Payroll is the process of paying employees and involves calculating the employee’s earnings, deducting payroll taxes, and distributing funds.
What are the components of payroll?
Payroll is typically one of the most time-consuming and costly business activities as it’s a complicated process and involves the following components:
Collecting employee information
Before an employer can pay an employee, they must ensure they have accurate information about the employee. For US-based businesses, this involves distributing IRS form W-4 to employees to collect information such as their address and social security number.
Calculating employee’s gross pay
Gross pay refers to the total amount the company owes the worker for the work done before any deductions. In other words, gross pay is the “before tax” earnings of the employee, also known as pre-tax earnings.
Payroll deductions relate to any funds removed from the employee’s paycheck and always include tax deductions. However, deductions may also go towards the following:
Employee benefits (retirement plans
Student loan repayments
Income tax withholding and reporting
As mentioned above, withholding employment taxes from an employee’s wages at the correct tax rate and paying them to the proper authority is essential to processing payroll.
In the US, employers must withhold federal income tax, state tax, and Federal Insurance Contributions Act (FICA) taxes (Social Security tax and Medicare tax) and make tax payments to the IRS.
Reimbursements include additional payments to cover an employee’s qualified purchases and expenses, such as travel, educational materials, or health insurance.
Maintain and distribute payroll records
Payroll records are the combined documents related to payroll that businesses must maintain for each individual they employ. Records include pay rates, total compensation, tax forms, deductions, hours worked, benefit contributions, pay stubs, invoices, and more. Record-keeping is essential for compliance with regulatory bodies.
Calculating employee’s net pay
Net pay, also called “take-home pay” is the term that describes the amount paid to the employee after all deductions.
Tracking employee time
Running payroll can involve keeping track of employee time during each pay period. Tracking time is particularly important for hourly employees that receive an hourly wage.
Calculating overtime pay
Depending on your company’s overtime policy and countries’ overtime laws, the payroll process may involve calculating extra earnings for employees that have worked overtime.
In the US, a company must pay nonexempt employees overtime if they work over 40 hours per week, as outlined by the Fair Labor Standards Act (FLSA).
How to manage payroll
A business can carry out payroll management in a number of ways:
In-house payroll: Companies with robust human resources (HR) departments can manage payroll manually internally or use payroll software to automate many of the payroll processes.
Outsourced payroll: Small business owners that lack the resources or large companies that wish to free their HR departments of time-consuming payroll administration can outsource payroll to an external payroll service provider.
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