Effective payroll processing is critical to your business operations. It ensures your workforce is compensated accurately, reduces the additional tax burden for your employees and improves compliance with state and federal tax and employment standard laws.
Here are eight simple steps to process payroll to determine if payroll outsourcing could increase efficiencies and improve compliance.
What is Payroll Processing?
Payroll processing includes the calculation of total wage earnings for each employee and ensures withholding deductions are made, payroll taxes are filed, and each employee is paid.
How Do You Manually Process Payroll?
Manually processing payroll includes the following tasks:
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- Overtime calculations for hourly workers
- Understanding state laws regarding overtime for salaried workers
- Statutory deductions required by federal and state laws
- FICA tax, including Medicare and Social Security
- FUTA tax you owe towards benefits for unemployment
- State income taxes
- Other statutory deductions
- Voluntary deductions
- Deduction deposits
- Employee payment
You can follow the manual process in detail here.
Payroll Regulations to Know
To ensure you remain compliant and avoid costly errors, you should be familiar with the following payroll regulations:
FUTA (Federal Unemployment Tax Act)
Employers pay 6% FUTA on the first $7,000 of an employee’s salary towards unemployment benefits.
SUTA (State Unemployment Tax Act)
Employers pay towards the state unemployment fund based on state rates.
FLSA (Fair Labor Standards Act)
Covered nonexempt workers are entitled to a minimum wage of not less than $7.25 per hour and overtime pay at a rate not less than one and one-half times the regular rate of pay after 40 hours of work in a workweek.
FICA (Federal Insurance Contributions Act)
Both employees and employers pay tax towards Medicare at 1.45% of earnings and Social Security at 6.2% of gross earnings up to the yearly wage limit.
8 Steps to Process Payroll Correctly
We recommend every employer review the following eight steps of payroll processing to ensure they are following the process correctly:
1. Collect Employee Information
Proper employee information avoids administrative issues that impact both your company’s and your employees’ deductions and payments. Information must include:
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- Full and correct employee name
- Full and correct employee address
- Social Security number (SSN)
- Birthdate
- Occupation
2. Establish a Payroll Schedule
The frequency you pay your employees impacts both your business and your employee’s financial health. There are four payroll schedules to consider:
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- Weekly: Paying your employees every week on a specific day of the week works well for employees as it provides ongoing cash flow for expenses. However, processing 52 pay periods a year ties up your payroll department’s time, becoming cost-prohibitive.
- Biweekly: Paying employees the same day every two weeks still provides regular cash flow, although it’s less popular than weekly. It also poses processing issues as the number of weeks each month varies. As a result, you’ll have two months a year with three pay periods. This makes calculations more complex and can cause issues with things such as monthly benefit deductions.
- Semi-Monthly: Semi-monthly schedules include two monthly payments on the same dates each month — usually the 15th and 30th. This provides 24 paychecks a year, making it much easier for your team to process. However, it also tends to contribute to financial strain for employees, especially if the payday falls on a weekend, further delaying access to their money.
- Monthly: A single payment each month and only 12 paydays a year makes it the easiest to process but also the least desirable for employees. It is also the schedule most likely to present issues with local payroll scheduling laws.
3. Verify Work Hours and Attendance
Manual work hours and attendance confirmation increase the risk of data entry mistakes, especially if employees are using outdated paper timesheets. Handwritten hours also lead to legibility issues and inaccurate hour calculations. It is more cost-effective to use time and attendance systems with hour-tracking software so employees can check in and out via the system, and managers can approve hours with auto notifications.
4. Calculate Gross Pay
Gross pay is the total amount earned for each payroll period based on your schedule and rate of pay before taxes or deductions. You calculate gross pay based on the following:
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- The number of hours worked
- The hourly wage
- Any overtime worked based on your state’s laws and a minimum of one and a half times regular salary based on Federal laws
- Other considerations, such as bonuses and commission
5. Deduct Taxes
Tax deductions are subject to new calculations introduced both federally and by state each year. You need to understand the Internal Revenue Service’s tax guide and use the employee’s W-4 form for the federal income tax amount. The annual IRS Publication 15-T provides instructions on how to calculate federal tax factoring in many influences, including:
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- Pay frequency
- Filing status (e.g., Single, married)
- Number of jobs the employee has
- Pre-tax deductions
- Annual withholdings
- Number of dependents
You also must calculate and deduct amounts for:
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- FUCA
- FICA
- SUTA
6. Deduct Employee Benefits
Employee benefits deductions include health insurance, retirement contributions and other company perks. There are also miscellaneous deductions you might have to contend with, such as wage garnishments for unpaid parental support or loan collections awarded to creditors.
7. Issue Paychecks or Direct Deposits
Direct deposit tends to be the best issuance process for you and your employees, ensuring:
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- Payments are secure
- Checks can’t be lost or stolen
- Disputes over lost or stolen checks being cashed or deposited by the employee are avoided
- Payments remain confidential
- Employees receive their pay even if not physically in the office
8. Recordkeeping and Compliance
Meticulous record keeping is critical for compliance purposes, including documentation of tax filings and audits. You can avoid paying penalties, which can range from 2% to 20% of the tax filing based on issues such as late filing, inaccuracies, and unpaid taxes. Additional fines can range from $50 to $260 for missed deadlines for 1099 forms. Ongoing non-compliance can lead to jail time if it is found you are knowingly not meeting deadlines or paying taxes.
Considerations for Outsourcing Payroll
We advise outsourcing when your business:
- Doesn’t have the in-house capacity/expertise to effectively manage payroll processing
- Lacks a Finance/Accounting department or has a small department that needs to spend their time on other tasks
- Requires assistance/support with compliance requirements
- Needs multinational payroll support
Outsourcing could be the solution to remain compliant and avoid time-consuming manual processes that cost you more money in the long run.
About the Author
Kayla is the Marketing Manager at Paypro Corporation overseeing all inbound and outbound marketing and sales efforts. She has 7+ years of experience working within the B2B and SaaS based solutions space and thrives on creating messaging and campaigns that introduce products and services to those who need them most.