June 17, 2020

Breaking Down The Basics of Payroll


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The Basics of Payroll

If your business has employees or you are new to the concept of processing payroll and want to understand how it works, this course is for you. 

Every business in the U.S., no matter the size, has to pay their employees and pay taxes on those wages the employees get paid. 

Payroll is the hours, salary, or commission amounts you or an administrator in the company pay employees during each payroll period. 

It also refers to the method of accounting, calculating and distributing wages and payroll taxes.

Most businesses process and run the payroll on one of the following pay period schedules:

  • Weekly. Employees receive paychecks every week on a specific day (52 payroll weeks per year). For example, you pay your employees every Friday.
  • Bi-Weekly. Employees receive paychecks every two weeks on a specific day (26 payroll weeks per year). For example, you pay your employees every other Friday.
  • Semi-monthly. You pay your employees twice per month on two specific dates of the month (24 payroll weeks per year). For example, you pay your employees on the 1st and 15th of every month.

Payroll processing is crucial to maintaining accurate accounting, and it isn't a straightforward process to manage. It requires an understanding of federal, state, and local regulations and laws and some tax knowledge to make sure you're withholding, reporting and filing the right deposit amounts (and paying all employees the correct amount of money every pay period!).

While it's possible to do payroll manually, it's very time-consuming and often leads to many mistakes. For that reason, entrepreneurs and businesses outsource their payroll to reduce stress and minimize errors and have peace of mind. 

What is payroll taxes?

Employers are required to deduct payroll taxes from the wages of every employee paycheck.

Payroll taxes include:

Federal income tax

There is no standard federal payroll tax rate for federal income taxes. The amount of federal income tax you withhold, deposit, and remit to the IRS depending on the employee's salary or wages, and the information the employee provided on Form W-4.

Social Security and Medicare taxes

Social Security and Medicare taxes are collectively known as FICA, which stands for the Federal Insurance Contributions Act.

Currently, the FICA tax rate is 15.3% of the employee's gross wages: The current tax rate for social security is 6.2% for the employer and 6.2% for the employee, or 12.4% in total. The current tax rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% in total.

State and local income taxes

Most states in the United States. have a state income tax. The only states that don't assess a state income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.

State and local income taxes generally apply to people who live or work in the state or locality, regardless of the business location.  If your business employs people who live or work in a location that imposes state or local taxes, you'll need to withhold those taxes from their wages.

Federal and state unemployment tax

Both federal and state unemployment benefits get funded by unemployment taxes based on employee wages. 

Only employers pay federal unemployment taxes (FUTA)— employees never pay FUTA taxes. The FUTA tax rate is 6.0% of the first $7,000 per year that you pay each employee. However, employers qualify for a tax credit of 5.4%, which lowers the FUTA tax rate to 0.6%.

In most states, employers also pay 100% of state unemployment (SUTA) taxes. However, if you have employees in Alaska, Pennsylvania, and New Jersey, you may have to withhold SUTA tax from your employee's wages. SUTA taxes don't have a standard rate. Each state sets its rates.

What is a payroll deduction?

Payroll deductions are the amounts taken out of your employee's paychecks each pay period.

Payroll deductions include the payroll taxes listed above, but they can also include other items, including:

  • Garnishments. Wage garnishments happen when a court orders you to withhold a specific portion of your employee's gross pay for child support or other debts. Employers are required to send the amount withheld directly to a creditor or other person to whom the employee owes money.
  • Health insurance premiums. If you offer employee benefits, such as health, dental, and vision insurance, you may deduct a portion of the health premiums from the employee's wages.
  • Retirement contributions. If you offer a retirement plan, such as a 401(k) or SIMPLE IRA, your employees can choose to have a portion of their wages withheld for retirement savings.

What is a payroll register?

A payroll register summarizes payroll information for a specific pay period. It includes many of the details usually found on an employee's pay stub, including the number of hours each employee worked, gross pay, net pay, and payroll deductions. There is usually a totals section at the end of the payroll register that summarizes all of the employee information.

You can use the payroll register to see how much money you need to set aside for certain payments, such as the employer-portion of FICA taxes. It also comes in handy when filing payroll tax reports.

What is payroll withholding?

Payroll withholding refers to the mandatory payroll deductions. Employers are required by law to withhold federal and state income taxes, FICA taxes, and garnishments from employee wages. Employers who don't withhold these mandatory deductions can face penalties, fines, and even jail time.

Other types of withholding, such as health insurance premiums and retirement plan contributions, are voluntary because business owners aren't required by law to offer them to employees.

What are payroll liabilities?

Payroll liabilities are any tax payments related to payroll that a business owes but has not yet paid. These typically appear on the company's balance sheet as Accrued Payroll.

These can include:

  • Wages employees have earned but not yet received
  • Taxes, garnishments, and other withholdings from employee pay that haven't been paid and remitted to the proper authority
  • The employer portion of FICA and unemployment taxes that haven't been paid and reported to the IRS

Payroll liabilities come with every payroll a business runs, but don't stay on the company's balance sheet for long. Accrued wages get paid out to employees according to your regular payroll schedule and payment method (i.e., paper checks or direct deposit). Payroll taxes, premiums, contributions, and garnishments will be reported and filed with the proper tax agency and authority.

Working with payroll software or a payroll service provider to automate running payroll can ensure that you withhold the proper payroll deductions and send amounts to the appropriate agency on time.

How can I make this easier?

If this all seems complex, you'll be comforted to know there are more straightforward options than the DIY manual route. You can outsource to a payroll provider to take care of most of the task of processing payroll for you.

How to run payroll (with software)

If you've been thinking about doing payroll yourself, or already have been and found that it's an overwhelming task. We've outlined some advantages of using a payroll software below.  

Payroll software will give you the ability to:

  • Run payroll (and produce paystubs) on the pay schedule you need (weekly, biweekly or semi-monthly)
  • Calculate wages for employees
  • Deposit and file payroll tax payments
  • Facilitate paychecks and direct deposits
  • Complete w-4 forms
  • Onboard new hires
  • Manage workers' compensation
  • Process year-end w-2s and 1099s

This educational content is to be used for informational and educational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her attorney, business advisor, or tax advisor concerning matters referenced in this post. Kadre, Inc assumes no liability for actions taken in reliance upon the information contained herein.