Payroll processing is a sensitive and critical business task requiring high accuracy. Unfortunately, approximately 40% of small businesses in the US experience yearly penalties due to payroll irregularities. This highlights the importance of implementing precise payroll processes to avoid financial setbacks and ensure compliance with IRS regulations.
This article explains what payroll processing is and how to do it properly.
Table of Contents
What is Payroll Processing?
Payroll processing is the management of all the steps of paying a company’s workforce. It is usually managed by a dedicated payroll specialist or the company’s human resources department.
The process ensures the pay for each employee is properly calculated, tracked and doled out. It also involves withholding the right amount of tax and other deductions.
Payroll processing consists of multiple steps including gathering employee information to sending paychecks. The process can be automated with a payroll system or can be handled manually.
How Does Payroll Work?
If you’re a new business that is about to issue its first payments to employees (on outsourcing these and other business services, find out what is BPO), before you begin asking yourself how to do payroll, you first need to:
- Apply for Employer Identification Number
- Get a local tax ID
- Gather employees’ Form W-4
- Pick a pay frequency such as weekly, biweekly, monthly, etc.
- Establish how you will perform payroll (with the help of professionals, payroll software or manually)
- Get employee banking info
How to Process Payroll in 7 Steps
- Step #1: Determine Your Employer Identification Number
- Step #2: Gather Employee Tax and Other Information
- Step #3: Decide on a Payroll Schedule
- Step #4: Estimate Total Gross Pay
- Step #5: Determine Each Employee’s Tax Deduction
- Step #6: Calculate Net Pay and Provide Payment
- Step #7: Keep Your Payroll Records
The following 7-step process is an outline of a typical, functioning payroll system that works for a company of any size and profile.
Step #1: Determine Your Employer Identification Number
Establishing your company’s Employer Identification Number (EIN) and your local tax ID should always be the first step in rolling out a sturdy payroll process.
These numbers are used by the government to keep track of your company’s payroll taxes and make sure you are meeting the requirements.
You can set up your EIN on the IRS website. As for the local tax ID, refer to your state and municipality authorities.
Step #2: Gather Employee Tax and Other Information
Have your employees fill out tax forms that will allow you to account for allowances and other tax details. The most common forms of this type are I-9 and W-4, but there are various others that you will need to provide, depending on your location.
In order to start processing your employees’ payrolls, have these documents on hand as well:
- Job application: This document can ensure all important payroll info is in one place.
- Deductions: Payroll processing ensures that you withhold the right amount of benefits that an employee can partake in, such as health insurance, health savings or retirement savings.
- Wage adjustments: If your employees owe money such as child support or IRS payments, your company may be required to adjust and garnish these wages. This is ordered by the court, so you’d need proper documentation in your records.
Step #3: Decide on a Payroll Schedule
Next, you need to pick a payment schedule that works best for your company: weekly, biweekly, semimonthly or monthly.
When you decide on your schedule, set your payday calendar and note down the days when you will be processing payroll for your employees so they can get their salaries on the chosen day. You should factor in quarterly tax payment dates, annual tax filing dates, holidays, etc.
This will need to be done at the start of every year, along with establishing the preferred payment delivery method for every employee.
Step #4: Estimate Total Gross Pay
After setting your payroll schedule, you are good to begin processing your first payroll. An employee’s gross pay is calculated by multiplying the total number of hours they worked in a given pay period by their hourly rate.
Remember to take heed of overtime hours. In accordance with federal law, this overtime needs to be paid at a higher rate.
Step #5: Determine Each Employee’s Tax Deduction
At this point, you need to collect information from your employee’s federal and state requirements, benefits requirements and instance requirements in order to establish each worker’s deductions.
As every US state collects different small business taxes, this may get tricky so you need to research your particular state policy.
Some of the most frequent requirements that you should get to know include:
- State taxes
- Local taxes
- Medicare
- 401(k) contributions
- Federal taxes
- Workers’ compensation contributions
- Other benefits
- Social Security
Step #6: Calculate Net Pay and Provide Payment
Once you subtract employees’ deductions from their gross pay, you are left with their net pay: the amount you need to pay your employee for them to take home.
The deductions are held onto and paid with monthly or quarterly payroll taxes.
Having defined each employee’s net pay, you can pay them on the previously set payday.
Some ways in which you can pay your employees include:
- Deposits to their bank accounts
- Paper checks
- Deposits into their mobile wallet
- Cash in hand
Step #7: Keep Your Payroll Records
Once your payrolls have been processed, make sure you keep your transactions’ records for compliance and taxation.
In case the IRS needs some documentation or an employee makes a dispute regarding a payment, you will need records and proof of payment.
Also, if you outsource all of your recruitment processes (find out what is RPO) your team can focus more on processing payrolls, while all other tasks are left in the hands of professionals.
How Long Does Payroll Processing Take?
On average, businesses spend several hours per week processing payrolls for the company. The exact time will depend on the payment methods and systems they use to process them.
A payroll service provider can help businesses automate the system to save time, improve efficiency and mitigate compliance risks.
What to Consider if You Want to Hire a Payroll Processing Company
If you are looking to hire a payroll company, you need to consider several things before deciding on one.
Their Core Features and Services
Think about the payment processing features and services you need in order to pay your employees.
For example, do you wish to automate payroll processing or are you looking for a full-service package?
Most payroll processing companies provide tiered pricing plans, from the basic to the most advanced. Besides the core service such as payroll processing, companies managing payroll also cover taxes, offer payment options, PTO management, garnishment payments, payment reports and others.
Consider which of these services you will need down the line and find payroll companies that provide them.
Cost of Their Services
Naturally, you’d want to find an affordable payroll provider in order to cut costs, as long as their price doesn’t compromise the quality of services. But, besides looking at the cost of their services, consider the pricing models you can opt for.
Service Integration
In case your company already uses specific software for HR or accounting, you may want to look for a payroll company that has the software capable of integrating with your platforms. This integration may make the payroll process better streamlined and more functional.
Tax Compliance
Payroll companies often provide tax services. But, as tax laws are changing frequently, they must stay on top of things and be able to apply the new changes in practice in order to avoid potential problems. When interviewing a payroll company, ask them about how they keep up with tax law changes.
Reputation
Look into each potential payroll partner’s track record, portfolio and list of clients to find evidence of their success and good reputation. Also, finding third-party reviews of their services will help you feel more secure and knowledgeable when deciding on whether you should employ their services or not.
Why You Should Hire a Payroll Process Company
- Effective Processes
- Better Productivity
- Proper Documentation
- Maintenance of Accountability
- Attention To Detail
- Better Scalability
Here are six reasons why hiring a payroll company may be a good idea if you wish to outsource payroll processes.
Effective Processes
Payroll companies have the tools and the know-how to provide efficient payroll management systems and processes. These include detailed filing systems, tools for managing data and so on. This set of tools and the specific knowledge they possess make outsourcing payroll services not only a more economical option but also a more time-efficient solution.
Better Productivity
Having an in-house team manage your payrolls can be very time-consuming. The payroll company’s expertise can help alleviate this, as your employees can then engage in more important activities that would generate leads and revenue for your company.
Proper Documentation
Even when outsourcing payroll processing services, it is a good idea to document the processes and have them in case your employees have questions and want to challenge the existing process.
This especially applies in the era of a growing global remote workforce. Flexible payroll processes are very important, so having a good foundation and a well-documented system can help in case of unpredictable developments and audits.
Payroll companies develop an effective, tailor-made payroll process that works the best for your business, therefore eliminating any guesswork.
Maintenance of Accountability
When it comes to payroll management and tax maintenance, every company is prone to errors that can prove to be very costly down the line.
With a business running payroll services by your side, you can manage the expectations and outcomes of how payroll works. When payroll rules are all established and communicated to everyone in the company, it is management that is responsible and accountable for the process.
Payroll processing companies help limit their client’s legal liability as they ensure they follow the payroll processing and taxation laws.
Attention To Detail
Payroll service providers are well-versed in their craft, have plenty of experience working with various clients, they maximize the payroll process while minimizing liability in order to help your business grow.
These specialists make sure you don’t miss out on anything important, since they take care of aspects such as employee classification and tax regulation. As they are able to predict and adapt to any changes ahead, you don’t have to worry about hidden obstacles.
Better Scalability
Payroll is not a one-size-fits-all process. And even though there are universal rules that everyone should follow, your company grows and changes. Payroll companies let you focus on your business and adjust your payroll process in accordance.
Payroll Processing Takeaways
Payroll processing is a delicate procedure that needs to be followed to a T in order to provide timely and accurate compensations, benefits and tax payments.
The general payroll process consists of these steps:
- Find your Employer Identification Number
- Collect your employees’ tax information
- Establish a payroll schedule and timetable
- Determine your total gross pay
- Establish employees’ tax deduction
- Calculate net pay
- Pay your employees
- Keep the payroll records
While these payroll processes can be conducted in-house – most commonly by a payroll specialist or an HR team – it is also advisable to consider hiring the services of a payroll processing company.
These specialized agencies excel in providing timely and accurate payrolls to clients’ employees, as well as keeping a finger on the pulse of the ever-changing tax laws, potentially saving you from hefty fines which help with scaling your business.
Payroll Processing FAQ
1. What are the major types of payroll processing methods?
There are three significant types of payroll processing methods:
- Manual payroll processing involves manually calculating employee wages, deductions, and taxes. While it can be cost-effective for small businesses with a few employees, it is time-consuming and prone to human error.
- In-house payroll processing is conducted internally using payroll software. The software automates the payroll process, providing more accuracy and efficiency than manual processing.
- Outsourced payroll processing involves hiring a third-party provider, such as a payroll service company or a professional employer organization (PEO), to handle payroll on behalf of the business. The provider handles all payroll-related tasks, leaving employees time to focus on core business activities.
