If you’re trying to figure out payroll, it probably means some good things are happening. You’re adding employees, growing, and probably quite the force to be reckoned with. Nice work!
Wrapping your head around what payroll is and how it works is one thing — trying to remember all the related terms, forms, and acronyms is another. Even seemingly simple words like “employee” and “salary” can feel like they’re part of a whole new language when the Internal Revenue Service (IRS) and Department of Labor (DOL) get involved.
But don’t let it get you down! We’ve pulled together a list of payroll terms you’ll see over and over again. Whether you need to know about classifying workers, paying them, or getting your taxes straight, here’s the vocab you’re bound to encounter.
Classifying your workers
There are a few different word pairs that help answer important questions about your employees. Understanding these three questions can save you a slew of headaches and unexpected costs down the road.
1. Do you work with “employees” or “independent contractors”?
This may seem simple, but it’s something businesses often get wrong. After all, it doesn’t matter whether you think a worker is a contractor or employee. What the IRS wants to know is the type of work they do and how they do it.
The distinction matters because your obligations to employees are different, and not just for tax purposes. Workers can be entitled to benefits and protections that aren’t available to freelancers. For example, you’re obligated to withhold and pay certain taxes on behalf of employees, while contractors cover these costs on their own. Or if you end a contract with a freelancer you can both go your own way, but if you lay off an employee they can fire an unemployment claim. Learn more about the difference between employees and independent contractors here.
2. Is each employee “exempt” or “nonexempt”?
When it comes to payroll, being “exempt” means an employee isn’t covered by Fair Labor Standards Act (FLSA) rules. Most significantly, exempt employees (who tend to either receive a salary or a high hourly wage) don’t qualify for overtime pay when they work more than 40 hours in a week. On the flip side, certain exempt employees also don’t qualify to receive the federal minimum wage.
Of course, it wouldn’t be a government regulation if it wasn’t a little complex. Which employees are exempt from overtime payments? The DOL says any of the following are exempt:
- Employees who are paid above a certain annual income threshold (defined by the FLSA)
- Employees who have a base salary that can’t be changed
- Employees who have a specific set of job functions. This includes roles like executives and sales professionals, but also babysitters and certain agricultural workers.
As of early 2017, FLSA rules are in flux, so some of these guidelines may be changing soon. Be sure to check with your lawyer if you have any questions. In the meantime, learn more about overtime rules and how to classify your employees.
3. Do your employees receive “salary” or “hourly” wages?
Generally speaking, how you calculate employee pay is relatively straightforward: You can pay them a salary or an hourly wage.
- Hourly workers are paid a set rate for every hour they work, recording their time in a timesheet that’s submitted each pay period.
- Salaried employees are paid a set amount of money each year.
One of the main considerations when deciding how to pay someone is knowing whether their position is exempt or nonexempt. Exempt positions are generally salaried, while nonexempt positions are typically hourly and entitled to overtime pay. Again, there are exceptions for highly compensated hourly workers (like lawyers and other highly skilled professionals), so be sure to check with your lawyer or accountant if you’re in doubt.
Common terms for running payroll
When it’s time to get your hands dirty and actually run payroll, there are a bunch of other terms you’re going to come across. Let’s start with some of the general ones you should know:
- Pay period: This is the amount of time a paycheck covers. Pay periods can be weekly, bi-weekly, semi-monthly, or monthly — different factors like cash flow, your employees’ preference, and state requirements can help you determine the best payroll schedule for your business. It typically takes a few days to process timesheets and transfer funds, so pay periods won’t sync exactly with the days people get paid. Payday is typically two to four days after the end of a pay period.
- Timesheet: Whether it’s a paper punch card or an online app, a timesheet is used by employees to track and report the number of hours they’ve worked.
- Off-cycle payroll: A payment that happens outside of your normally scheduled pay period, such as a one-time bonus or paying a contractor’s invoice.
Making sense of a typical pay stub
A pay stub is a document that shows an employee how much money they’ve earned during a pay period, as well as the amount deducted and the total they’ll receive via check or a direct deposit into their bank account. It’s basically a receipt for their services and a record that you paid them what you promised.
The typical pay stub has its own set of terms that all relate to how the paycheck is calculated and how much of the money an employee earns actually goes home with them:
- Gross earnings: This term refers to the amount of money an employee earned before taxes and deductions are accounted for. Gross pay doesn’t just refer to basic wages; it can also include tips, allowances, overtime, bonuses, and commissions.
- Pre-tax deductions/contributions: These are considered “tax free” deductions from gross earnings because they’re made before any taxes are calculated. For example, contributions to a 401(k), health benefits, a health savings account, or dependent care assistance are made from pre-tax dollars.
- Post-tax deductions/contributions: Once taxes have been withheld from an employee’s gross pay, there are additional deductions that may be made such as charitable donations, wage garnishments, contributions to a Roth 401(k), or payments for voluntary insurance.
- Net pay: The amount that is paid to an employee once taxes and other deductions are, well, deducted. It’s the amount they take home in their paycheck.
A lot of information is summarized in a pay stub, and the details included will vary from one business to another (sometimes even between employees in the same business). Here are some of the other terms you might see:
- Imputed pay: Also referred to as a “fringe benefit,” this is the value of non-cash services or benefits employees receive. These can include things like life insurance premiums above a certain amount, gym memberships, or moving expenses. The value of these benefits are typically reported to the IRS using form W-2 at the end of the year, but can also be reported on individual pay stubs.
- Reimbursements: When employees spend their own money on work-related expenses, you can pay them back by adding reimbursements to their paycheck. Since reimbursements aren’t income an employee has earned by working, they aren’t typically taxed (but there are a few exceptions).
- Overtime: Unless an employee is exempt, the FLSA says they aren’t eligible for overtime pay (one and a half times their regular rate) if they work more than 40 hours a week. There are also state rules that can apply. For example, California employees may be entitled to overtime pay if they work more than eight hours in a single day. This can get tricky: Depending on their status under the FLSA (exempt or nonexempt), both salaried and hourly employees, as well as freelancers, may be eligible for overtime pay. There’s a chance that overtime rules will be updated in 2019, so keep an eye out for changes.
- Bonus: An amount of money an employee receives that’s beyond their normal wages. Bonuses can be used to recognize great work, celebrate achievements, or otherwise reward employees.
- Commission: Usually tied to sales and marketing positions, a commission is typically a percentage of the value of the goods or services sold, or a flat rate based on volume.
Making sense of tax talk
When we talk about how taxes influence payroll, there are actually a few different types we’re talking about:
- FICA (Federal Insurance Contributions Act) taxes are contributions from employers and workers that go toward two national insurance programs: Social Security and Medicare.
- Income taxes are any state or federal taxes on the wages an employee earns. These are withheld from people’s paychecks.
- The ACA (Affordable Care Act or Obamacare) was created to improve access to health insurance. The Act creates incentives for smaller small businesses to offer health insurance — and requires companies with more than 50 employees to provide health plans. Learn more about your requirements here.
While specific taxes vary from state to state, here’s a look at some of the federal tax terminology you’ll run into when you’re running payroll:
- EIN (Employer Identification Number): This is the tax ID the government uses for your business. Think of it as your company’s very own Social Security number. Every business with employees needs one to run payroll, so here’s how to get yours.
- Withholding (aka “employee taxes withheld”): The act of pulling the taxes your employees owe out of their gross earnings, and sending them directly to state and federal governments. The amount withheld is determined by each employee’s Form W-4.
- Quarterly Federal Tax Return: Most businesses need to check in with the IRS once per quarter to let them know how much income tax, Social Security tax, or Medicare tax they’ve withheld from employees. You also pay your federal income taxes for the quarter in your quarterly return.
- Federal Unemployment Tax Act (FUTA) and state unemployment taxes: While some organizations or positions may be exempt from these particular taxes, FUTA helps cover the costs of unemployment insurance (UI) as well as state-run job programs. These taxes are usually based on employees’ gross earnings, meaning they aren’t withheld from their wages. Instead, they are an additional obligation that employers must cover.
Do you feel like you’ve got the basics down now? Well, it sure looks like it. You’re now one step closer to getting that payroll ball rolling.