Payroll processing involves a lot more than simply issuing a check to your employees for hours worked.
While pay and tax calculations are a significant part of payroll, there’s a lot more to it. This includes setting up your business as an employer and making sure tax withholdings and reports are submitted on time and to the proper tax authority.
For HR managers, ensuring everyone is paid correctly and on time is a critical responsibility. Even a small mistake puts employee trust and the company’s reputation at risk. There’s simply no room for error.
In this guide, I’ll discuss payroll processing in detail, and share some best practices and useful tools to help you effectively and efficiently navigate your payroll obligations every time.
What Is Payroll Processing?
Payroll processing refers to the process of managing employee payments, starting from adding an employee to your payroll to giving them their paychecks.
It involves several steps to ensure the payment is calculated properly, tracked, and doled out and that the correct amounts for tax, company benefits, and other deductions are withheld. Typically, payroll is managed and administered by a dedicated payroll professional in your company’s accounting department, but it can also fall under the purview of an HR manager.
My recommendation? Buy a reliable and efficient payroll solution that can help your organization ensure payroll compliance and keep you at the top of the whole shebang.
The Basics of Payroll Processing
Managing payroll isn’t just about writing a check to employees for their work. There’s so much more that goes to it.
All employers have to ensure they follow through on reporting payroll practices before submitting payroll tax payments to the relevant tax agencies. Below are the basics of payroll processes to help you get started on the right track.
Obtaining an Employer Identification Number (EIN)
An EIN, also known as a federal tax ID number, is a nine-digit number that identifies a business. Every business needs one to set up various tax accounts. Plus, banks require an EIN for opening business banking accounts.
The good news is the IRS issues EINs free of cost. You can apply for them directly via the IRS.
Gathering Employee Information
Business owners need certain forms to establish payroll for an employee. Some of these include:
- IRS Form W-4 (Employee’s Withholding Allowance Certificate): This tells you how much federal income tax to withhold from an employee’s pay.
- State W-4: While many states use the IRS W-4 form, others have their own version of the W-4. Before starting any job, your employees must complete a state W-4, unless the state doesn’t collect state income tax.
- W-9 (Request for Taxpayer Identification Number and Certification): You don’t have to withhold taxes from an independent contractor’s compensation, but must track what you pay them and issue a 1099 Form at every year-end.
- USCIS Form I-9 (Employment Eligibility Verification): All your new hires must complete this form to verify their identity and whether they have the legal authorization to work in the United States.
- Health Insurance Forms: If you provide medical, dental, and vision insurance to your employees, all participating employees will have to complete these forms to determine any applicable payroll deductions.
- 401(k) Plan Paperwork: If you provide a 401(k) option to employees, you should know the funds to withhold from your employee’s pay before depositing it into their 401(k) account.
Determining Taxes and Withholding
Your employee’s net pay is their gross wages or salary minus the various withholding (taxes, medical insurance premium, retirement contribution, etc.). Some deductions are made before taxes have been assessed, while some are after-tax deductions, which is where the complications arise.
Moreover, a few states have rules that are different from that of the federal government. As such, you have to find out your state’s standing before making any deductions.
Below are a few taxes that employers generally withhold from an employee’s wages and salary:
- Federal income tax
- State and local income taxes
- Social Security and Medicare taxes
- Other payroll deductions, court-ordered wage garnishments, union dues, 401(k) and other retirement fund contributions, child support payments, unpaid vacation time, health and life insurance premiums, and so on
If you’re also withholding funds, make sure you transfer them into a separate account until submitting them to the IRS, Social Security Administration (SSA), or other agencies.
Noting Payroll-Related Fees Not Paid by Employees
Payroll processing includes the specific taxes and fees payable by the employer. But these aren’t deducted from the employees’ wages and salaries.
Federal Unemployment Taxes
As per the Federal Unemployment Tax Act (FUTA), employers have to pay federal unemployment taxes if they pay at least $1,500 in wages during any calendar quarter in the current year or the one before. Once the employee’s year-to-date wages exceed $7,000, the employer no longer has to pay FUTA for that employee in that tax year.
The current FUTA rate is 6%. Also, the IRS allows employers to take credit as much as 5.4% of FUTA taxable wages for amounts paid into state unemployment funds.
State Unemployment Taxes
Some states have their own unemployment insurance program. As an employer, you must register to file a wage report and submit tax payments. The State Unemployment Tax Act (SUTA) in these states sets the limit to how much of employees’ wages will be taxed.
Remember, this “taxable wage“ and the unemployment tax rate varies from one state to another.
Workers’ Compensation Insurance
Workers’ compensation is a type of insurance that employers purchase to cover costs associated with an employee’s work-related injuries and illnesses. Employees that collect workers’ compensation benefits are unlikely to sue their employers.
In most cases, workers’ compensation insurance is administered through a state-mandated program. However, federal employees’ workers’ compensation insurance and claims are handled through the federal government directly.
Setting Up End of Year Payroll Activities
You must keep records of withholding funds from employees’ pay throughout the year. This way, you’ll have all the data to report and summarize it on W-2 Forms (for payroll employees) or 1099 Forms (for independent contractors).
Every employer must send copies of each employee’s form to the IRS, the employee, and the Social Security Administration. Additionally, at the end of the tax year, employers must submit IRS Form 940 to report their FUTA tax, along with any payroll and tax reporting forms needed by the state.
5 Tools to Improve Payroll Processing
Payroll processing can be a strenuous job when done manually. Luckily, you can use several excellent payroll processing tools to process your payroll faster and more efficiently.
Gusto helps businesses with onboarding, pay, and benefits. It lets you easily calculate and file taxes and helps with compliance, time tracking, PTO, employee benefits, and more. Plus, it gives the staff easy access to pay stubs, W-2s, and everything else your employee would need online.
You get a beautifully designed interface, along with plenty of features to make payroll as simple and straightforward as it can be. Thanks to its easy software setup, you can be ready to run payroll in a few minutes flat.
When you have tipped employees, you’re responsible for withdrawing and paying income, Social Security, and Medicare taxes on all of your employees’ tips. While this would’ve made tax compliance harder, you won’t feel much of a difference if you use OnPay.
Because of its automatic tax calculation functionality, the software can automatically deduct taxes from every paycheck after your employee enters their tips. It can also pay and file your taxes quarterly with the right government agencies to further reduce any burden.
Other features include in-app messaging, electronic signatures, PTO management, and generating and distributing W-2s or 1099s.
Paychex is an incredibly popular payroll software solution.
It has a modular format that makes it easy to scale between small and larger-sized businesses. You can process complex payroll on different schedules in just a few clicks. Depending on the plan you choose, employees can receive payment via direct deposit, paper checks, or prepaid debit cards.
You also get access to a variety of HR services, along with 24/7 support, background checks, and effective training. Detailed analysis and reporting are also possible with Paychex.
Zenefits is another great payroll software for small and medium-sized businesses that provides a wide range of HR solutions—all placed in an easily manageable platform.
This payroll software can simplify administration features with its self-service benefits portal. Here, employees can update their benefits coverage and personal information by themselves, making the lives of the employer and the employee easier.
It offers several seamless integration facilities as well. In addition to human resources, you can take advantage of integrations concerning benefits, time, and scheduling plans as well.
SurePayroll is a comprehensive solution that is user-friendly and fast processing when it comes to handling payroll functions. It is an online payroll system that comes equipped with all the necessary features for efficient payroll processing.
Although designed for small business organizations, even medium business owners can take advantage of the software. It offers several functions, such as wage calculation, record keeping, regulation compliance, tax calculation, and so on. What’s more, SurePayroll has a mobile app that can be downloaded on iOS and Android devices for payroll processing on the go.
5 Tricks for Payroll Processing
Here are a few payroll processing best practices to set yourself up for success:
Paperless payroll expedites your payroll operations. It cuts costs by ensuring top-notch data security and minimizing mistakes. Eliminate the need for cumbersome time-tracking methods like cards and sheets, physical paychecks, and paper pay stubs.
Going digital will make everything much more convenient too. Plus, a majority of employees prefer receiving their check stubs and pay information electronically. It’s a win-win for everyone involved.
Use Clean Data
Employment misclassifications are common during onboarding. Not only do mistakes impact your employee’s health insurance and retirement benefits, but also affects the total funds withhold from their paychecks.
You can add a checkpoint to confirm whether the employee classification is correct. The employee can verify their personal information and tax code before they’re added to your payroll system.
Know Your Tax Filing Dates
Federal payroll taxes have to be filed quarterly. But other tax deadlines depend on state and local laws.
You should create reminders for yourself to file taxes throughout the year. The IRS already has a list of important small business and self-employed tax deadlines and forms, which can make things very convenient.
This is crucial because missing a tight deadline could result in expensive fines and penalties. So if you want to avoid them, make sure you file taxes as early as possible.
Maintain Accurate Records for Payroll
Accurate recordkeeping will protect your business in the event of a tax audit, FLSA, or other labor lawsuits. This is why keeping detailed records of all your payroll processes and employee paychecks is crucial.
As per the IRS, businesses have to maintain employee tax records for at least four years. The FLSA recommends 14 basic records employers must keep on every non-exempt employee for three years. This include:
- Employee’s legal name and Social Security number
- Employee’s address and ZIP code
- Employee’s date of birth and legal gender
- Employee’s occupation
- Time and day of the week when the employee’s workweek begins
- Hours worked each day
- Total hours worked each workweek
- Basis of pay (hourly or weekly rate, commission, service-based, or salary)
- Regular hourly pay rate
- Total daily or weekly straight-time earnings
- Total overtime earnings per workweek
- All deductions made from the employee’s wages
- Total wages (gross and net pay) paid every pay period
- Pay dates and pay period dates
Use Technology Whenever Possible
Payroll has several dynamic parts, which makes it hard to juggle.
Luckily, there are several software solutions—some we’ve already mentioned above—that use automation, smart data, and connectivity to make the whole process time-saving and effective. You’ll get reports with minimal errors faster and be able to ensure compliance easily.
What to Do Next
You can pay your employees after processing payroll. But the job isn’t done yet.
You’ll have to keep all payroll records and make any corrections to avoid disputes down the line. Being mindful of ongoing considerations, such as reporting new hires to the IRS, while doing business is also important.
To help you understand payroll better, here are a few other Quick Sprout guides: