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Paying employees is a fast and fairly simple process with electronic payment systems. However, the prep work done prior to payday, which often determines if employees are paid the right amount, is more time-consuming.
Whether you have a small business with a few employees or a larger company with many workers, you want to ensure your employees are paid correctly, that you meet your obligations related to payroll taxes and that you maintain legally required paperwork.
There are several key decisions you need to make before the first payroll run can be set into motion. To start, you'll need to decide on:
Once these decisions are made, you'll also have to set up:
Some payroll software products help you set up withholding by allowing employees to fill out W-4 forms and make benefits elections through self-service portals. Most also handle tax filings and payments on your behalf.
In some cases, you might also have to handle wage garnishment orders for employees. With some payroll products, garnishment management services come included in the basic plans; in other cases, you need to purchase a higher-tier plan for those services.
Whether done manually, with payroll software or by a payroll service, the following steps are used to determine the amount employees are paid.
Gross pay is the total amount an employee earns before taxes and deductions are taken out of their paycheck. It's used to determine the amounts of taxes that are withheld from an employee's pay and is calculated based on an employee's classification:
Overtime pay and commissions could also be included in the gross pay for hourly and salaried employees. It depends on the pay structure of the business and state labor laws.
Many small businesses hire to do work for them. But contractors aren't employees. While they may be paid at the same time as employees, the gross pay a contractor receives is a business expense and tax payments are their responsibility.
Based on pre- or post-tax guidelines, the following taxes and deductions will typically be calculated for each employee:
After the above amounts have been determined, they will be deducted from the employee's gross pay to arrive at their net pay amount.
The net pay of each employee will be delivered to them each payday. How that is accomplished will depend on available company options and employee preference. Here are three typical options:
In a 2020 survey from the American Payroll Association, about 94% of respondents said they receive their paychecks through direct deposit. In some states, employers can make direct deposit mandatory; in other states, businesses need to offer alternatives.
The employer is responsible for forwarding the taxes withheld from their employees to the appropriate taxing agency. They are also required to pay for Social Security and Medicare that match the amount paid by the employee. The payment schedule for payroll taxes is typically set by the individual taxing agency.
If deductions were made for employee health, insurance and retirement plans, the premiums, along with any employer contributions, should be sent to the appropriate carrier. These payments can be made directly by the employer or automatically through payroll software or a payroll service.
Payroll records is a broad term that refers to documents associated with the payroll process. The employer needs to keep any documents used to determine an employee’s pay. For example, W-4 and W-2 forms, direct deposit authorizations, timecards, salary sheets, commission plans, employee benefits forms and pay stubs would all be considered payroll documents.
Generally, employers are required to keep most payroll records for per the Fair Labor Standards Act. However, the Internal Revenue Service advises small businesses to keep . As a best practice, employers may want to maintain payroll and tax records for a longer period of time or consult a professional before destroying documents.
At some point, an error might be made when paying employees. Minor errors can be fixed with the next payroll run, but large mistakes can often take a significant amount of time and effort to correct and can result in an unexpected expense for the employer. Here's what to avoid.
The IRS has These rules relate to how much control the worker has over their work, their pay and their relationship with the business. Because employees and independent contractors are paid differently, incorrectly classifying them can have tax consequences and result in fines and penalties assessed against the employer.
Employers must make payroll tax payments to the IRS on a monthly or semiweekly schedule. The frequency of payments is determined by the total tax liability of the business. If the employer doesn’t make the deposits on time, it could face penalties up to 15% of the amount due. The employer will also face similar penalties if required state payroll taxes are not paid on the scheduled date.
Employers are responsible for staying current on federal and state payroll laws, and they can face fines and penalties for not paying their employees correctly. Subscribing to newsletters, joining related business associations and attending seminars are a few ways employers can stay informed. They may also take it a step further and contract with a payroll service, professional employer organization, accountant or attorney who can advise them on changes related to payroll laws.