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How to Manage Payroll: The Ultimate Guide to Processing Payroll

  • Payroll
  • Article
  • 6 min. Read
  • Last Updated: 11/10/2022
a small business owner processing payroll on her laptop

Table of Contents

Processing payroll is an essential part of operating any business that has employees. But it doesn't come without its challenges. And the more employees you have, generally the more complicated the process can become. So how are businesses handling this essential process? A 2020 Paychex poll* of principals of U.S.-based businesses found that 39% of businesses do payroll manually, yet only 17% of respondents would consider changing from a manual to an outsourced solution.

These and other professionals may not realize that if or when things go wrong, they often come at a high price. To help prevent this from happening at your company, read this overview on how payroll works, how to manage payroll, as well as your options for completing the process.

How Does Payroll Work?

Once you have hired employees, you need to pay them and handle applicable taxes each pay period. There are many steps involved to complete these tasks, which we will cover in detail. These and other responsibilities make up the payroll process, which you or another staff member can do, or you can find an accountant or payroll provider to handle these tasks for you.

Business Information Needed

Before getting acclimated with payroll basics or getting started, the following business items should first be in place:

  • Apply for a Federal Employer Identification Number (FEIN): This is assigned by the IRS and is used to identify a business entity. You need this nine-digit number to pay federal taxes, hire employees, open bank accounts, and apply for business licenses and permits. You can do this online on the IRS website.
  • Register with your state and local government: Depending on your business structure and location, you'll need to register for a state ID number to pay your business's state taxes. Tax obligations and steps to get an ID number both differ at the state and local levels, so check with your state and local agencies.
  • Look into workers' compensation coverage: This insurance is mandatory in most states, although rules vary from state to state as to how many people a business can employ before it is required. Nonetheless, it's strongly recommended that you have workers' compensation coverage if you have employees.
  • Report new hires: State and federal laws require employers to report information on new and rehired employees to the appropriate agency, generally within 20 days of beginning employment. Some states require reporting this data sooner. Among other things, this information is used to locate parents who owe child support.

Employee Information Needed To Process Payroll

There are also specific pieces of employee information you'll need to gather before getting payroll started. They include:

  • Worker classification: (employee vs. independent contractor) It's important that any worker you bring on board is classified correctly. This will help you determine the appropriate way to pay your worker.
  • New-hire documents: (Form W-4, Form I-9, etc.) Although certain forms are completed by nearly all new hires, they may vary from company to company due to industry-specific regulations, company benefits, and policies. In addition, for employers with more than one location, different state and local laws may require that employees at only one worksite complete certain documents. It's your responsibility to ensure that all required new-hire forms are completed as part of the onboarding process.
  • Payment method: Depending on the options you offer, you will have various tasks to complete to successfully deliver paychecks via direct deposit, paper checks, or paycard. Learn more about employee pay options that may be available to your business.

What Are the Steps to Processing Payroll?

As you learn the steps for processing payroll, remember that on-time, accurate paychecks are often correlated to employee morale and a solid business reputation. Missing even one of the following steps could put either in jeopardy:

  • Classifying workers correctly.
  • Collecting and tallying the hours worked by each employee.
  • Paying the right amount, including double-checking all employee information, tax withholding amounts, and payment information.
  • Processing payroll on time every pay period.
  • Paying attention to bank holidays, which are holidays when your bank closes, when your payroll processing timelines may have to be adjusted.
  • Depositing and reporting employment taxes correctly to all federal, state, and local tax authorities.
  • Printing and signing paychecks, as well as administering direct deposit for employees if you offer this payment method.

How Do You Process Payroll?

Employees depend on and expect timely, accurate delivery of their paychecks. Any disruptions or errors can prevent your process from running smoothly, and could even lead to turnover. When learning how to run payroll, the following factors are key foundational basics with which you must become familiar.

Track Worker Time

Accurate payroll relies on tracking employee work time correctly. There are various methods for tracking hours worked, including time and attendance software that may integrate with payroll systems or having employees track their time manually. Keep in mind that, like payroll, manual methods can lead to inaccuracies. This is why, when evaluating your payroll process, you may also want to evaluate whether your time and attendance solution is the best fit for your business.

Understanding Different Types of Pay

Before you can calculate your employees' wages, it's important to understand the different types of pay so you can mitigate payroll errors. Here are a few examples:

  • Gross pay: Gross pay is an individual’s total earnings for a given pay period prior to taxes and other deductions being withheld.
  • Net pay: This is the amount an individual takes home, after deductions.
  • Bonus pay: This is additional compensation provided to an individual on top of their regular earnings. Both cash and non-cash bonuses are subject to income tax withholding and other payroll taxes.

Calculate Employee Wages

There are many calculations and factors that go into determining an employee's wages, including:

Determine Your Business's Payroll Schedule

A payroll schedule establishes employee pay dates in compliance with state pay frequency laws, tax payment due dates, tax return filing deadlines, etc. You'll also want to account for scheduling special payrolls, such as for seasonal or annual bonuses.

Calculate Gross Wages

Calculate gross wages in compliance with applicable federal, state and local laws depending on the basis of pay, overtime worked, etc.

Account for Overtime Pay

If an employee worked more than 40 hours in a single workweek and is classified as non-exempt, they are eligible for overtime pay. In general, if there is no additional remuneration such as non-discretionary bonuses or commissions, the employees overtime rate can be calculated by multiplying their hourly rate by 1.5, and then apply that rate to the overtime hours worked.

Comply With Wage Garnishments

A wage garnishment is any legal or equitable procedure where some portion of a person's earnings is withheld by an employer for the payment of a debt such as alimony, child support, student loan default, or other circumstance. If notified by an enforcement agency, employers should immediately start the wage garnishment process to ensure that payments are sent to the appropriate agency or creditor. This helps protect the business from any legal repercussions for failing to respond to the order.

Factor in Benefits Contributions

Account for benefits contributions such as workplace-sponsored retirement plans, health, life, or disability coverage, and flexible spending accounts. In such cases, you'll need to calculate and deduct each employee's individual contributions from each paycheck.

Deduct Payroll Taxes

Employers generally must withhold federal and state income tax from all employees' taxable wages, based on what employees enter on their Form W-4. Here's a brief explanation of a few mandatory payroll taxes:

Federal Income Tax

This is withheld from an employee's wages, reported to the federal government, and applied to the employee's calculated tax liability at the end of the year.

Social Security and Medicare Taxes

This tax is generally paid equally by the employer and employee to fund these entitlement programs.

Federal Employment Tax

This is paid to provide funds for paying unemployment compensation to workers who lost their jobs.

There is also the state unemployment (SUI) tax that subject employers must pay. Except for a few states, state unemployment taxes are not deducted from an employee's wages.

Can You Process Payroll Yourself?

Running payroll is an essential part of operating any business with employees, no matter the size or type of industry. Business owners have several options when it comes to running payroll, including outsourcing the process. Depending on the method you choose, consider factors such as how much control or oversight you want to have, cost considerations, and time commitments, among others.

For business owners who want to manage payroll themselves, they must become familiar with the terminology, options, and basics of running payroll, as well as payroll tax laws to avoid making mistakes. So while you can certainly figure out the process, processing payroll can be difficult when you do it on your own.

The IRS estimates that approximately 33% of all employers make payroll errors, and those mistakes can be costly. Unpaid taxes or wages can result in hefty penalties, and mistakes on employee paychecks can erode worker morale and be a detriment to your business reputation.

Understanding the ripple effect that payroll inaccuracies can have on a business, today’s leading payroll processing companies such as Paychex have developed safeguards such as pre-check services to help increase payroll accuracy before payday, as well as reduce the chance of costly human error. These HR features and technology that let employees quickly review and approve their paycheck before payday are usually not available when doing payroll on your own and could leave your business potentially more vulnerable to payroll errors, miscalculations, and penalties.

Is Doing Payroll Yourself Worth It?

Given its complex nature, processing payroll on your own can cost more in the long run than what you may save initially. Plainly speaking, doing payroll on your own may not be worth it.

If part of your consideration is wondering how long payroll processing takes, consider the time it takes to do payroll yourself. A Paychex survey found that HR professionals spent an average of 11 hours each week on payroll — equating to a full day and a half every week with an office that has a typical eight-hour workday. Recognizing this, 30% of respondents said that processing payroll was the top function for which respondents wished they had better systems and technology in place.

Benefits of Outsourcing Payroll

There's simply too much at stake for business owners to commit time-consuming (and potentially expensive) payroll processing errors. Consider the benefits of using payroll services from a professional provider:

  • Time saved: Payroll outsourcing can make the entire process more efficient, versus taking time to manually input data and double-check for errors every pay period. In fact, 1/3 of HR leaders polled in the 2022 Paychex Pulse of HR Survey said changing their current payroll solution or technology saved between 60 and 120 hours a year in both preparing payroll and fixing payroll issues.
  • Greater efficiency: Look for a provider that allows you to import multiple files at one time, from one location, so you don't need to wait for each file to complete before processing a new one.
  • Money saved: Costs saved on printing and distributing paychecks, as well as generating reports for in-house and accountant use.
  • Greater security: Protection against identity theft, embezzlement of funds, and tampering with records for personal gain.
  • Professional know-how: Payroll providers with expertise on how to process payroll can help at any point in the process.

Keeping up with the complexities of employee withholdings, minimum wage legislation, and IRS forms can be daunting. Outsourcing payroll can also alleviate the burden that often comes with payroll tax compliance, including mitigating your business's risk of penalties for late or inaccurate payments.

How Can You Process Payroll Manually?

Even knowing the benefits of payroll outsourcing, some business owners may want to know how they can do payroll manually. One of the most important things to keep in mind is that there are standard expectations that need to be met during each pay period when doing your own payroll. Depending on how employees are classified (exempt or non-exempt), you will need to:

  • Determine the appropriate gross wage and net pay amounts.
  • Calculate and subtract the state unemployment, FICA, state taxes, garnishments, and any other withholdings.
  • Print and sign the actual paychecks.
  • Make deposits to the appropriate tax agencies according to the calculated or assigned frequencies.
  • Handle all the necessary tax reporting, tracking, third-party payments, etc. Paying mandated taxes on a regular schedule through your payroll is one key to avoiding penalties.

Ease the Burden of Payroll Processing With Paychex

Among the many items on small business owners' to-do lists, payroll tasks can be particularly important and complex ones. However, there any many risks and costs to handling these administrative responsibilities on your own, perhaps most significantly the time they can take away from your already-busy workday. If you think the time is right to reexamine how your business handles payroll, learn more about how to get started with a third-party provider. You may also want to compare payroll services to find a solution that can work best for your business.

*Paychex conducted four separate online surveys of 300 principals of U.S.-based businesses with 2 to 500 employees. Wave 1 was fielded April 17-20, 2020; Wave 2, April 24-27; Wave 3, May 1-4; Wave 4, May 15-17. Each survey has a +/-5.66% margin of error

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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.