When you think of payroll you probably associate it with issuing paychecks. While this is an important part of payroll, payroll is also responsible filing and withholding taxes and handling paycheck deductions like benefits and garnishments.
In short, payroll is an extremely part of a business for legal and financial reasons. Perhaps that why in National Small Business Association (NSBA) 2014 Small Business Taxation Survey, “Payroll taxes were ranked as the number one most financially burdensome and number two most administratively burdensome federal tax among small firms.”
If you’re small business or someone looking to become a payroll expert, this guide will define what exactly payroll is, why it’s important, where you can learn about payroll, and how to set-up your own payroll system.
According to Investopedia, payroll is “The sum total of all compensation that a business must pay to its employees for a set period of time or on a given date,” which includes salaries, wages, deductions, bonus, and net pay. In many cases, payroll is handled by the accounting department of a business. Small-business owners may also choose for payroll to be managed directly in-house or by an associate.
Payroll typically makes up the largest deductible for a business because of the expense it takes to compensate each employee’s salary or wage. Pay periods can also vary due to situations like overtime or sick days.
Besides compensating employees, payroll also involves the taxes that employees are required to pay, such as Withholding taxes. Also known as Pay-As-You-Earn (PAYE) taxes, these are taxes that employers must withhold from the wages of every employee. Income tax withholdings are assigned by the federal, state, and local governments.
Employees and employers are required to also pay payroll taxes like Social Security and Medicare. The IRS states that “The current tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, or 12.4% total. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total.” Another required payroll tax would be unemployment taxes to compensate employees who have lost their job.
There are federal and state-level systems in place to assess and collect payroll taxes in a majority of the developed world.
Payroll is one of the most important financial components of a business because it can have a serious impact on the net incomes of an organization. Additionally, payroll is subjected to several laws and regulations. Because of the legal, and even ethical, factors involving payroll it’s important that a business keeps a precise record of its payroll.
Organizations must pay employees on a timely and accurate manner - which a payroll system will provide. If you do not compensate employees their full salary or hourly wages, you’re essentially stealing from them. You’re also breaking the law.
The U.S. Department of Labor, Wage, and Hour Division has established numerous guidelines that determine everything from minimum wage, minimum paydays, overtime pay requirements, which deductions are allowed and which employees are exempt or nonexempt. If a business fails to comply with these laws,the employer will be forced to pay the employee’s back wages, a waiting time penalty, attorney fees, liquidated damages, and may even face criminal or civil penalties.
The federal government requires businesses to withhold a percentage of a paycheck, for both the employer and employee. These taxes include Social Security and Medicare, Unemployment, and Federal Income Tax. Employers must also pay state income taxes, as well as state unemployment and disability taxes. Some states may even require additional taxes like a job-training tax. Failure to pay these taxes can result in penalties, a tax lien or levy against the taxpayer’s property, and tax audits.
To avoid any prosecution of problems with the IRS, businesses must gather a W-2 form from each employee and file it with the Social Security Administration by Mid-April of each year.
Payroll can also be used to provide valuable feedback for you business. The most obvious feedback that payroll can show a business is whether or not the business is making a profit. A precise payroll could determine that a business is losing more money then it’s bringing in because it is spending too much on paying employees. If that’s the scenario, the business may have to consider laying off some of it’s employees so that it can become more profitable.
Every business owner must have an accurate and consistent payroll so that they can pay employees correctly, withhold the right amount of taxes, and have a better understanding of their cash flow.
In most cases, the most important person involved with payroll will be a payroll coordinator. This individual has numerous roles and responsibilities for their respective accounting department, which can include being the liaison between employees, payments, and the Payroll Office and processing OPUS entries (hiring, budget number changes, leave of absence changes).
Payroll coordinators are also responsible for entering employee hours into the Time Reporting system for payroll processing. After payroll has been processed, there needs to a be review of each employee payroll. If the coordinator catches an errors, such as underpayments or overpayments occur, it is their responsibility to work with the Payroll office to correct these errors.
Depending on the size of your business, the payroll department could also include management (payroll supervisor, payroll director/manager), staff (payroll technician/assistant, payroll practitioner, payroll administrator), and technical manager, (data entry, system analyst, payroll system coordinator).
Always remember, no matter the role or position, the payroll department is in charge of:
The payroll department should also be aware of Federal and State deadlines and calculating and correcting hours, wages, tax holdings, and benefits.
If you’re involved with payroll, it’s imperative that you learn the following:
It would also be useful to learn:
Where you can you learn these skills and regulations? Here some of the best ways where you can learn payroll whether you’re a small business owner, accountant, or someone wanting to get involved in the field.
If you want learn the basics of payroll, you don’t necessarily need a college degree. In fact, you may only need a high school diploma and can be hired to learn most of the payroll skills on the job. However, it is beneficial to have some additional payroll courses under your belt. Many community colleges and vocational training schools offer payroll accounting clerk certificate programs.
You can also earn a payroll certification, such as the Fundamental Payroll Certification (FPC) and the Certified Payroll Professional (CPP) online from the American Payroll Association or the National Association of Certified Bookkeepers.
If you want to become a payroll manager or supervisor, you’ll most likely need a bachelor’s degree in accounting. If you’re interested in attending a educational institution to earn an accounting degree, here are eighteen of the leading colleges and universities:
There are also plenty of online courses, which are usually free, that are available. While they will help you understand payroll basics, you will not earn any credit for taking these courses, which may not be ideal for someone looking for a career in payroll. These courses may be more useful for business owners who are looking to do payroll themselves.
If you don’t have to time to attend an accounting course or learning the basics of payroll online, you can also consider using the following resources for learning payroll
At this point you should be well aware of the responsibilities regarding payroll; paying your employees, paying taxes, and filing the correct forms. With this information, it’s time to decide which payroll system you would like to set up. Typically, you have four choices:
Regardless of which system you settle on, you should also have the following in place:
If you opt to establish your own payroll system for your business, here’s what you’ll need to get started:
Apply for you employment identification number by contacting the IRS or online. Your EIN, also known as an Employer Tax ID or as Form SS-4, is important because it’s required when reporting taxes to the IRS.
You may need a business ID in certain states in order to pay process taxes. You see if your state requires an ID by visiting the SBA’s State Tax Guide. This guide is also helpful since it also provides state information on taxes like worker’s compensation, unemployment, or business tax registration.
There can be major differences between how you pay employees and independent contractors. Knowing how these two types of employees can affect your payroll is important to understand. The IRS has an informative page that can help you understand how employees and independent contractors differ.
In the United States, the most common pay periods are at the end of the month, semi-monthly (twice a month - on the 1st and the 15th, or on the 15th and 30th), biweekly (every two weeks) and weekly. Since accountants run monthly reports, they prefer semi-monthly periods, which would be 24 throughout the year. Benefits are also monthly, so if a semi-monthly pay period makes these deductions easy to manage.
Biweekly pay periods are preferred by hourly employees and overtime can be calculated easily. Since semi-monthly pay hourly employees at 86.67 hours per period, calculating overtime can become a bit more complicated.
Weekly pay periods are favored most by the trade industry, such as construction. Most other businesses tend to avoid weekly pay periods because they’re expensive, vendors charge for each payroll process, and it’s time consuming.
Besides finding the pay period that works best for your business, also consider your state’s law regarding pay periods.
As mentioned earlier, having precise payroll records are a necessity. Make sure that you have a system in place to accurately track employee hours, how you handle paid time off, employee compensation, and business deductibles. This guide on Employment and Labor Law can be used to direct you in this area.
There are federal and state laws the require you to keep certain records for a certain amount of time. For example, W-4 forms must be kept for all active employees and for four years after they leave your organization. You should also keep W-2's and copies of tax forms and dates. This article, Keep Good Records; But How Long Should I Keep Them For?, is an excellent resource for figuring out the length of certain records.
There are both federal and state laws, such as (Fair Labor Standards Act or FLSA), that require employers to pay their employees. These laws also establish the minimum wage rate, explain when employees must be paid, and detail situations like overtime. As a business owner, it’s in your best interest to contact the proper agencies prior to issuing any paychecks. If you break the law regarding paychecks, you could face legal actions, and severe penalties.
Before you start paying employees, make sure that you have the following items in order. If not, you will not be able to withhold the correct amount of taxes and pay employees the proper amount.
You required by the federal government, unless the employee is tax exempt, to withhold Federal Income Tax, Medicare tax and Social Security tax from an employee's income. Whenever you hire a new employee make sure that you issue them a W-4. The new employee must complete the form by documenting which withholding conditions apply to them. This gives allows you to know how much federal tax income you have to withhold. Don’t forget to check with your state’s guidelines regarding local income tax as well.
You do not have to issue forms for Medicare and Social Security tax withholding. You can use the RS Circular E, the Employer’s Tax Guide to locate these rates.
Regardless if you pay an individual a salary or by the hour you still need to classify them as either an employee or independent contractor. By classifying employees, you are able to determine who is eligible for tax exemptions and who is not. Usually, a non-exempt employee can qualify for overtime, while you are not required to pay an exempt employee overtime.
Because these regulations can be complex, the Department of Labor released a 15-page memo that should be used to help you determine the classification of your employees. This is a simplified list from the 15 page memo of the Labor Department that you can start using to consider six major factors:
Classifying your employees allows you to issue them the proper forms, such as Form SS--8, and helps you to be aware of which taxes need to be withheld.
You required under The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 to report newly hired employees to your state directory within 20 days of being hired. You must submit the following information: employer name, address and federal employer identification number, as well as the employee’s name, address, Social Security number and hire date.
Each state state varies, so please review the specific requirements of your state by visiting this directory on SBA.gov.
While the Fair Labor Standards Act (FLSA) requires employers to pay employees for payable hours worked when payable, it does not have a requirement for payment frequencies. However, most states set either a weekly, biweekly, or semimonthly payday schedule. For example, states like Nebraska and Pennsylvania allow the employer to designate paydays. States like Arizona make things complicated by requiring employers to pay employees twice a month, but 16 days apart.
Review the laws regarding the state-mandated minimum paydays by visiting this page on FindLaw.
After reviewing your state’s guidelines, you can should set-up a payroll frequency that works best for your business. Weekly paychecks are typically issued every Friday, while monthly paychecks could be issued on the first each month. Biweekly and semimonthly paychecks can be a little more confusing, so here are the main differences:
FLSA also allows you to determine how you wish to pay your employees. Cash, checks, money orders, and direct deposits are all acceptable forms of payment methods. You are even allowed to meet the minimum wage requirements by compensating employees through food, lodging, and utilities.
Employers are not permitted to pay employees with vouchers, coupons, discounts, or tokens.
Throughout this guide you’ve come across numerous mentions of the various deductions that are taken out of your paycheck. Here is a closer examination of these deductions so that employees can understand what’s being taken of their paychecks and what employers are responsible for withholding.
There could be other deductions depending on what other benefits are offered. Keep in mind though that no matter how much is withheld from a paycheck you need to know the difference between gross pay and net pay.
Gross pay is the amount of the paycheck before taxes have been taken out. If you are an hourly employee, then your gross pay would be the hours that worked multiplied by the amount of money you made per hour. If you make $10 per hour and worked twenty hours, then your gross pay would $200. If you are paid by salary, your gross pay would be your annual salary divided by the number of paychecks that you receive in a year. For example, if your salary is $65,000 and you receive 26 paychecks a year, your gross pay would be approximately $2,500 per month.
Net pay is the amount of money left over after all of the deductions mentioned above have been taken out.
What happens if you’re a business owner who can not pay your employees when payday arrives? Here a couple of options that you may want to consider if this ever happens to you so that you can still manage to compensate your hard working team members.
Ultimately you need to increase your business’s cash flow, unless you’re completely shutting the business down. Here are some recommended ways to get that cash flowing again so that you can handle payroll again.
Even if you are honest about your financial problems and your employees are understanding and willing to work with you, you are still required by law to pay them. Whatever direction you go into in order to pay your employees, make sure that it’s not prohibited in your state. But, if you run into this problem, move quickly to fix it. It will not go away by wishing, waiting, or ignoring the problem. Swift, decisive action - and luck - is the quickest way to fix a problem like this.
Invoicing and payroll are intertwined. Not only are both a major part of a business's accounting department, invoices are needed to keep a positive cash flow, which can be used to put towards payroll.
If you’ve never put together an invoice, there are the essential components needed to make ensure that your business gets paid on time.
Since your invoice is an official document from your business it should reflect your brand. Your invoice may include the same colors and wording that your organization already uses. It is beneficial to add your logo to help your clients have an immediate recognition of who sent the invoice. If your company is called “Legal Eagles” then you may want to have your invoice reflect your professionalism by writing the terms in lawyer’s English. If your company is more quirky, then it would be fine to have more casual language used on your invoice.
Your invoice might include your corporate legal status - in Europe invoices would include VAT if registered. In the U.S. the most common forms of businesses are:
The reason that you should be aware of your business structure and include it on your invoice is because each business must complete the correct forms and file them with the IRS so that they can meet the correct tax obligations.
Speaking of taxes, you must also determine if you are required to include sales tax. This varies depending on the industry that you are in and which state the business is located. If you are in the service industry, most states allow for sales tax to be exempt.
Prior to starting a project, you and the client must agree on the scope of the work, deadlines, how much you’ll be paid, and how you’ll be paid. You must also discuss what happens if you accrue additional charges and whether or not the work will be kept until the payment has been made. Other details, such as deposits, late fees, and taxes also need to be addressed.
While you don’t necessarily have to a contract written, you should have the terms written down - even an email will work, so that you have evidence to protect both employee and employer.
Businesses and freelancers should incorporate the following elements for a more effective and professional invoice:
Getting paid on time starts with your invoicing system. If you use effective invoicing software, such as Due.com, the faster you’ll get paid - which keeps a positive cash flow. With invoicing system you can quickly create and send out invoices. If you have recurring clients you can store their contact and billing information so that you just have to fill-out the details of the new invoice. Additionally, you can set-up an automated billing system so that each month the client’s credit card or bank account is automatically charged the amount that they owe you.
Here are some other ways to ensure that your invoice gets paid on-time.
Every business owner and employer should be familiar with invoicing basics - even if they’re not handling the invoices themselves. If you happen to be an independent contractor, such as a freelance writer or consultant, you should especially be familiar with invoicing since it will be a task that you’ll have to perform yourself if you want to get paid for your services.
It’s not uncommon for businesses to outsource payroll functions. Thanks to technological advances, payroll is becoming increasingly easier to conduct internally. To help you make this decision, here are the benefits of keeping payroll in-house instead of outsourcing this function.
Whether you hire someone on your staff to handle and manage payroll or you’re using software to do payroll yourself, keeping payroll internally has the following benefits:
For larger enterprises, they can easily sustain a payroll division. This may also be the case with small business owners who opt to outsource their payroll for the following reasons:
There are pros and cons for both keeping payroll in-house - or outsourcing it to another company. When deciding to figure out which option you should settle on, make sure that you consider what works best for your business. How many employees do you have? Do you multiple locations? What business structure is your business? Do you offer benefits? A small business owner of five employees probably does not need all of the robust features of ADP.
You also need to think about the costs. Spending $1,500 for payroll software is extremely pricey for a small business owner who may be able to outsource their payroll at a better rate. Are there an additional fees that you’re not aware?
If you’re still uncertain, select a payroll software provider and give it a trial. If the service satisfies your needs, then keep using it for your payroll moving forward. If it doesn’t work out for, you may want to outsource your payroll.