Payroll is the term used to refer to the various tasks and responsibilities businesses must perform to pay their employees accurately and on time. It encompasses calculating wages and salaries; preparing checks; withholding taxes and other deductions; reporting and paying taxes to the appropriate federal, state, and local agencies; and more.
Businesses must handle payroll correctly because it impacts their net income and can result in additional fines, fees, and penalties if not managed according to federal, state, and local rules. Because there are legal and financial implications with payroll, it’s wise for business owners to seek guidance from professionals who can advise them on their obligations and the laws they must comply with.
How Does Payroll Work?
According to the U.S. Bureau of Labor Statistics, most companies in the U.S. use a biweekly payroll cycle (pay period), meaning they pay employees every two weeks. Other possible payroll cycles include weekly, semi-monthly, and monthly.
Generally, it’s up to the business to decide what its payroll schedule will be. However, some states have specific standards that companies need to follow.
Businesses must comply with all of the federal, state, and local regulations for payroll.
Key Elements of Payroll
Besides ensuring that employees are paid correctly according to their hourly or salaried rate and any commissions, bonuses, or reimbursements owed to them, employers must also accurately calculate and withhold certain income and payroll taxes from workers’ pay. Then, they must report and remit those withheld taxes to the appropriate tax authorities.
Employee Paid Withholdings
Employees’ net pay is calculated by taking the gross wages or salary and subtracting withholdings (such as taxes, medical insurance premiums, retirement contributions, and possibly other deductions). Some deductions are calculated before taxes are assessed, and some are calculated after—so the computations can become confusing! The IRS provides details about withholdings on its website. It’s also critical for business owners to review their state’s rules—they might be different from the federal government’s requirements.
Federal, State, and Local Income Tax
The amount of federal income tax an employer should withhold from an employee’s pay is based on the information provided on the employee’s IRS Form W4 (Employee’s Withholding Allowance Certificate).
In states that levy state income tax (SIT), employers must also withhold that tax. Seven states (as of this writing) have no state income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). And the states of New Hampshire and Tennessee tax income on investment earnings but do not have income tax on employees’ wages. Keep in mind, if employees are paid bonuses, that income might be taxed differently from how wages are taxed. Not all counties charge local income tax, but employers must withhold local taxes from employees’ pay in the areas that do.
What if a business has an employee who lives out-of-state? That requires withholding state income tax according to the rates and requirements of the employee’s home state.
Social Security and Medicare Taxes
The IRS generally requires employers to withhold half of Social Security and Medicare taxes from their employees’ wages and salaries, and the employer pays a matching amount.
The Social Security wage base limit is $137,700 for 2020 and $142,800 for 2021. The Social Security tax rate is 12.4 percent (6.2 percent paid by the employee and 6.2 percent paid by the employer). The Medicare tax rate is 2.9 percent (half to be paid by the employee and the other half to be paid by the employer).
Other Payroll Deductions
Some of the other deductions employers’ may need to withhold from employees’ pay include:
- Retirement fund contributions
- Court-ordered wage garnishments (e.g., child support, alimony, loan payments, bankruptcy payments)
- Health and life insurance premiums
- Unpaid vacation and sick time
- Union dues
Employer Paid Withholdings
Through the FUTA (Federal Unemployment Tax Act) and state unemployment systems, workers that lose their jobs through no fault of their own can receive unemployment compensation.
Most employers pay federal and state unemployment tax. FUTA tax is a cost to the employer; it is not deducted from employees’ wages. The threshold at which employers must file federal unemployment taxes is if they paid wages of $1,500 or more to employees during any calendar quarter in the current year or the one before. The six percent FUTA tax applies to the first $7,000 paid to each employee during a calendar year (after subtracting any FUTA-exempt payment amounts).
In addition to state income taxes, some states have their own unemployment insurance program and require employers to pay a State Unemployment Tax, or SUTA. The SUTA (State Unemployment Tax Act) in those individual states establishes how much of employees’ wages are taxed. The taxable wage threshold and the unemployment tax rate vary from state to state.
Workers’ Compensation Insurance
Workers’ compensation (“workers’ comp”) is a form of insurance that employers are, in most states, required by law to purchase. A workers’ comp policy covers costs resulting from employees’ work-related injuries and illnesses. Employees that collect workers’ compensation benefits may not sue their employer for lost wages or injuries. However, employees may be able to sue a business for things not covered by the workers’ comp insurance policy.
For most employers, workers’ comp is administered through a state-mandated program. For federal government employees, workers’ compensation insurance and claims are handled through the Federal Employees’ Compensation Act (FECA).
What Employers Need to Process Payroll
It can vary depending on where the business is located. Below are some of the likely requirements:
- EIN (Employer Identification Number) – Also known as a Federal Tax ID Number, all employers need to obtain this nine-digit identification number from the IRS.
- IRS Form W-4 (Employee’s Withholding Allowance Certificate) – This determines how much federal income tax the employer should withhold from an employee’s pay. Note that some states also have their own version of the W-4.
- Health insurance and retirement plan documentation – These verify the desired deductions and authorize the employer to withhold money from the employee’s pay.
- Employee’s bank and information – Businesses must obtain this information if they direct depositing pay into an employee’s bank account.
- Payroll Tax Registration – To withhold, report, and file payroll taxes and report and pay unemployment taxes, businesses need to register for accounts with the tax authorities they must answer to. Registering for payroll taxes isn’t overly complicated, but it can be confusing because different states have different requirements and processing policies.
Options for Executing Payroll
Businesses have three options for taking care of their payroll responsibilities. Which is ideal for a business will depend on how complicated the company’s payroll will be, the level of knowledge the business has in-house about payroll requirements, and the business owners’ preferences:
- DIY – Many small businesses gravitate to this route to save money. This method requires calculating, processing, and tracking many details manually in-house. It also requires that the business owner (or whoever is handle’s a company’s payroll) understands all of the rules, is detail-oriented, and has the time to complete tasks accurately and on-time.
- Payroll Software – A variety of payroll software solutions exist to help businesses set up and automate many aspects of their payroll. Most are cloud-based solutions, (many integrate with popular accounting software solutions) that allow 24/7 online access.
- Outsource – Another method for handling payroll is outsourcing the work to an accounting firm, bookkeeper, or payroll services provider. This option comes with the peace of mind that someone with specialized expertise is carrying out all or most payroll tasks. For that reason, it will likely cost a business more than the other two options.
General Best Practices for Businesses
Some helpful suggestions for business owners regardless of the method they choose for handling payroll include:
- Keep accurate records.
- Follow the rules for classifying individuals as employees vs. independent contractors (they require different IRS forms, and individuals classified as independent contractors do not have payroll taxes withheld from their payments from a business)
- Take care not to misclassify exempt (salaried) and non-exempt (wage-based) employees.
- Make sure to calculate overtime correctly.
- Make sure to factor in bank holidays when setting up a payroll schedule.
- Get help if you do not have the knowledge or time in-house to set up, manage, and monitor payroll activities.
CorpNet Can Help You Get Payroll Up and Running
CorpNet supports businesses in all 50 states in their payroll efforts. From obtaining an EIN to registering for the state and local tax accounts needed for payroll management, our filing specialists provide personalized service you can depend on.
Contact us today to help you simplify your payroll setup!
Burgess, Matt. 2014. How frequently do private businesses pay workers. May. Accessed December 4, 2020. https://www.bls.gov/opub/btn/volume-3/how-frequently-do-private-businesses-pay-workers.htm#:~:text=Biweekly%20is%20the%20most%20common,pay%20frequencies%20are%20less%20common
Contribution And Benefit Base
Topic No. 759 Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return – Filing and Deposit Requirements
Federal Employees’ Compensation Act
This information is for general informational purposes only. It should not be considered legal, financial, or tax advice. Please consult a licensed attorney, accountant, or tax advisor for specific legal, tax, and accounting questions or concerns.