Payroll Processing Explained w/ Detailed Steps

Payroll processing encompasses preparing employee compensation, including calculating their gross and net salaries and wages, withholding taxes, overtime pay, PTO, and other deductions.

Understanding the importance of establishing a systematic process for preparing payroll is one secret to earning the trust of your employees. When employees trust your management, open communication and better cooperation at work ensue.

So, if you’re eager to improve your payroll management process, this article is the perfect guide.

Key Takeaways

• The meaning of payroll processing is defined as the steps or methods involved in preparing and managing employee compensation, benefits, and taxes.
• An efficient payroll processing system requires employers to acquire an EIN, collect employee tax information, calculate gross salaries, taxes, and applicable deductions, choose a suitable payment method, and keep payroll records organized.
• Some of the best strategies for managing payroll include adjusting payroll policies as needed, seeking professional advice, using online tools and payroll software, creating individual employee files, and staying up-to-date with labor laws.

What is Payroll Processing?

Payroll processing is a series of steps in compensating employees. It is akin to a set of guidelines employers must follow to ensure 100% accuracy in calculating salaries, wages, and deductions.

Typically, businesses begin processing payroll upon the completion of a pay cycle or period. A pay period comprises the total work hours rendered by each employee and any adjustments, such as overtime pay, PTO, or bonuses, applied to the employee’s earnings.

Payroll policies may vary according to the size of the business or industry type. Some companies use payroll software to streamline their HR and payroll processes, while others prefer hiring professionals or outsourcing their human resource operations.

Companies can also choose to use a combination of both manual and automated payroll management tools.

Either way, a smoothly implemented payroll process guarantees that the correct net salaries are disbursed into employee’s accounts and that the percentages withheld to pay employees’ taxes are accurate.

More importantly, it prevents businesses from making mistakes when preparing their budgets and reviewing their expenses for the previous and upcoming quarters.

8 Steps on How to Process Payroll

The following steps describe the fundamental components needed in payroll processing. You can follow these steps as is or modify them to suit your business and perfect your company’s payroll process:

Step 1: Acquire an Employer’s Identification Number (EIN)

Acquiring an Employer’s Identification Number is a must if you meet any of the following conditions:

• Hire employees to work in your company or organization
• Withhold percentages of income and wages to pay taxes
• File tax returns annually
• You own a business that is a corporation, a partnership, or LLC
• You’re a sole proprietor

Your Employer’s Identification Number (EIN), or Federal Tax Identification Number, is a unique nine-digit identifier assigned to your business. It is vital for reporting business taxes to the IRS.

You can also register for an EIN if you are changing businesses or opening a new one. When registering for a Federal Tax Identification Number, you must complete Form SS-4: Application for Employer Identification Number.

The IRS lets businesses register for an EIN through their website.

Step 2: Collect Employees’ Tax Information

The next step is to gather each employee’s tax information. Each employee has a different tax situation, particularly in terms of their tax brackets and filing status.

Similarly, some employees may qualify for specific tax deductions, particularly if they have dependents or happen to be working students. It is essential that newly hired employees fill out Form W-4, Employee’s Withholding Certificate.

Your HR and payroll departments should also routinely check for any necessary updates on your tenured employees’ tax information. Form W-4 helps employers determine the correct federal amount to withhold from employees’ wages and salaries.

Step 3: Choose a Payroll Schedule

A payroll schedule determines the frequency at which you disburse salaries and wages to your employees and sets the pace of your entire payroll processing setup.

There are four payroll schedules to choose from, namely:

• Weekly payroll. It entails paying your staff at the end of each week and yields 52 paychecks annually.

• Biweekly payroll. A biweekly payroll compensates employees twice a month or every other week. Workers paid biweekly receive a total of 26 pay stubs in a year.

• Semimonthly payroll. Also called a bimonthly payroll, it pays employees twice a month. Unlike a biweekly pay cycle, a semimonthly payroll compensates your staff every 1st and 15th or 15th and last day of the month.

• Monthly payroll. In a monthly pay schedule, your business releases salaries once a month or 12 paychecks per year.

Note that choosing a pay schedule also means taking note of specific payroll deadlines and aligning your operations with critical due dates set by the IRS and government labor agencies.

Step 4: Develop Payroll Policies

After choosing a payroll schedule, you must focus on establishing guidelines or policies that will help keep things in order and govern your payroll processing practices.

Typically, your policy should elaborate on the following factors that comprise your payroll:

• Your employees or workers’ pay rates
• Voluntary and obligatory payroll deductions
• Tracking employee attendance and work hours
• The total number of regular work hours expected from your staff each week
• Tracking and updating overtime hours or paid time off
• State and local labor regulations concerning your payroll processing practices

Step 5: Calculate Gross Salaries

Calculating gross salaries with precision prevents mistakes in determining your staff’s net salaries. Your employees’ gross earnings are their total income earned before taxes,andvoluntary deductions are subtracted.

Note that gross wages for hourly workers differ from salaried staff's gross income. Hourly employees are paid per hour, while salaried staff are paid a fixed rate.

Here’s a pro tip: Use online tools such as a pay stub generator to help manage your payroll processing steps, particularly when calculating each staff member’s hourly or salaried gross pay.

Use this formula to calculate the gross wages of hourly workers:

If an employee’s hourly rate is $14.18 and they complete 20 work hours in a week, then following the formula above, you should calculate their hourly wage as follows:

On the other hand, here’s the formula to determine salaried gross income:

Let’s say an employee earns $58,000 per year and is paid monthly, equivalent to 12 pay periods. Then, using the formula above:

Step 6: Subtract Taxes & Deductions

An integral step in your payroll processing involves subtracting federal, state, and local taxes and voluntary deductions from workers’ salaries and wages. Calculating and withholding the correct taxes and deductions on your employees’ gross earnings is just as important.

Taxes

When processing your payroll, you should consider two types of taxes: payroll taxes and income taxes. Payroll taxes include FICA (Medicare and Social Security taxes), FUTA (Federal Unemployment Tax Act), and SUTA (State Unemployment Tax Act).

Employers and employees share FICA tax payments, paying 2.9% each for Medicare and 6.2% each for Social Security taxes. FUTA taxes are covered solely by employers and are imposed on the first $7,000 worth of earnings paid to each employee.

Employers also shoulder the payment for SUTA taxes, although not all states impose the said type of tax.

Income taxes include federal, state, and local taxes. State income tax rates differ by state. Not all locales levy local taxes on employees or businesses.

Voluntary Deductions

Voluntary deductions include the different benefits and insurance coverage that your business offers to your employees, namely:

• Retirement benefits
• Health insurance premiums
• Group term life insurance
• Union dues

Step 7: Decide on The Payment Method

In choosing a payment method to send employee payments, consider the convenience, preferences, and security of your business and your staff. Some of the most common payment methods used by companies include:

• Direct deposit. This payment method involves depositing employee salaries and wages directly into their bank accounts. It also entails creating a direct deposit pay stub for transparency purposes.

• Cash payments. When workers are paid in cash, their salaries are placed in individual envelopes with a label enumerating their total earnings for the pay period.

• Bank or paper checks. Some small businesses and midsized enterprises compensate employees by using or printing paper checks. This is more manageable and leaves a paper trail for easier tracking of payroll expenses.

• Mobile payments. Also called online payments, this method sends salaries electronically through a payment gateway.

• Payroll card. Payroll cards are prepaid debit cards distributed to employees, where employers deposit salaries and wages every payday.

Step 8: Maintain Organized Payroll Records

Keeping your payroll records organized and well-secured prevents the loss of your business’s financial data. Your payroll records also come in handy when reviewing your accrued payroll and operational expenses.

At the same time, you can use your payroll records to assess how to improve your payroll processing practices.

For instance, you might observe discrepancies in updating your employee’s remaining paid time off, thereby underscoring the need for a more efficient system to monitor PTO hours.

Ideally, you must store printed and electronic copies of your payroll documents for backup and to maintain the confidentiality of your employees’ and businesses’ personal and financial information.

5 Best Strategies for Effective Payroll Processing

Now that you know the integral steps in processing payroll, we’ve compiled some of the most effective strategies that will help improve and streamline how you manage your company’s payroll:

#1. Adjust Payroll Policies

Expect that there are bound to be changes in existing labor laws and IRS tax regulations that may directly affect your existing payroll processing guidelines.

For instance, a startup may settle with using payroll services for one employee but may have to consider expanding its HR and payroll practices as the need to hire more workers arises.

Adjusting your payroll policies to accommodate industry changes and modern workforce demands is suitable.

Make sure to have the changes in your guidelines reflected in your company or employee handbook. Also, inform your HR and payroll staff of any updates and convey the information concisely to your employees.

If possible, explain the policy changes and allot time to address your staff’s concerns and queries.

#2. Consult With an Accountant

Consult with an accountant or a payroll professional to make more objective and informed decisions about how to regulate your payroll processes.

Accountants, tax, and payroll experts are well-versed in federal, state, and local regulations on managing employee compensation.

You can also have them review your existing payroll guidelines and point out specific areas and factors where your policies may be lacking efficiency or need more polishing to make them work.

#3. Create Individual Employee Files

Take the time to prepare individual files for your workers or staff. Each employee’s files must contain their resume, application form, Form W-4, Form I-9, documents detailing their benefits, and employment contract.

In this manner, it will be easier to update their tax information and employment records later on.

For instance, if an employee wants to add a dependent, they must update their Form W-4 and fill out the necessary forms, along with claiming a dependent.

Similarly, when employees are promoted or laterally transferred to a different department, HR must prepare a new contract reflecting the change in their work status and job role.

When workers leave their jobs, they may also contact their former manager and request copies of their last paychecks. This will make it easier for the Human Resources department to sift through the records of past employees and find the requested documents.

#4. Use Pay Stub Generators

Pay stub generators allow you to create multiple pay slips in one sitting. It is a cost-efficient tool that suits startups and midsized enterprises.

Paystub.org offers a generator with ready-made templates and a built-in calculator, making it easier to fill out each staff member’s paycheck information.

Since the essential fields, such as their name, personal details, and information about their taxes and salaries, are already outlined, you also refrain from misspelling employees’ names, inputting the wrong payroll dates, or miscalculating gross and net earnings.

Once the pay stubs are ready, you can either download a PDF copy and upload the file to your employee portal or print a physical copy.

#5. Automate Your Payroll Process

In addition to a paystub generator and other practical online tools, payroll or bookkeeping software can help you automate your payroll processing steps.

Payroll and bookkeeping software help reduce payroll errors by streamlining tax and salary calculations, organizing payroll data, and generating payroll reports.

Some software providers offer additional features for tax support, HR management, reporting and analytics, and employee self-service.

Final Thoughts

Payroll processing is indeed a tedious task. It may even take a couple of trials and errors or require spending more money to establish a solid payroll management process.

But, if you’re a responsible employer and business owner, you would know that polishing your payroll policies and methods means adhering to your employees’ labor rights.

Furthermore, a well-oiled payroll management process protects your business’s finances, reduces employee turnover, and boosts your company’s reputation.

Did you enjoy reading this article? Check out our informative guide on the best payroll tips and strategies for 2024 to expand your HR and payroll management knowledge!