Employers use payroll systems to manage everything that has to do with paying employees and filling employment taxes.
Payroll systems are usually put in place to keep track of worked hours, calculate wages, withholding taxes and other deductions, print and deliver the necessary checks, and pay federal employment taxes.
While most people may assume that payroll management is all about paying workers, it isn’t nearly as simple as that.
The payroll management process encompasses various steps and responsibilities that require an employer to take specific actions or make decisions that impact how the company’s human resources are paid while ensuring that the company is compliant with any government regulations that apply within the business’ host country.
Startup company owners or small business owners need to figure out how to take care of each of the critical steps of the payroll management process or outsource a trusted company that provides payroll services for small business owners. It is worth noting that if payroll processes are disorganized, errors may be made. And payroll errors can be very damaging to a company either by upsetting workers or causing unending legal issues.
Managing Payrolls: Different Approaches
Paychecks are usually calculated depending on the structure of a specific company. Employees may receive hourly rate wages, salaries, commissions, get paid by the job or the piece of work or have tips to figure in. However, an employer chooses to calculate his/her payroll, having a system in place that automatically tracks money owed to employees will be beneficial when processing payroll.
When managing payroll, an employer can choose from any of these three options:
Although being the least expensive option, calculating payroll manually can be confusing and tiresome. However, if one is an expert, this is a non-issue. Suppose an employer falls in the category of people with no extensive training in payroll. In that case, they may be forced to learn the complex essential payroll procedures, including how to submit taxes accordingly and how to calculate the amount of payroll taxes that should be withheld from each paycheck. Without extra care and alertness to proper payroll best practices, an employer may be vulnerable to costly mistakes and penalties from the IRS.
Managing payroll using a payroll software
Managing payroll using payroll software is beneficial as it allows an employer to handle several payroll managements online instead of on paper. Investing in payroll software may be costly, but it helps limit the amount of time spent on payroll management. Moreover, it makes it easier for an employer to handle complicated aspects of the payroll process, such as keeping track of critical payroll deductions. Essentially, this reduces the risk of payroll mistakes and errors that can be damaging to the company.
This method of payroll management can be more expensive compared to managing payroll by yourself. However, it can still be one of the most cost-effective solutions based on the amount of time an employer saves and the number of compliance issues and potential fines avoided. When a company outsources a payroll administration to an outside company, it implies that the employer has access to payroll and other human resource professionals who can take care of each payroll management function. While the outsourced payroll management company manages all these processes, the employer still holds complete control and direction over their employees.
A typical payroll management system setup is comprised of two major components. These components comprise multiple aspects that an employer of a small business must address.
- Account registration and critical payroll decisions
- Collection of employees’ information
Account registration and payroll decisions
Under account registration and critical payroll decisions, an employer must address the following essential aspects:
Employer’s identification number
Before developing a payroll management system, an employer will first need to apply for an EIN (Employer Identification Number). An EIN is a distinguishable nine-digit number assigned by the IRS to identify each business. As such, an employer must include their EIN when submitting certain payroll documents to the IRS and federal government agencies. While an EIN is not essential for all businesses, it is required by law if an employer:
- Has employees
- Operates their business as a corporation or a partnership
- File employment tax returns, excise duty, or alcohol, tobacco, and firearms
- Withholds taxes on income, other than wages paid to a non-resident alien
- Has a retirement plan set aside for self-employed people
- Is involved in any of the listed types of organizations:
- Non-profit organizations
- Farmers’ cooperatives
- Plan administrators
- Trusts, except certain grantor-owned revocable trusts, IRAS, and exempt organization business income tax returns. After obtaining an EIN, a small business owner must also register their business for an Electronic Federal Tax Payment System (commonly abbreviated as EFTPS) account for purposes of paying federal taxes. Registering for EFTPS is usually free, and it allows business owners a convenient way to pay taxes online or via phone. For registration, one must provide the following information:
- A Tax Payer Identification Number or an EIN
- A valid bank account number and routing number
- The names and addresses of the business owner
Based on the company’s location, an employer may be required to do some business setup work, including some employer ID numbers for state and local governments. However, this may diverge from state to state as each state has its new hire reporting process. Most state’s new hire reporting process information is readily available online. Therefore, a business owner can register their business online. Moreover, one will be able to collect the following state-specific information:
- Data elements, both mandatory and optional, including employee name, address
- The reporting time frames
- Contact information
- Transmission method
- Whether or not the given state requires the reporting of independent contractors
Pay frequency and salary status
A small business owner will also need to decide how often his/her employees will be paid and precisely how they will be paid. For most companies, pay frequencies tend to be weekly or monthly. The most common payment methods include paychecks, payroll cards, direct account deposits, and cash payments. The other aspect that the employer must address revolves around which of their employees will have hourly or salary wages and exemption status. While making this decision, it is essential to note that according to employment laws, non-exempt employees must be paid at least the set minimum wage and receive overtime pay. in comparison, exempt employees are not eligible for overtime pay and must meet specific requirements.
- Be paid on a salary basis
- Accumulate at least $23,600 per year or $455 per week
- Be in positions that are considered exempt, for example, an Executive, Administrator, or hold any professional role.
Collection of employee information
Under this component, business owners will be required to collect employee information. Existing employees will need to fill out form W-4 to establish how much they will have withheld payroll taxes individually. Form W-4 details the number of dependents and allowances that each employee will be claiming. This reduces the amount of tax that the employee must pay; therefore, the amount of tax that should be withheld from each paycheck varies. For each new hire, employers are advised to have the employee fill out a Form W-4. Besides the W-4 form, new employees must fill out the form 1-9 to verify their employment eligibility before starting work.
Form W-2s must also be submitted to every employee within the organization at the end of the year. Employees should also provide their benefits information as this plays a significant role in payroll management. If an employee pays into benefits like health insurance, retirement plans, etc., an employer will need to know how much to deduct from their paycheck into those benefits.
An employer can use payroll software which is usually configured with certain settings that generate the required reports. Moreover, the software allows the employer to automatically send these reports to the respective parties, thus saving time and managing payroll more efficiently and accurately than using manual payroll systems.
Free Payroll Templates
Here are a few customizable free payroll templates that you can download as per your company’s need.
The various steps that an employer must take to run payroll for their business and how much time they’ll spend on payroll management rely on the type of payroll management they decide to use. If outsourced, their payroll partner will manage some of the company’s payroll responsibilities, including calculating taxes based on the data. However, the business owner must maintain responsibility for other aspects of running payroll since they know their employees better than the outside partner. This involves handling processes such as:
- Entering the hours worked for each employee for the duration of the current pay period.
- Accounting for overtime worked during the pay period for non-exempt workers.
- Reviewing payroll for accuracy and paying employees according to how they have chosen to be paid.
Suppose an employer decides to handle payroll on their own. In that case, it means that they will handle all the above processes and handle tax calculations, creating a system to help organize and report data and other essential compliance functions for each payroll period.
There are several types of taxes that employers of small businesses need to manage. All these taxes need to be withheld, deposited, and reported from each employee’s paycheck. In addition to these taxes, there are some other employer taxes such as SUTA and FUTA that an employer needs to pay based on employee wages, which are not withheld from their employee’s paychecks. These taxes include:
Federal income taxes
Any form of payment made to an employee is subject to federal income taxes. The taxes withheld from each employee’s paycheck is determined by factors such as how much the employee is paid, the number of personal allowances an employee claims as outlined on Form W-4, among others. Although rare, there are instances where an employee claim to be tax-exempt. In this case, the employer doesn’t need to withhold any federal income tax from the employee’s wages.
Calculating income tax withholding
There are two main methods for calculating income tax withholding, namely;
- The percentage method: This method requires the employer to identify the amount for one withholding allowance depending on an employee’s payroll period and then multiply it by the employee’s total number of allowances. Once that has been established, the employer must subtract the total from the employee’s wages and find the withholding total from a range of wages as provided in the IRS table.
- The wage bracket method: This method involves finding out which wage range an employee falls under and establishing how much to tax to withhold based on the specific employee’s total allowances.
Tip: The IRS provides tables to help determine the withholding amount for each of the above-discussed methods, plus details and examples of how they are applied, in Publication 15. The use of payroll software or outsourcing a payroll expert also saves employers from the hurdle and bustle of manually calculating federal income tax withholdings.
Tax depositing frequency
The number of times an employer is required to make federal payroll tax deposits depends on their previous tax liability. In essence, the IRS usually reviews what the employer reported on a four-quarter look-back period on Form 941 and determines the employer’s depositing schedule based on the amount of taxes reported. In most cases, these taxes need to be reported four times on April 30, July 31, October 31, and January 30 each year.
If an employer reported $50,000 or less in taxes or is a new business without four quarters of reported taxes, he/she will be required to make monthly deposits. These deposits are due by the first of the following month. However, if the employer reported more than $50,000 in taxes, the deposits are semiweekly, based on the dates that the company’s employees are paid. For example:
- If a company’s payday is Monday through Wednesday, taxes must be deposited by the following Monday.
- Suppose the employer’s payday is Saturday through Tuesday; the employer must deposit taxes by the following Friday.
FICA (Federal Insurance Contributions Act) tax covers two separate taxes: Medicare and Social Security. An employer needs to withhold a total of 7.65% from his/her employee’s wages per paycheck to account for this tax. FICA taxes follow similar depositing and reporting schedules as federal income taxes.
- Medicare taxes: Employers need to withhold 1.45% from each employee’s paycheck to cover this tax. Besides, the employer might need to match that percentage as a separate payment that is not withheld from the employee’s wages. Medicare taxes only apply to wages of up to $200,000 for single employees and $250,000 for married ones who file taxes jointly. For employees who are married but file taxes separately, Medicare tax applies to wages of up to $125,000. Any wage above these mentioned thresholds is subject to an additional 0.9% deduction from each paycheck that the employer has no match.
- Social security taxes: These taxes call for an employer to withhold 6.2% of every employee’s gross wages of up to $137,700. Like Medicare taxes, Social Security Taxes also calls for an employer to pay an additional matching portion of 6.2% in taxes.
State and local income taxes
State and local income taxes may differ depending on the location of the business. An employer may not have to withhold any state or local income taxes in some states. Currently, nine states do not have any income tax or have an income tax that does not apply to employment income. These states are listed below:
- Tennessee (dividend and interest income only)
- New Hampshire (dividend and interest income only)
- South Dakota
Of the remaining 41 states with income taxes, 16 require employers to withhold local taxes. These states include:
- New York
- New Jersey
- West Virginia
Each state with state and local income taxes has its state-specific rates. While some states may have a flat withholding rate, others will have multiple brackets that affect tax deductions.
Employer taxes, including FUTA and SUTA
Employers are required to pay two different taxes on employee’s wages. Federal Unemployment (FUTA) and State Unemployment Act (SUTA).
FUTA usually funds the federal government’s oversight of every state’s unemployment program, and it is often reported as part of form 940. FUTA should be filed quarterly by the exact dates as Form 941. Generally, this translates to 6% of the wages up to the first $7,000 paid to employees per head. However, the IRS usually allows up to 5.4% credit when one files their form 940.
SUTA is the state’s equivalent of FUTA. Typically, each state will require an employer to register for a SUTA account once they have hired their first employee. Signing up is online. Once an employer has signed up for the SUTA account, the state will provide them with an initial unemployment tax rate. These rates vary depending on how long the business has been operational and the industry type. As for filling and reporting SUTA Taxes, the business owner will be required to fill out a quarterly return for their specific state. While some states may accept online fund transfers, others may not. Thus, confirm your state’s available payment options.
Withhold and pay state taxes
During each pay period, employers are tasked with the responsibility of ensuring that they withhold the accurate amount of taxes from each employee’s paycheck. The tax withholdings are then paid to the appropriate parties and a portion from the employer for each employee at specific times of the year. Any delays can result in penalties or fines. To avoid such issues, employers are advised to set up a system that automatically calculates and makes these payments as required.
Keep payroll records
According to the Fair Labor Standards Act (FLSA), employers must keep detailed and accurate records for non-exempt employees. These records entail:
- Employee’s biodata and social security number
- Employee’s sex
- Employee’s addresses, including state and zip code
- The day of the week and time when the employee’s workweek begins
- The number of hours worked each day
- Total hours worked weekly
- The basis upon which employee’s wages are paid, for example, per hour, per week, per piece of work, etc.
- The regular hourly pay rate
- Accumulated daily or weekly straight-time earnings
- Total overtime pays for the workweek
- Additions to or deductions from each employee’s wages
- The total number of wages paid during each pay period.
- The date of payment and the pay period covered by the payment.
Employers need to keep these records for extended periods if the DOL needs to review anything in the future. In essence, payroll data and records should be kept for at least three years, whereas documents involving wage calculations should be stored for at least two years.
Frequently Asked Questions
Biweekly pay refers to what day of the week an employer runs payroll and which day employees receive their paychecks. Having a biweekly payroll plan in place means that employees receive their wages the same day for each pay period.
On the other hand, semi-monthly payroll implies that employees are paid on specific dates such as the 15th and last weekday of each month.
To get payroll initiated for your business, you will need to submit the following documents: Employer Identification Number, State/Local Tax ID number, your state’s Unemployment ID number, Your Employee’s addresses, and Social Security numbers, Form 1-9, Form W-4, State Withholding Allowance Certificate, as well as your Department of Labor Records.