Labor can be one of the largest costs for many businesses. By association, that means payroll can also be one of the biggest expenses. It can be time-consuming and hard to get right consistently, too. But it’s important that you do. Why? Past research has found that nearly half of employees will begin a job search if there are two payroll errors. So to stay in the good graces of your employees and the Internal Revenue Service (IRS), begin by learning these payroll basics.
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What is payroll?
Payroll is defined as the regular process of paying your employees and ensuring employment-related tax withholding. It can follow different schedules, such as weekly, biweekly, semimonthly, and monthly. It generally includes the following steps:
- Figuring out how much you owe employees
- Determining how much the government gets
- Delivering everyone a paycheck and a pay stub
- Processing tax forms like W-2s and 1099s
In most places, you can set your own payroll schedule, but some states have specific requirements. Check with your state Department of Labor to make sure you know about any requirements that apply to you.
There are some secondary definitions for payroll, too. For example, it can also refer to all your payroll records of employee salaries, wages, bonuses, and tax deductions. Or in a larger business, it might even be what you call the department that manages the whole process in-house. Some businesses (like sports teams) also think about payroll as a line item in their budgets—the total cost of paying all their employees.
Determining what a pay stub should look like
Here’s a breakdown of the typical pay stub:
- Gross pay: The amount of money your employee has earned, before any deductions.
- Pre-tax deductions: A package of nontaxable benefits, called a cafeteria plan, is something you can offer to employees. It might include contributions to things like a 401(k), dependent care assistance, a health savings account, or commuter benefits.
- Taxes: Social Security and Medicare payments, federal and state income taxes, and any other employee deductions.
- Post-tax deductions: Additional deductions such as contributions to a Roth 401(k), wage garnishments, some health insurance payments, or charitable donations.
- Net pay: The final amount that makes it into your employee’s bank account: gross pay minus all the deductions and taxes.
But wait, there’s more! Some additional payroll-related taxes are reserved just for employers, rather than deducted from your employees’ wages. These include federal unemployment taxes (FUTA) and state unemployment taxes, both of which provide a safety net for people who’ve recently lost their jobs.
Maintain the paper trail
The easiest way to get a handle on all the forms you’ll need to file is by checking in with your friendly neighborhood accountant or outsourcing with a reliable payroll service that could even sync with time tracking. But if you’re dedicated to DIY, there are standard IRS forms you should have on your radar. For example, every employee—including you—needs to do a bit of paperwork when they join your business:
- Form I-9: This form that captures employee information, such as a Social Security number, is used to confirm someone’s identity and verify that they can legally work in the US.
- Form W-4: This form tells you, as an employer, how much federal tax you need to withhold every pay period. (Want to learn more? We’ve got answers to your biggest W-4 questions.)
Other forms you may need to include:
- Form 941: Filed four times a year, this form documents the total amount withheld for the Federal Insurance Contributions Act (FICA), which includes Social Security tax and Medicare tax, as well as federal income taxes for each quarter.
- W-2: This is a wage and tax statement you need to give to each employee at the end of the year. They need it to file their taxes.
- 1099-MISC: Also at the end of the year, you’ll likely need to file this form for independent contractors or professionals you’ve worked with who aren’t incorporated. It’s the income statement contractors use to show the IRS how much they earned.
And don’t forget:
- Set up your EIN: There can be no payroll tax paper trail unless the government has a way of connecting everything back to you. That’s why every employer needs an Employer Identification Number (or EIN). You can apply for one easily with the IRS.
It may feel like an alphabet soup, but staying on top of all these forms for employment taxes, payroll taxes, and record keeping—along with making sure the information is accurate—helps you avoid those penalties and fines down the line. For instance, employers need to comply with the Fair Labor Standards Act (FLSA), which mandates minimum wage pay rates, overtime pay for hourly employees, and other requirements that need to be met. With a lot to track, anyone can make a mistake when they don’t have expert help. These are the seven most common payroll mistakes small businesses make.
Payroll takes care of people
It may be stating the obvious, but payroll is part of the deal you make with your employees. They help your business shine, so you compensate them with wages and benefits every payday. It’s easy to see payroll as just one more obligation, but consider how it impacts your team:
Business is about people, not transactions
Whether they’re focused on customer service, sales, or another business function, everyone you work with is on a mission to keep your customers happy and watch your company grow. Lots of things can contribute to a great workplace, and some of them cost nothing. But getting paid still tops the list. Finances are stressing out 60% of full-time employees, according to a 2023 PwC survey of more than 3,600 full-time US employees across industries. In fact, that same survey also found that among those same employees with money worries, 44% are distracted at work by personal finances, and they are twice as likely to seek new employment elsewhere, too.
When comparing better health benefits to higher wages, money wins out as well. Only 27% of the 38,862 people who responded to PayrollOrg’s “Getting Paid In America” 2023 survey want better health benefits compared to the 73% who want higher wages. That overwhelming response wasn’t limited to this year, even though nearly 11,000 more people responded to it than the number of people who responded in 2022 to this same annual survey. The results for that question were similar last year: More than 65% wanted higher wages compared to nearly 35% who wanted better health benefits. To sum it up, while your business is about people, and you need to have more than a transactional relationship with your team, remember that money matters a lot to them.
Timely payroll is a sign of strength
Once you set a pay period, know that any inconsistency in payroll can sidetrack your workers with feelings of uncertainty about your business. You don’t want them concerned that they can’t pay their bills. Put yourself in their shoes and ask what happens if your employee’s paycheck comes late. Maybe they’ll miss a credit card payment or sweat about a check clearing. Your employees count on you to be on time, and it sends a pretty bad message when you’re not.
More than 78% of the 38,605 people who responded to the same PayrollOrg 2023 survey mentioned above said that it would be challenging to meet their current financial obligations if their next paycheck was delayed for a week. Of that percentage, more than 49% said it would be very difficult and more than 29% said that it would be somewhat difficult.
But payroll isn’t just about your employees and contractors. There’s someone else you need to think about: The tax people. Regular payments keep the government satisfied, too. Just like an apple a day can keep the doctor away, being consistent with your payroll will help protect the health of your business. Why? Because every time you run payroll, you also make payments toward employee benefits, employee entitlements, and taxes.
No pain, no gain
“What is payroll” is actually a pretty involved question, isn’t it? If you’re feeling more overwhelmed than when you asked the question, take a deep breath. You aren’t alone. Nearly 5.5 million small businesses with one to 19 employees have figured this out, so you can do it, too. And there’s plenty of help available.
This complete guide covers every stage of the payroll process, including how to calculate it. Or take a closer look at how you can automate payroll through a dedicated service, which would handle payroll management as a whole, such as:
- Direct deposit
- Income tax withholding
- Other payroll deductions, including voluntary deductions (e.g. for retirement plans for healthcare) and mandatory ones (e.g., wage garnishments)
When you run a small business, many things are beyond your control. Fortunately, payroll isn’t one of them. By investing the time and energy to get your payroll system set up correctly, you can be confident you’re looking after your team and staying compliant with employment and tax laws. Dive into our expert recommendations and comparisons of affordable payroll software that can meet and streamline your needs. Without those two big weights on your shoulders, you and your employees should be able to accomplish some awesome things together.
