Corporate Finance & Accounting

Payroll

What is a payroll?

Payroll is what a business has to pay its employees for a certain period or a given date. It is usually managed by the company’s accounting or human resources department. Payroll for a small business can be handled directly by the owner or partner.

Payroll is increasingly outsourced to specialized firms that handle payroll processing, employee benefits, insurance, and accounting tasks such as tax withholding. Many payroll fintech companies, such as Atomic, Bitwage, Finch, Pinwheel, and Wagestream, are leveraging technology to streamline the payroll process. These solutions pay employees with greater convenience and speed, and provide digital payroll-related documentation with innovative technology-enabled services needed in the gig and outsourcing economy.

Payroll can also refer to a list of the company’s employees and the amount of compensation for each. Wages are a major expense for most businesses and are almost always deductible, meaning the expense can be deducted from gross income, reducing the company’s taxable income. Payroll may vary for overtime pay, sick pay, and other variables due to overtime pay, sick pay, and other variables.

key takeaways

  • Payroll is what a business has to pay its employees for a certain period and on a given date.
  • The payroll process can include tracking employee hours, calculating wages, and distributing payments via direct deposit or check.
  • However, companies must also do accounting, record-keeping, and set aside money for Medicare, Social Security and unemployment taxes.
  • If companies don’t want to do it themselves, they can use professional services and outsource payroll or use cloud-based software.
  • Calculating payroll involves many components and can be complex.

Understanding Payroll

Payroll is the process of paying employees of a company, including tracking hours worked, calculating employee wages, and distributing payments by direct deposit to employee bank accounts or checks. However, companies must also perform accounting functions to record wages, withholding taxes, bonuses, overtime pay, sick leave and vacation pay. Companies must set aside and record the amounts to be paid to the government for Medicare, Social Security and unemployment taxes.

Many companies use software solutions to manage their payroll. Employees enter their hours through the API and their pay is processed and deposited into their bank accounts.

Many medium and large companies outsource payroll services to simplify the process. Employers track the hours worked by each employee and pass this information to the payroll service. On payday, the payroll service calculates the total amount owed to the employee based on the number of hours or weeks worked and the pay rate during the pay period. The service deducts taxes and other withholding taxes from income and then pays it to employees.

special attention items

Employers with gross annual sales of $500,000 or more are subject to the requirements of the Fair Labor Standards Act of 1938 (FLSA). This is a US law that protects workers from certain unfair pay practices. FLSA has established various labor regulations, including minimum wages, overtime pay requirements, and restrictions on child labor. For example, FLSA rules dictate when they are considered for work and when they should be paid overtime.

The law requires that overtime (working more than 40 hours per week) be paid at one and a half times the regular hourly rate. Some employees are exempt from the FLSA, which does not apply to independent contractors or volunteers because they are not considered employees.

Some hourly workers are not covered by the FLSA but are subject to other regulations. For example, railroad workers are governed by the Railroad Labor Act and truck drivers are governed by the Motor Transport Act.

The FLSA also regulates how jobs that are compensated primarily through tips are treated. For tipped service workers, employers must pay employees the minimum wage unless they regularly receive more than $30 per month in tips.

Pros and Cons of Using Professional Payroll Services

A major benefit of payroll services is their ability to generate a variety of reports that simplify accounting procedures and help companies ensure they comply with legal and tax filing requirements. The payroll service can also keep records of how much vacation or personal time employees have used.

On the downside, when companies outsource their payroll systems, they have to rely on individuals outside the business for accurate accounting. When something goes wrong, company field personnel have to deal with distraught employees. Companies can also face tax penalties for errors in payroll services.

Another downside is that payroll services are more expensive than running payroll in-house. These services may charge a fixed monthly fee or offer different payment structures for different service levels. Due to cost, payroll services may not be the best option for small companies with tight operating budgets.

As a business grows, its accounting needs become more complex. Larger companies may need to invest in a custom enterprise resource planning (ERP) system for their accounting and payroll functions.

Pros of Professional Payroll Services

  • Access various reports

    Simplify accounting and tax compliance

  • Employee vacation time and personal time records

Disadvantages of Professional Payroll Services

  • Financial and tax information is kept confidential from individuals outside the business.

    Internal staff must still help employees with payroll issues.

  • Companies can face tax penalties due to errors in payroll services.

  • Payroll services can be expensive, which is a concern for small businesses.

Payroll Software Program

Some companies do not use specialized payroll services, opting instead to rely on payroll software programs. After the company purchases the software, there is no additional monthly fee. Software programs often include printable tax forms and withholding tax forms.

In addition to saving money, an internal payroll system can help companies keep confidential financial information private. However, software programs can be time-consuming, which can cause problems for small companies with few employees.

Small business owners benefit from accounting software because it helps them track accounts receivable and payable, measure their profitability, and prepare for tax season. A small business is one that can use out-of-the-box software without extensive customization. As businesses grow, their accounting needs become more complex and often require customized enterprise resource planning (ERP) systems.

There are many different types of cloud-based accounting software available for small businesses. The type of industry and the number of employees are two factors that determine which accounting software is suitable. For example, freelancers don’t need the same accounting software features as restaurant owners.

lidero provides an overview of accounting software for small businesses and evaluates their cost, ease of use, functionality, integration and scalability. QuickBooks Online is considered the best overall software, while Xero is considered the best software for micro business owners. FreshBooks is best for service-based businesses, and QuickBooks Self-Employed is best for part-time freelancers, but Wave is the best free software.

What is the payroll tax deduction?

Payroll taxes include Social Security, which deducts 6.2% of your income, up to $132,900. Payroll taxes also pay for health insurance, which deducts 1.45% of your income. Employers also pay payroll taxes. They pay 6.2% of your income, so the government gets 12.4% of your total income and your employer pays 1.45% of your income to Medicare.

Payroll tax cuts will mean fewer Social Security and Medicare taxes are withheld and deducted from paychecks. The idea is that workers and businesses will take home a little more from each paycheck, which will encourage them to spend more and stimulate the economy.

What is a payroll tax holiday?

A payroll tax holiday is the deferral of payroll tax collection to a later date, when those taxes are due. The payroll tax deferral is designed to provide workers with some temporary financial relief by temporarily boosting their take-home pay.

How to calculate payroll tax?

How you calculate payroll taxes will depend on your business and local laws. However, here are some general guidelines provided by QuickBooks. The first step is to calculate the employee’s gross salary.

1. Calculate the employee’s gross salary

You can use the employee’s pay rate and your scheduled pay period to determine the employee’s total pay. Most businesses will pay their employees weekly, bi-weekly or monthly. To calculate an hourly employee’s gross pay, multiply their hours worked in a pay period by their hourly pay rate. The formula is as follows:

Hourly rate x total hours worked in pay period = gross pay

To calculate a salaried employee’s gross salary, divide their annual salary by the number of pay periods in a year. The formula is as follows:

Annual salary / annual payment period = total salary

E.g. An employee earns $50,000 a year. Their company pays employees bi-weekly for a total of 26 pay periods. Therefore, the employee’s total salary is $1,923.08.

2. Deduction of tax deductions

After you have determined your gross salary, you will need to take the deduction. These are tax deductions, but other pre-tax deductions may also apply. Tax deductions include:

  • 401(k) and some retirement plans
  • health insurance plan
  • Health Savings Account (HSA) or Flexible Spending Account (FSA) Contributions
  • some life insurance plans

3. Tax deductions (FICA, unemployment and income tax)

After the pre-tax deductions are deducted, the remainder of the salary will be taxed. The FICA rate is 7.65% – Medicare 1.45% and Social Security 6.2%. Other rates will be determined by federal, state or local law and your employee’s W-4.

Use the IRS tax form to calculate federal income tax. In most cases, you will pay federal taxes when you pay Social Security and Medicare taxes. Report all payments on IRS Form 941.

7.65% FICA tax is deducted from the employee’s gross salary. As an employer, you must match each employee’s contributions. Businesses submit employee and company contributions to Social Security and Medicare.

For example, an employee’s total salary for the most recent pay period was $1,923. To calculate an employee’s Social Security tax contribution, multiply $1,923 by 0.062 to get $119.26. To calculate an employee’s Medicare tax contribution, multiply $1,923 by 0.0145 to get $27.88. The employee’s total FICA tax contribution during the pay period is $147.14, which the employer must match. In this case, the employer must pay the IRS $294.28. Half is a direct cost to the company, and the other half is deducted from the employee’s salary.

Employers don’t match the income tax deduction, but they pay federal unemployment tax. The IRS’s Income Withholding Assistant will help you determine how much federal income tax your employees should pay.

4. Any voluntary deductions must be deducted from remaining wages.

These may include:

After all taxes and deductions are deducted, the remaining amount is what the employee takes home on payday.

bottom line

Processing payroll is a complex and time-consuming job that requires compliance with strict federal and state regulations. It requires a lot of record keeping and attention to detail. Small businesses often use cloud-based software to process their own payroll. Other companies choose to outsource their payroll functions or invest in integrated ERP systems that manage overall accounting and payroll.

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