What Is Payroll (and How Can I Get It Right)?

Gusto Editors

Payroll is typically the single biggest expense for most businesses, and it can be hard to get it right consistently. In fact, SCORE says that more than 40 percent of small businesses make mistakes on their payroll each year — with an average fine of $850.

So how can you stay in the good graces of your employees and the IRS? It all starts by learning the payroll basics.

Just what is payroll?

Payroll is defined as the regular process of paying your employees and withholding employment-related taxes. 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, payroll can also refer to all your 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. 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 to check in with your friendly neighborhood accountant or to sign up for a reliable payroll service. But if you’re dedicated to DIY, there are standard Internal Revenue Service (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 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 Social Security, Medicare, and federal income taxes 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-MISCAlso 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 tying everything back to you. That’s why every employer needs an Employer Identification Number (or EIN). You can get one from the IRS in a few minutes.

It may feel like an alphabet soup, but staying on top of all these forms — and making sure the information is accurate — helps you avoid those penalties and fines down the line. See what to watch for in our crash course to avoiding payroll mistakes.

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 these three things:

1. Business is about people, not transactions.

Whether they’re focused on customer service, sales, or building a better mousetrap, everyone you work with is on a mission to keep your customers happy and watch your company grow. Customers won’t stick around if they feel they’re just a number, and neither will your team.

Put yourself in your employees’ shoes and ask what happens if your 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.

2. Money matters. A lot.

Lots of things can contribute to a great workplace and some of them cost nothing. But what people get paid still tops the list.

“Survey after survey indicates that the number one most important thing to employees about a job is salary,” says career coach Ashley Stahl. “And why shouldn’t it be? We all want to be paid what we’re worth.”

3. Timely payroll is a sign of strength.

Once you set a pay period, know that any inconsistency in payroll can sidetrack your workers with a blast of stress, feelings of insecurity, and worries about your business.

“Nothing causes employee morale to plummet faster than missing payroll,” says business owner and IT consultant Susan Ward. “Even though it may not be the case, most employees will immediately assume that the company is in financial difficulty and some may start looking for employment elsewhere.”

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 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. First off, you aren’t alone. Six million small businesses have figured this out so you can, too. And second, there’s a lot of help available. Find links above to get answers about every stage of the payroll process, or take a closer look into how you can automate payroll through a dedicated service.

When you run a small business, a lot of things are beyond your control. Fortunately, payroll isn’t one of them. By investing the time and energy to get your payroll set up correctly, you can be confident you’re looking after your team and staying compliant. Without those two big weights on your shoulders, you and your employees should be able to accomplish some awesome things together.

Looking for cost-effective payroll solutions for your business? Dive into our guide for expert recommendations and find affordable software that meets your needs.

Gusto Editors Gusto Editors, contributing authors on Gusto, provide actionable tips and expert advice on HR and payroll for successful business management.
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