Common frequently asked payroll questions and answers
Processing payroll means compensating employees for their work. It involves calculating total wage earnings, withholding deductions, filing payroll taxes and delivering payment. These steps can be accomplished manually, but an automated process is usually more accurate and efficient and may help you comply with various payroll regulations.
How do you manually process payroll?
If you’re a small business with only a few employees and choose to process payroll manually, you will need to keep precise records of hours worked, wages paid and worker classifications, among other details. You must also ensure your calculations are correct and remember to file all the necessary taxes and paperwork with government authorities on time. As you add more employees, the more challenging payroll becomes and any mistakes you make can result in costly tax penalties.
Payroll’s impact on cash flow
Even if you’re not paying someone else to do payroll for you, it’s still considered a business expense. This is because your employees’ wages and your share of payroll taxes cut into your profit margin. And if business slows down, you may be faced with the difficult decision of delaying payments or diverting money from other resources.
One way to limit payroll’s impact on your cash flow is to pay your people using direct deposit or digital pay options instead of paper checks. Because you don’t know when someone will cash a paycheck, it becomes more difficult to ensure you always have sufficient funds in your bank account. With direct deposit, you only need to cover the cost of payroll on certain days of the month, allowing you to better manage your finances. Plus, going digital cuts the expense of printing paper.
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Certain aspects of payroll processing are regulated by the Internal Revenue Service (IRS) and the Department of Labor (DOL). Some of the laws you must comply with include:
Fair Labor Standards Act (FLSA)
The FLSA entitles nonexempt workers to a minimum wage of not less than $7.25 per hour (effective July 24, 2009) and overtime pay at a rate not less than one and one-half times the regular rate of pay after 40 hours of work in a workweek. This means that you need an accurate means of tracking time and attendance so you can apply overtime wages in accordance with the law.
The FSLA also requires you to keep certain records for each nonexempt worker. Payroll records, for example, typically include hours worked each day, total hours worked during the workweek, the basis on which employee wages were paid, regular hourly pay rate, total overtime for the workweek, date of payment and the period covered, and total wages paid each period. These records must be kept for at least three years and the records on which payroll calculations are based, such as time cards, need to be kept for two years.
Federal Insurance Contributions Act (FICA)
FICA requires that a portion of every employee’s gross earnings help pay for Medicare and Social Security benefits. Each pay period, you must deduct 6.2% for Social Security tax (until the wage base is met) and 1.45% for Medicare tax. You’re also required to match these deductions, which brings the total FICA tax per employee to 15.3%.
Federal Unemployment Tax Act (FUTA)
Most employers contribute to the federal and a state unemployment programs that compensate workers who have lose their jobs. As such, FUTA is not a payroll deduction because it only applies to employers, not employees. To comply, you must pay 6% in taxes on the first $7,000 you pay an employee in a year. Exemptions may apply, however, if you have household or agricultural workers.
Payroll processing state by state rules and regulations
In addition to federal regulations, you must abide by state payroll processing laws. Each state has its own rules, some stricter than others, governing minimum wage, payday schedules and recordkeeping. So, if you’re conducting business across state lines, your payroll compliance becomes that much more difficult.
A good way to stay compliant is to task an executive or someone from your legal department to compile a list of all the labor laws that apply to your organization. Ask that he or she track changes to existing laws and document any new laws being proposed. Review these findings on at least a monthly basis so you can adequately adapt your operations and avoid penalties.
Apply for an EIN
An employer identification number, also known as federal identification number, is a nine-digit number (format: 00-0000000) the Internal Revenue Service (IRS) uses to track your organization for tax purposes. Think of it as a Social Security number for your business. You can apply for an EIN free of charge online or by sending Form SS-4, Application for Employer Identification Number (EIN) to the IRS. Once approved, it can’t be cancelled and will stay associated with your organization for as long as you stay in business. Some state and local governments may also require you to have a separate tax identification number.
Documents required for payroll
Before you begin processing payroll, you generally need to gather these documents, some of which may be required by government agencies:
Form W-4, Employee’s Withholding CertificateOn their first day of work, new hires usually complete a Form W-4, Employee’s Withholding Certificate, which you will use to deduct the correct amount of federal income tax from their pay. Although not required, your employees should fill out a new form each year if their personal or financial situation changes.
Form W-9, Request for Taxpayer Identification Number and CertificationIf you hire freelancers, or independent contractors, you should ask them to provide their name, address and Social Security number or tax identification (ID) number on a Form W-9, Request for Taxpayer Identification Number and Certification. This document is for your records and does not get sent to the IRS. At the end of the year, you will use the information on the W-9 to file a Form 1099-NEC, Nonemployee Compensation, which shows how much you paid independent contractors.
Form I-9, Employment Eligibility VerificationIn the United States, use Form I-9, Employment Eligibility Verification to verify the identity and employment authorization of any individuals you hire. Employees must fill out this form on their first day of work. Once they do, you have three business days to complete and sign Section 2. Employees also need to present identification documents, such as a passport or driver’s license, and must attest to their employment authorization. Forms I-9 do not get sent to a government agency unless requested by an authorized representative.
Job applicationAlthough candidates often supply a resume, job applications help you obtain consistent information about potential new hires. Most require a signature, verifying the accuracy of the details, which you can use to start preparing a payroll record for anyone you decide to hire.
Bank informationIf you plan to offer direct deposit, you will need your new employees to provide you with the name of their bank and an account number and a routing number. Or, they can supply a voided check.
Medical insurance formsYou may have the best intentions and truly care about your employees’ health, but you can’t deduct insurance premiums from their pay without first obtaining written authorization.
Retirement plan documentsLike health benefits, retirement plans are a voluntary payroll deduction and require an employee’s signature before you can withhold contributions to a 401(k) or other retirement account.
How to classify workers
In order to comply with federal payroll tax laws, you need to properly classify you workers as either employees or independent contractors. The general steps to do this are:
- Assess the nature of the work being done.
A worker may be an independent contractor if you have the right to control or direct only the result of the work, not what will be done and how it will be done. If you control both what will be done and how it’s done, the worker is usually an employee.
- Determine if payroll deductions apply.
Withhold income tax, Social Security tax and Medicare tax only on wages paid to employees, not independent contractors. These types of workers pay self-employment tax on their income.
- File Form W-2, Wax and Tax Statement with the IRS for employees.
Include all forms of compensation paid to employees, including wages and tips, as well as the taxes that were withheld.
- File Form 1099-NEC, Nonemployee Compensation for independent contractors.
You generally must report payments of $600 or more to nonemployees. The completed form gets sent to both the IRS and the worker.
Pay particular attention to details when determining a worker’s status. Misclassifying a workers can result in penalties and you may be responsible for any unpaid wages, including overtime. If you need help determining the status of a worker, you can submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to the IRS.
What is a typical payroll cycle?
The most common payroll cycle or pay period in the United States is biweekly. See how it compares to other payroll frequencies:
|Payroll Cycle||Paychecks Per Year|
Payroll schedule considerations
Payroll schedules are a matter of preference, but minimum standards may apply. Some states require at least semimonthly payments for all employees, while others have specific frequencies for different types of workers. If you are not bound by state payday requirements, you can choose whichever pay period works best for you and your workers. Employees, especially those in low-wage jobs, usually prefer to be paid more often, but as your pay frequency goes up, so does your payroll processing costs. You’ll need to carefully weigh the expectations of your workforce and your budget and comply with all state laws.
Create a payroll policy
To ensure that your payroll is accurate, processed timely and in accordance with all regulations, you’ll need to establish guidelines with both your employees and your payroll department. A typical payroll policy covers:
Clearly defined workweeks are necessary to comply with FSLA overtime rules, as well as state wage payment requirements. You can choose when your workweek starts and ends, but they typically must constitute seven consecutive 24-hour periods.
Time and attendance
Accurate payroll begins with precise timekeeping. Your employees should know how to log their hours – time clock, paper timesheets, etc. – the approval process, and disciplinary action for submitting false records.
The federal government does not require lunch or meal breaks, but most states do. When offering rest periods, clearly define their length and let employees know if the break is paid or unpaid and if they need to clock their time.
Explain who is eligible for overtime pay and how the rate is applied. Nonexempt employees covered by the FSLA must be paid no less than minimum wage for all hours worked and at least one-and-a-half times their regular pay rate for each hour worked over 40 in a workweek. If your state also has overtime regulations, you must follow the law that provides the most generous benefit to the employee. For example, California requires one and one-half times an employee’s regular rate of pay for all hours worked over eight hours in any workday and over 40 hours in the workweek. Additionally, CA has a requirement for the payment of double time, which is not required by the FLSA.
Document how often you will pay your employees. Weekly, biweekly and semimonthly are the most common. Also note which specific day of the week will serve as payday.
Mandatory payroll deductions
Make clear all the federal and state taxes that will be deducted from your employees’ paychecks. Include information on the forms they need to complete to get their withholding amounts correct and how wage garnishments work.
Voluntary payroll deductions
If you offer your employees health insurance or retirement plans, explain the costs and how they can participate. Also provide information on paying for benefits on a pre or post-tax basis.
Be transparent about the different ways employees are compensated at your business, whether it’s hourly pay, salary, bonuses, commission or stock options. In addition, pay careful attention to state laws covering the payment of final wages to those who leave your organization.
The FSLA and state authorities require payroll records to be kept on file for certain periods of time. Document the recordkeeping laws that apply to you and how you will maintain confidentiality.
Designate a payroll manager
Every business needs someone to administer payroll. You can hire an employee specifically for this purpose, but in most cases, the role is filled by an office manager, human resources director or even the owner. As a result, many payroll administrators have responsibilities beyond simply running payroll. They’re often tasked with providing customer support and answering employee questions, analyzing the payroll system, keeping up with regulatory issues, working with auditors, and troubleshooting technical errors.
Those who excel as a payroll manager have a specific skill set. They tend to be detail-oriented, organized, analytical and technically inclined. Their success, however, requires the collective teamwork of employees, managers and the human resources department. For example, workers must submit accurate information and managers need to promptly approve timecards in order for payroll to be processed correctly and timely.
Track employee time and attendance
How your payroll administrator manages time and attendance – whether it’s a time clock, a mobile app or a pencil and paper – is entirely up to you. Keep in mind, however, that doing it manually opens the door to human error. You can help eliminate many of these mistakes, speed workflows and make the payroll manager’s job easier by using an automated time and attendance solution that integrates with payroll.
As an employer, you’re responsible for calculating and withholding money for federal, state and local taxes from every employee’s paycheck. The amount you withhold is determined by the Forms W-4 submitted by your employees and current tax rates. In addition, the United States government requires that you pay federal unemployment tax (FUTA) and match what your employees pay in Social Security and Medicare taxes.
Withhold additional payroll deductions
Employees can choose to have you withhold money from their paychecks to fund retirement plans and insurance premiums. Each of these requires a separate consent form. Sometimes, you must also withhold deductions for court-ordered garnishments, such as child support and alimony.
Pay statement compliance
Most states require you to provide a pay statement in either print or electronic format at the time wages are paid. Some laws allow employees to opt in or out of electronic statements and you may have to ensure they are able to easily view or print their pay information.
The goal of these regulations is transparency. The hourly rate, total hours worked, gross pay, net pay and deductions are usually required details. Avoid violations by contacting state labor departments for specific pay statement guidelines.
How to issue paychecks
You can purchase check stock from the bank that has your payroll account or a stationary supply store. When placing your order, make sure that the check stock is designed to prevent fraud, uses ink that can be interpreted by bank check readers and has all of the necessary information. Most will display your business name, the employee’s name and address, the check number and date, and the bank’s name and address. Once the checks are printed, seal them in a double-window envelope so that the destination and return addresses are visible, apply the appropriate postage and put them in the mail. This process can be simplified by using a payroll service, which in some cases, includes paycheck delivery.
Direct deposit vs. pay cards
Printed paychecks were the tried and true method of compensation for many years, but thanks to technology, there are more efficient and less expensive ways to pay your employees. Two such methods in use today are direct deposit and pay cards.
Direct deposit electronically transfers money from your payroll bank account to the personal bank account of an employee. The transaction is instantaneous and most banks don’t charge for it. For these reasons, direct deposit has surpassed printed checks as the preferred method of payment. However, employees must have a valid bank account and it can sometimes take up to two weeks to set up.
A more recent payment option that’s growing in use are prepaid debit cards or payroll cards. They’re ideal for workers who don’t have a bank account, but still want immediate access to their pay.
Whichever wage payment methods you choose to offer to your employees, be sure to review all state-specific requirements. Most allow electronic payment, but it generally cannot be the only option.
How can I improve my payroll process?
Long hours spent on administrative work and responding to letters from the IRS or court orders for wage garnishments are tell-tale signs that your payroll process could use some improvements. Here are some tips to streamline your operations:
- Unify your pay periods
Paying different types of workers on different schedules (i.e. paying hourly employees weekly and salaried employees semimonthly) complicates payroll. Find a pay period that complies with state laws and works best across your entire workforce.
- Invest in payroll software
The automated features available in payroll software eliminate repetitive tasks, like manual data entry. This reduces errors, saves time and improves compliance.
- Integrate your payroll with other processes
Many types of payroll software can be seamlessly integrated with time clocks and accounting ledgers. When these operations are in sync, you may have more accurate payroll calculations.
- Use digital timekeeping solutions
Paper timesheets often lead to mistakes. Time tracking software uses biometric identification to prevent fraud and automatically calculates the hours worked.
- Keep current with regulatory requirements
Laws governing payroll and employment are constantly changing. Staying informed of the latest legislation will help you maintain compliance and avoid expensive penalties.
- Work with a payroll service provider
Often, the surest way to improve your payroll process is to work with a provider who can handle all aspects of payroll on your behalf. You may have peace of mind knowing that your employees are paid on time and your taxes are prepared correctly.
Payroll processing FAQs
See what other employers are asking about payroll processing:
How long does payroll take to process?
The method you choose to process payroll will determine how long it takes. Manual calculations can take hours to days, depending on how many employees you have and the laws that you must comply with. If you’re a large business that operates across state lines, processing payroll this way is usually unfeasible. A more efficient approach is to use payroll software, which can run payroll in minutes thanks to automation.
What is full-cycle payroll processing?
The amount of time in between each pay day is known as a payroll cycle. It can be as short as a week or as long as a month. During this period, several repeatable steps take place:
- Employees work and track their hours
- Gross pay is calculated based on hourly wage
- Taxes and other deductions are withheld from wages
- Net pay is delivered to employees via paycheck, direct deposit or pay card
What is end-to-end payroll processing?
End-to-end payroll processing integrates payroll with other aspects of workforce management, such as performance measurement, training, scheduling, benefits and compensation. By making this connection, you can improve communication, recordkeeping, analytics and efficiency throughout the employee life cycle.
Why is the payroll process important?
Payroll processing is important because paying employees late or filing taxes incorrectly may result in penalties and interest on back taxes. Payroll that’s unreliable can also hurt employee morale and tarnish your business reputation. When you consider these ramifications, it’s often best to dedicate the necessary resources, whether it’s time or money, to make sure you get payroll right.
What is needed to process payroll?
A payroll process must be in place before you hire your first employee. You generally will need to:
- Apply for a federal employer identification number (EIN)
- Obtain state and local tax identification numbers, if applicable
- Gather employee tax documents (Form W-4, Form I-9 and Form W-9)
- Open a bank account specifically for paying employees and taxes
- Hire or designate a payroll manager
- Develop a payroll schedule
- Create a company payroll policy
What are the types of payroll processing?
When it comes to processing payroll, you have several options to choose from, depending on the size of your business and individual needs. The most common are:
- Do it yourself (DIY)
- Outsource payroll to an accountant
- Purchase payroll software
- Work with a managed payroll provider
This guide is intended to be used as a starting point in analyzing an employer’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
Tax figures provided are as of the 2020 tax year.