and deductions using spreadsheets, paper-based records, or accounting software. Manual payroll processing involves entering employee hours, calculating wages, and issuing paper paychecks or direct deposits.
Payroll software: Employers can use payroll software to automate and streamline payroll processing tasks, such as calculating wages, withholding taxes, generating pay stubs, and issuing direct deposits. Payroll software often integrates with accounting systems and offers features like tax compliance, time tracking, and employee self-service portals. Check out our pick of the best payroll software.
Accountant, CPA services, or payroll service: Employers may choose to outsource payroll to certified public accountants (CPAs) or firms specializing in payroll services. These professionals handle payroll processing, tax filings, and compliance matters on behalf of the employer, providing expertise and peace of mind. Check out our shortlist of the best payroll services.
Professional employer organizations (PEOs): PEOs offer comprehensive HR outsourcing solutions, including payroll administration, employee benefits management, compliance assistance, and risk management services. Check out our pick of the best PEO companies.
Employer of record (EOR) services: EOR services, also known as co-employment arrangements assume legal and administrative responsibilities for payroll and employment matters while the employer retains control over day-to-day operations and employee management. They’re particularly useful for global expansion. Check out our pick of the best EOR services.

Who’s Responsible For Payroll Processing?

Does HR do payroll? Is something we get asked a lot.

In reality, the responsibility for payroll can vary depending on the size and structure of the organization.

In a small business, the business owner might be the one responsible for handling payroll.

In a more mature business, it might come under the remit of either accounting/finance and/or human resources. As mentioned above, there’s always the option to outsource to a professional service.

Here’s a breakdown of the different departments’ roles in processing payroll.

Human Resources (HR) department: HR is responsible for aspects like maintaining employee records, overseeing timekeeping and attendance, determining benefits and deductions, and ensuring compliance with labor laws.
Accounting or finance department: The accounting or finance department often handles the financial aspects of payroll. This includes processing payments, managing payroll software, calculating gross and net pay, handling taxes and deductions, and ensuring that all financial records are accurate and up-to-date.
Payroll department: Larger organizations may have a dedicated payroll department. This department specializes in all aspects of payroll processing, including calculating pay, managing deductions, ensuring tax compliance, and addressing employee queries related to payroll.

11-Step Payroll Process

Step 1: Gain your EIN and state/local tax IDs. Follow this guide from the IRS to do so.
Step 2: Establish your payroll policy
- Define payroll schedule: Decide on a regular payroll cycle (weekly, bi-weekly, semi-monthly, or monthly).
- Set up payroll policies: Establish clear policies for overtime, leave, benefits, deductions, and other payroll-related aspects.
Step 3: Collect and verify employee information
- Check employee data: Check you have accurate employee information including:
  - Tax forms (W-4, W-9, I-9)
  - Identification numbers (like Social Security numbers)
  - Deductions: benefits such as health insurance and retirement plans
  - Bank account details
  - Employment contracts with correct salary or hourly rates.
Step 4: Track time and attendance
- Tally work hours: For hourly employees, track the number of hours worked, including regular hours and overtime.
- Manage leave and absences: Take note of any vacation, sick leave, or other absences as it pertains to worker pay.
Step 5: Calculate gross pay
- Determine gross pay for hourly employees: Multiply the number of regular hours worked by the hourly rate, and add any overtime pay.
- Calculate gross pay for salaried employees: Divide annual salary by the number of pay periods to get the gross pay for each cycle.
Step 6: Calculate deductions
- Withhold taxes: Calculate and withhold federal, state, and local taxes based on employee tax information.
- Deduct benefits and other contributions: Deduct contributions for benefits like health insurance, retirement plans, etc.
- Account for other deductions: Include any other garnishments, deductions legally required or agreed upon such as from on-demand pay.
Step 7: Determine net pay
- Subtract deductions from gross pay: The result after all deductions is the net pay for each employee.

Step 8: Process payments
- Issue payments: Pay employees via the chosen method (direct deposit, check, cash, etc.).
- Provide pay stubs: Distribute pay stubs to employees, detailing gross pay, deductions, and net pay.
Step 9: Record and report payroll
- Maintain records: Keep detailed records of each payroll cycle for internal and legal purposes.
- Report to government agencies: File required reports with tax authorities and other government agencies.
Step 10: Prepare for year-end processing
- Year-end reports: Prepare and distribute year-end tax documents to employees (like W-2s in the U.S.).
- Reconcile yearly data: Ensure all payroll data for the year is accurate and complete.
Step 11: Review and update payroll information
- Regular audits: Periodically audit the payroll process for accuracy and compliance.
- Update policies and records: Make adjustments as needed for changes in tax laws, employee information, or company policies.

Payroll Best Practices

Follow these best practices to help ensure you run an efficient and accurate process.

Stay updated on regulations: Regularly update your knowledge of local, state, and federal tax laws and employment regulations. This includes understanding changes in tax rates, minimum wage laws, overtime rules, and benefits regulations. Resources like the US government’s compliance assistance will help here.
Maintain accurate employee records: Keep accurate and up-to-date records of all employees, including their details, tax information, benefits, and any changes in their employment status or pay rate.
Regular audits and reconciliation: Periodically audit your payroll process to ensure accuracy and reconcile payroll records with bank statements and general ledger accounts regularly.
Open communication with managers. Communicate your payroll process with managers highlighting what’s required of them and when.
Clear communication with employees: Maintain open lines of communication regarding payroll policies and changes, provide clear, detailed pay stubs, and be available to answer employee queries about their pay.
Timely and accurate tax filings: Ensure that all payroll-related tax filings are accurate and submitted on time. This includes withholding the correct tax amounts and timely remittance to tax authorities.
Data security and privacy: Implement strong security measures to protect sensitive payroll data. This includes safeguarding digital records and ensuring privacy in handling employee information.
Make efficient use of technology:
- Invest in payroll software that can automate calculations, manage data, and stay updated with the latest tax rates and regulatory changes. To help, here are some key payroll software features.
- Use a reliable system for tracking employee hours, especially for hourly workers. Ensure that the system accurately captures regular hours, overtime, and leave.
Prepare for year-end processing early: Start the year-end payroll process well in advance. This includes verifying employee information, updating payroll records, and preparing for tax document distribution.
Seek professional advice: When in doubt, consult with payroll experts or legal advisors, especially for complex issues or major changes in payroll laws and practices.
Document payroll procedures: Maintain a written record of all payroll procedures. This helps in maintaining consistency and serves as a training tool for new staff.
Plan for contingencies: Have a backup plan for payroll processing in case of emergencies or unexpected disruptions (like technological issues or natural disasters).
Seek employee input. As Malcolm Ferrante, senior accountant at CBS Group, highlights “Seeking employee input can also shed light on pain points and highlight opportunities for improvement.”
Double and triple-check EVERYTHING before submitting.

Toward Timely And Accurate Payroll

While payroll can seem daunting, modern technologies such as payroll systems have made handling the process much easier.

Consider attending one of these payroll conferences to expand your knowledge and connect with industry leaders.

For further guidance, check out our article on how to do payroll yourself and subscribe to the People Managing People newsletter to receive our latest articles covering all aspects of talent management.