As an employer, it is imperative that you remain compliant with all federal and state tax and labor laws. Part of that process involves proper payroll processing.
Unless your business is a one-man operation, you’ll need to process payroll to pay your employees. Payroll processing is just one of the many tasks and responsibilities faced by business owners. However, it is one of the most crucial components of business operations that you cannot overlook.
Business owners must run payroll accurately to calculate their employees' earnings. The payroll process consists of:
- Maintaining the financial records of all employees.
- The timely distribution of employee paychecks.
- Annual records that show employee wages.
The payroll process is complicated and one of a business’s greatest overhead expenses.
What is payroll processing?
Payroll processing is the act of managing all aspects of payment processing to pay employees.
The management of payroll is not for the faint of heart. The process is actually complex and tedious. And, each pay period can and will whittle away at your time to complete.
You’ll also need to take steps to make sure you have properly calculated everything and then double-check. Finally, you have to track and distribute the employee payments. Payroll processing has to always be correct and show the amount of money withheld for company benefits, taxes, and other important deductions.
Companies vary in how they manage payroll processing solutions. Some will hire a person to administer and manage the payroll and others use their human resources. Many businesses opt to hire an external company to ensure their payment processing is overseen professionally without error.
Payroll processing is not a straightforward process even if you decide to purchase a program and automate the procedure. You’ll still need to constantly check the hours employees work, calculate pay and taxes, plus figure out withholding while issuing reports to the property tax authorities. It’s time-consuming and tedious.
If you make a tiny calculation mistake, your employees' trust in your company will be jeopardized and they might start seeking employment elsewhere. Remember, your employees expect and should always receive their pay on the day promised and the amounts must always be correct. Anything less is simply unacceptable.
One of the most important parts of being a successful employer is ensuring that your team is paid. Accurate payroll compliance and processing are difficult tasks that take a huge chunk of time and effort to complete.
Many employers compare payroll processing to completing their taxes, but the process has to be carried out once a week, twice a week, or once a month depending on how frequently you pay. So, you can certainly understand why payroll processing is a dreaded task for most employers and why they regularly seek the skilled help of payroll professionals.
Why is payroll processing so important?
You want your staff paid on time and you also need to ensure that your business maintains its legal obligations.
Delayed or inaccurate payments create problems for your company. Your employees expect to be paid on time. The action is a requirement so you can keep morale high and ensure satisfaction.
It’s common for businesses to experience compliance problems if they misclassify employees, fail to report payroll taxes or miscalculate withholdings. The Fair Labor Standards Act (FLSA) can issue violations if you fail to properly comply with recordkeeping and overtime laws.
Each payroll cycle can quickly become a tedious headache. The slightest inaccuracies can cause disgruntled employees, fines, penalties, and a bevy of potential compliance violations.
Accurately and efficiently processing your payroll benefits your business.
Advantages of hiring a payroll processing company
You can run payroll processes in HR or employ a specialized accountant to keep track of everything. However, many companies are turning to skilled payroll services.
Payroll processing companies handle everything from beginning to end.
Here are a few advantages to proper payroll services:
- Happy and resolute employees
- Ease of mind knowing your business is tax-compliant
- Easy and streamlined bookkeeping
- Reducing the chances of potential FLSA lawsuits over violations
- Peace of mind over accounting accuracy
- Uncomplicated pay runs
- Reduction in manual time wasted on miscalculations
Imagine putting all of your payroll processes on autopilot and never having to worry about accuracy or compliance — You can do that with a skilled payroll processing company!
Payroll regulations you need to know
Various aspects of payroll procedures are regulated by either the Internal Revenue Service (IRS) or the Department of Labor (DOL). Every business owner who is even contemplating handling payroll needs to familiarize themselves with payroll regulations. Below is a quick rundown of payroll regulations.
Let’s examine some of the laws you’ll need to comply with when carrying out payroll processes for your business:
Fair Labor Standards Act (FLSA)
The Fair Labor Standards Act (FLSA) entitles workers in the United States to a federal minimum wage of not less than $7.25 per hour (effective July 24, 2009). Many states also set their own minimum wage laws, but they cannot dip below the federal minimum wage. In addition, workers are paid overtime pay at a rate of one and a half times the regular rate after they have worked 40 hours each week.
As an employer, you’ll need to accurately calculate time and attendance so you can pay overtime wages and remain in accordance with the law.
The FLSA mandates that employers must keep certain records regarding each nonexempt worker. Payroll records will include the hours worked each day and the total hours worked during each work week. It will also outline the basis of how each employee’s wage is paid and their regular hourly rate:
Record any overtime for the work week, the date that payment is issued, and the period that the payment covers along with total wages each period. All payroll records must be kept for a minimum of three years along with time cards which an employer must keep for no less than two years.
Federal Insurance Contributions Act (FICA)
The Federal Insurance Contributions Act (FICA) requires that a certain portion of an employee's gross wages be put towards Social Security benefits and Medicare. Every pay period, you’ll need to deduct 6.2% for Social Security tax (until the base wage is met) and 1.45% for Medicare tax. You also must match the deductions which brings the total FICA tax to 15.3% per employee.
Federal Unemployment Tax Act (FUTA)
Employers typically contribute to federal and state unemployment programs which assist workers when they are laid off or become unemployed for a variety of reasons.
The FUTA is not considered a payroll deduction because it is something the employer pays and not the employee.
In order to be within compliance, an employer must pay 6% in taxes on the first $7,000 paid to the employee. In some cases, exemptions may apply such as if you are employing agriculture or household workers.
State rules and regulations for payroll processing
You’ll not only need to worry about toeing the line with federal regulations, but you’ll also need to follow state payroll processing laws.
Every state has its own set of rules and regulations. Many are strict and others somewhat lax. The rules govern everything from minimum wage to recordkeeping and payday schedules. If your company conducts business across state lines, then your payroll compliance becomes even more complicated.
Compliance is not an easy task.
You’ll need to gather the assistance of someone from your legal department or reach out for legal advice from an attorney to compile a complete list of all labor laws that impact your business. Then you’ll need to track changes that occur with existing laws and make note of any new laws being proposed.
Staying up to date on changing laws is crucial. All findings must be reviewed on a monthly basis so you can tailor your company’s operations and payroll processing to avoid penalties. Clearly, you can see why it is in your best interest to partner with a payroll processing company and forego the entire time-consuming headache and hassle.
Applying for an EIN
An employer identification number (EIN) is often referred to as a federal identification number. It is a nine-digit number that the Internal Revenue Service (IRS) tracks your organization and then uses for tax purposes. It’s like a Social Security number but for a business. The application process for an EIN number is free.
You can apply online or send Form SS-4, Application for Employer Identification Number (EIN) directly to the IRS. Once approved, it becomes your business’s unique number and cannot be canceled. It will continue to be associated with your company for as long as you stay in business.
In some situations, state or local governments might also require an additional separate tax identification number.
Documents needed for payroll
Prior to ever trying to process payroll for your business, you’ll need to gather the following documents which are all required by the various government agencies listed above.
Form W-4 Employee's Withholding Certificate
When you hire a new employee, they must complete a Form W-4, Employee’s Withholding Certificate. You’ll use the form to deduct the correct amount of federal income tax every pay period from their taxes depending on their answers on the form.
Ideally, you should have your employees fill out a new form every year or any time there is a personal or financial situation that justifies a new form. Circumstances such as the employee having a new baby, getting married, or divorced are all reasons to fill out a new W-4 because the employee’s withholdings will change due to the life changes.
Form W-9, Request for Taxpayer Identification Number and Certification
If you use freelancers or independent contractors then you’ll need to collect their name, address, tax identification (ID) number, or Social Security number. You’ll find these located on a Form W-9, Request for Taxpayer Identification Number and Certification.
The document is kept solely for your records and is not sent to the IRS. When the year ends, you’ll gather the information on the W-9 to file a Form 1099-NEC, Nonemployee Compensation. The form shows how much you paid to the independent contractor for the work they performed during the year.
Form I-9 Employment Eligibility Verification
Form I-9, Employment Eligibility Verification is used to verify the entity and authorization for employment of any employees that you hire. You’ll need to have the employee fill out the form on their first day of work. Once they have filled it out, you have three days to complete and sign Section 2 of the form.
Employees must also provide identification documents such as a driver’s license or passport to attest to their employment authorization. You will not send the Forms I-9 to a government agency unless they request that you do. Instead, you’ll need to keep them for your own records, and in the event that you do have to provide the completed forms to an authorized representative.
Job application
Many candidates will supply a resume, but a job application can help you obtain vital information about any new hires.
The application requires a signature that verifies the accuracy of all of the information provided. You can then use the application to prepare your payroll record or to present it to the payroll processing company that you plan to use.
Bank information
Nowadays, most employers offer direct payroll deposits for employees.
If this is the situation, then you’ll need your new employees to provide you with all of the information about their bank such as their account number and routing number. Typically, it is easiest if you ask for a voided check and then you can accurately gather the information.
Medical insurance paperwork/forms
Will you be offering medical insurance to your employees? If so, then you’ll need them to fill out medical insurance forms giving you permission to deduct insurance premiums directly from their pay using the written authorization.
Retirement plan documents
Retirement plans are not mandatory. Similar to health benefits, if an employee wants to contribute to a retirement plan, then you’ll need the employee’s signature stating that they grant permission for the payroll deduction. Once you have their signature, you can then deduct their contributions to a 401(k) or other determined retirement plan.
Classifying employees
You’ll need to classify your employees to comply with federal payroll tax laws. They must be classified as either employees or independent contractors.
Here are a few ways to make the determination:
- Consider the nature of the work.
With an independent contractor you will control and direct the work’s direction and not necessarily the work that is done or how it is done. If you control both how the work is done and what work is done, then the worker is usually considered an employee.- Think about the payroll deductions.
Are you withholding income tax, Medicare, or Social Security then they are a paid employee? You do not withhold anything with independent contractors. Instead, independent contractors pay self-employment tax on their one income.- File a W-2, Wage and Tax statement to the IRS for employees.
You’ll include all forms of compensation that you paid to your employees such as wages and tips as well as the tax withheld.- File Form 1099-NEC, Nonemployee Compensation, for independent contractors
You usually have to report $600 or more paid to nonemployees. The completed form is sent to the worker and the IRS.- It’s important that you pay close attention to the details of a worker’s status.
Any misclassification can lead to costly penalties, and you could even be responsible for unpaid wages such as overtime. If you need to determine the status of a worker then submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to the IRS.
The payroll cycle
In the United States, the most common payroll cycle or pay period is to pay employees biweekly which will result in 26 paychecks per year. However, some companies opt to pay weekly which provides 52 paychecks to employees per year.
If you opt to pay semimonthly, then you will issue 24 paychecks in twelve months. Of course, on rare occasions, some businesses pay monthly which means you will issue 12 paychecks for the year — one for each month.
Considerations for the payroll schedule
Usually, payroll schedules are simply a matter of preference. However, some states do require at least semi-monthly payments for all employees and others have extremely strict frequencies depending on the type of worker. If your state does not have payday requirements, then you can pick what pay period works best for your company’s particular needs.
Often employees in low-wage jobs prefer to be paid often, but if you pay more frequently, your payroll processing costs can also increase.
As an employer, you’ll need to factor in the expectations of your workforce and examine your budget to determine your payroll schedule while complying with state laws.
Creating a payroll policy
If you decide to try to carry out payroll yourself then you’ll need to create a payroll policy to ensure that paychecks are processed in a timely fashion and in accordance with all regulations.
The first step is to create guidelines for both your employees and whoever is conducting your payroll in your business.
Most payroll policies cover the following:
Workweek definitions
Workweek definitions are needed to comply with FLSA overtime rules plus meet state wage payment requirements. Choose when your workweek starts and ends — they must just be seven consecutive days in 24-hour periods.
Time and attendance
You must maintain precise timekeeping. Ensure that each one of your employees knows how to log in their hours using paper timesheets, time clocks, phone apps, etc. Also, go over any approval process or possible disciplinary action if the employee should submit a false time log record.
Break periods
The federal government does not mandate meal or lunch breaks, but most states do require them. Remember, when offering rest periods, clearly define their length and then let your employees know if the break is paid or unpaid. Also, advise them on how they need to clock in their time.
Overtime
Determine who is eligible for overtime pay and how to apply the rate. Non-exempt employees who are covered by FLSA have to be paid minimum wage for all of the hours they worked and overtime if they exceed an hour work week at a rate of one and a half times their regular pay.
However, remember that different states have different laws which trump the federal laws on overtime. California, for example, requires that an employee be paid one and a half times their pay if they exceed eight hours in a day. The state also requires double-time pay which is not required federally. You’ll need to examine your state’s requirements.
Pay periods
Always document how often and when you pay your employees: weekly, biweekly, semimonthly, or monthly. Make note of which day of the week is payday.
Mandatory payroll deductions
Always ensure that all federal and state taxes are deducted from your employees’ paychecks. Include the information on the forms about how much you are withholding to ensure you are doing it correctly. Also, determine how wage garnishments in your state work.
Voluntary payroll deductions
Health insurance is often a voluntary deduction if you offer it to your employees. You’ll need to keep records showing you are paying for the benefits both pre- and post-tax. This includes any retirement funds that the employee has also opted to have deducted from their paychecks.
Wage structure
You should always maintain a state of transparency about how employees are compensated at your business whether it is via hourly, salary, commission, stock options, or bonuses. You’ll want to pay careful attention to any state laws that cover the payment of final wages to employees who are no longer with your business.
Recordkeeping
Companies with employees are required by the FLSA and state authorities to keep payroll records and maintain them in a confidential manner.
Designating a payroll manager
You’ll need to designate a payroll manager in your company to administer the payroll. You can hire an employee specifically for the position or you can delegate it to an office manager or human resource directly.
However, sometimes it's in your best interest to simply employ a payroll company to approach all of your business’s payroll needs:
A payroll company stays up to date on all regulatory laws, changes, and issues. They will analyze your payroll system and make sure you are not facing any penalties or problems. In addition, they will collaborate with auditors if necessary. A payroll managing service employs experts who are meticulous, analytical, and organized. They will effectively manage all of your company’s payroll needs so you don’t have to worry about it.
Direct deposits, paychecks, or pay cards
For years, paychecks were the standard way that employers paid employees, but times have changed. Nowadays, the most popular payment method consists of direct deposit. Pay cards, which are like debit cards, are also gaining in popularity.
Here are a few widely used payment methods:
- Checks — A common payment method, but no longer the most desirable.
- Direct deposit — The electronic transfer of money from the employer to the employee’s checking account. At this time, it is the preferred method of payment.
- Prepaid cards — A common payment method that is often used by employees who do not have a bank account.
When deciding on a payment method, you’ll want to review your state laws. Usually, you are required to offer two options to your employees to pick between.
Payroll processing FAQs
Why not let your human resource department handle payroll?
Many companies think that payroll should fall under the realm of human resources, but the reality is that most HR departments encounter monthly bottlenecks so adding payroll processing to their list of functions only complicates things further. Operations slow down and repeated payroll errors frequently occur.
Isn’t manual payroll processing the best?
Absolutely not.
Manual reporting and time tracking are tedious and fraught with errors. Not to mention the time it takes to regularly check and double-check spreadsheets to plan out check deductions.
A payroll company brings innovation to the table along with a skilled team to seamlessly oversee all of your payroll issues with ease, so you don’t have to worry about conducting the process or learning how to handle new software.
How long does payroll take to process?
The payroll process method you choose will dictate how long it takes. Clearly, manual calculations are the slowest and can take hours or days if you have a large number of employees. If you are a large business or you operate across state lines, then manual calculations are not a feasible option. You can opt to use payroll software, but the programs are not foolproof and often involve hours or days of learning.
Ideally, a payment processing company is your best choice for speedy processing because they employ professionals who can quickly manage even the largest and most complex payrolls.
What is full-cycle payroll processing?
The term full-cycle payroll processing refers to the time between each payday which is known as a payroll cycle. The time is often as short as a seven-day period or as long as a month.
During this period, numerous repeatable steps are required to conduct the payroll process:
- Employees are required to work and keep track of their hours.
- Gross pay must be calculated based upon the hours worked.
- Deductions such as taxes are then withheld from the paycheck
- Net pay is given to the employee by either direct deposit, a paycheck, or a pay card.
What is end-to-end payroll processing?
End-to-end payroll process refers to the integration of payroll with other workforce management such as training, benefits, scheduling, performance measurements, and compensation. You can often improve communication if you focus on all analytics, recordkeeping, and efficiency within an employee cycle.
What is needed to process payroll?
Payroll processing is needed by all businesses that employ employees. It is imperative that your workforce is paid on time and correctly or you’ll face stiff penalties, tax issues, and disgruntled employees. Undoubtedly, payroll is so important that you’ll want to dedicate resources to ensure that it is carried out correctly.
From the minute that you hire your first employee, you’ll need to start a payroll process that works for your company and meets all of the legal requirements in your state and federally.
Here's how you can get started:
- Apply for a federal employer identification number (EIN)
- Obtain any applicable state or local tax identification numbers
- Obtain employee tax documents such as a Form W-4, Form I-9, and Form W-9.
- Create a bank account specifically for payroll to pay your employees and for taxes
- Hire a designated payroll management, allot the job to human resources, tackle it yourself, or work with a qualified professional payroll processing company.
- Develop your company’s payroll schedule which falls within the parameters of the law.
- Create your company’s payroll policy and share it with all employees.
What are the types of payroll processing?
Payroll processing is complicated so you’ll want to make the correct decision about what type will work best for your particular business.
Your payroll process options include:
- DIY (do it yourself)
- Purchase payroll software
- Hire an employee dedicated to payroll processing
- Delegate the task to human resources
- Work with a qualified payroll processing company
This article is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice.
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