Whether you employ a few contractors or run a company with a 500-person staff, it’s critical to pay the people who work for you on time and in the correct amount. A functional payroll system can make sure this cornerstone of business operations remains strong and empowers everyone to work with confidence. If you’re starting a business or growing your company, this guide provides the basics on “what is payroll?” and how it works.
What Is Payroll and Why It Matters
When a staff member completes work, a company provides them with a paycheck. A simple payroll definition refers to the funds and systems in place to make those payments regularly and correctly. However, this payroll meaning goes deeper, as it involves many components of employee salary matters, such as hours worked, overtime, taxes deducted, and benefits paid. It‘s also the process of moving funds from company accounts to the employee—such as through a physical check or direct deposit.
No matter the size of your business, having a payroll system is critical to ensuring employees are paid correctly and on time according to a set schedule. This consistent effort goes a long way in maintaining trust with your team, giving them confidence that they will receive earnings as they should. With proper procedures, a company can stay tax compliant, keep accurate records, and avoid financial errors.
The Payroll Process: How Does Payroll Work?
To define payroll is to outline the complete process it comprises. First, relevant employee information is collected upon hiring—such as their tax identification and payment preferences. Next, the payroll team will use the employee’s reported hours (if hourly) and calculate gross pay. Next, taxes and other deductions are taken from the gross total, with the remainder paid out to the employee from a funded account in the company.
Taxes collected from each paycheck are used to pay state and federal agencies when employer taxes are filed. Other deductions may be taken to pay organizations that manage benefits—such as health insurance and retirement providers. Accounting software meticulously tracks all of these transactions for accurate record-keeping.
Payroll Breakdown: What’s Included in Each Paycheck
For many, the most important number on a paycheck is the total amount that makes it into their bank account. But upon a closer look at the pay stub, you’ll find many other details expand upon how an employee is paid.
A pay stub will show the time an employee worked. Non-salaried employees show the specific hours they worked according to the company’s time-keeping reports. They may also show overtime hours as determined by state laws. Checks for salaried employees will typically just show a set standard of hours worked, usually a full-time amount of around 40 hours. If applicable, pay for vacation or paid time off (PTO) will be included.
Paychecks detail a base pay, determined by the “regular hours” reported multiplied against an hourly earning rate. The hourly rate of a salaried employee is usually calculated by dividing their base annual salary by the standard number of work hours in a year.
Additional pay will also be detailed on a paycheck. For hourly employees, extra income may refer to “overtime” rates or commissions. Salaried staff usually won’t have overtime taken out but may still have pay reported for bonuses or commissions.
Next, a paycheck reveals a series of deductions. These deductions typically include relevant taxes, wage garnishments, insurance payments, and retirement contributions. The net pay is the gross pay subtracted by these deductions.
Choosing the Right Payroll System for Your Business
In the past, companies often relied on messy, manual payroll records calculated by hand. Now, most businesses rely on some type of payroll or accounting software to streamline the process.
Small businesses will often use an in-house software application to record, calculate, and automate payroll. Depending on the company’s needs, the software may run through an internal computer and store the data on a local drive. However, cloud-based software is often the better choice, as it allows payroll professionals to update the system from anywhere. Cloud systems also tend to back-up data outside the physical business location for greater peace of mind.
Setting Up Payroll: A Step-by-Step Guide for New Employers
If you’re launching a new business or expanding to hire people for the first time, you’ll need to get an Employer Identification Number (EIN) and register with state and local tax agencies before establishing payroll.
Once recognized as an employer, choose a payroll system that fits your company’s size and operations. Internal or cloud-based software may be cost-effective, but managing it alone can increase financial oversight risks. Figuring out “what is payroll” for your organization isn’t always easy, so hiring a third-party payroll service can offer a smoother, more accurate, and safer experience.
Next, collect all the appropriate employee information when they’re hired. Typically, you can get the information you need through a W-4 (for tax withholding), an ACH authorization form (for setting up direct deposit), and an I-9 (for employment eligibility verification).
Collect employee information through forms like the W-4, ACH authorization, and I-9, and input it into your payroll system. Set up deductions for Social Security, Medicare, taxes, and benefits, and establish a clear pay period so employees know when to expect their checks.
Make sure to file and pay taxes on time, and use your payroll software to generate year-end W-2 forms for employees to complete their personal taxes.
Understanding Payroll Taxes: What Employers Need to Know
What's payroll without taxes? Simply a payment that’s missing the essentials that keep your business compliant with state and federal laws.
To comply with regulations, a company must deduct federal, state, and FICA (Social Security and Medicare) taxes from earned wages. The employer must also match FICA deductions for most employees, except for independent contractors and unpaid interns. These taxes must be filed and paid on schedule by the company in order to avoid fees and penalties.
Common Payroll Deductions and How to Track Them
Taxes, like those mentioned above, must be deducted from gross wages. But there are many other deductions often found on a paycheck.
Most of these deductions refer to additional benefits that a company may offer. For example, any FSA, HSA, and retirement contributions an employee elects must be included. If the company requires employees to pay for insurance coverage—including medical, dental, vision, and life policies—their portion will also be deducted from the check.
You might also be wondering, what is a payroll deduction that’s less common? Some examples include wage garnishments and union dues.
Payroll software is the best tool for tracking all deductions, as it can automate the calculations and keep detailed records for easy reference and compliance.
Stay Compliant: Payroll Laws Every Small Business Should Know
There are many aspects to payroll compliance, but the bulk of them are covered by the Fair Labor Standards Act (FLSA). This act details the rules an employer must follow regarding overtime, minimum wage, and overall payroll record-keeping. In addition to meeting federal minimum wage requirements, employers must also comply with state minimum wage amounts.
Business owners must also comply with tax regulations, which involve correctly calculating, filing, and paying an assortment of various taxes—including federal, state, and FICA taxes.
It’s also important to note that pay should also be paid on time as outlined by the pay policy. Late wages can result in substantial penalties, often determined by state laws. If tight cash flow is preventing you from satisfying on-time payments, consider options from the best payroll loans & lenders that can help you cover the gap with reasonable terms.
Record Keeping Made Easy: How to Stay Organized
Companies are required to keep payroll records for several years, depending on federal and state regulations. Between various wages, taxes, and deductions, keeping proper records of payroll can quickly become complicated.
Fortunately, most payroll software systems are designed to automate these records. However, this software should be overseen by a trained professional to ensure the right information is being recorded—hiring an accountant or third-party payroll provider can simplify every aspect of this process. Make sure the data is securely stored and backed up—such as through a cloud-based system—so that it can be easily accessed in the event of an audit.
Final Thoughts: Streamlining Payroll for Business Success
Keeping your business running smoothly and legally compliant relies on efficient, accurate payroll management. Whatever the size of your company, having the right system in place will help keep the process running like clockwork, as well as avoid costly errors. While it’s important to have a good understanding of what is payroll, you don’t have to navigate it alone. For a hassle-free experience that lets you focus on other aspects of your growing business, consider partnering with a third-party payroll administration to process, record, and organize this information in a timely fashion.