Fortunately, payroll doesn’t have to be difficult. With a bit of preparation and the right software, you can automate your entire business’s payroll. Find out exactly how to do payroll today in our complete guide.
There Are Three Ways to Do Payroll
Today’s businesses typically do payroll in one of three different ways:
- Manual (do-it-yourself method)
- Hire a part-time accountant
- Use a payroll software solution
You can also have some combination of the three methods. Some businesses bundle payroll software with accounting software, for example. Or, you can bundle basic payroll software with a part-time accountant.
Payroll software is the most popular option for today’s small and medium-sized businesses, although larger businesses often require full-time accountants or accounting departments.
With payroll software, you typically pay a base rate (say, $20 to $50 per month) as well as an extra cost per employee (say, $2 to $5 per employee). It’s more expensive than doing payroll yourself, but significantly less expensive than hiring an accountant (or hiring a full-time accountant).
Of course, some people genuinely prefer the DIY method of manual payroll. This can be an ideal option for small businesses with fewer than, say, 5 people. However, many people will still feel like they can save time and money by using payroll software.
Three Basics Parts of “Doing Payroll”
There are three basic jobs you need to accomplish when “doing payroll”:
1) Paying Employees: Do you pay them every week, every other week? Every month? This part of the job requires you to add up employees’ hours, calculate their earnings, and withhold the correct amount of taxes and deductions from each paycheck.
2) Paying Payroll Taxes: The government needs payroll taxes to pay for critical services. When doing payroll, you need to pay the government the correct amount of state and federal tax along with any payroll taxes owed by your business.
3) Filing Tax Forms: The IRS needs plenty of forms, and you’re required to fill and submit all of these forms in a timely manner. Most businesses file quarterly forms to the IRS, although some choose to do it monthly or yearly.
How Does Payroll Software Work?
All payroll software works in basically the same way. Payroll software lets you do all of the following using either a web-based interface or desktop computer software:
- Calculate gross pay for employees
- Calculate employee take-home pay, which is the amount they earn after income tax, FICA, health insurance deductions, retirement fund payments, child support, etc.
- Pay employees by printing out checks or sending out direct deposits
- Fill out and submit required paperwork for local, state, and federal income tax reports
- Submit electronic payments to the tax authorities
On your end of things, you basically just enter employee information and the number of hours they work each week (or their salary). Then the payroll software does most of the hard work for you. The most time-consuming part of most payroll software is entering your company information in the first place.
Of course, not all payroll software programs are built equally. Some payroll software won’t submit electronic forms to the IRS, for example, which means you’ll need to do that on your own quarterly, monthly, or annually.
Not all software will even calculate local tax, which means you could have to enter your own deductions for state tax or other region-specific tax codes.
How to Keep Track of Employee Hours for Payroll
Keeping track of employee hours is one of the biggest struggles for business owners. Do you make employees enter a time card every morning? Do you track computer logins? Do you trust them to honestly enter their daily hours?
Well, there are a number of different ways to track employee hours.
Some payroll companies actually comes with built-in self-reporting tools for employees. Employees basically receive access to a basic payroll software account that lets them add their own hour information. Then, at the end of each payroll period, the manager takes all of that information and runs it through the form to create paychecks.
If your payroll software doesn’t have this feature (or if you’re not using payroll software), then there are other basic methods available. Dovico.com has a number of free employee time sheets available at its site, for example.
You can also use free web-based clocks like Time Clock Free, which also lets employees track hours using mobile devices.
How to Deal with Overtime
Payroll software is adept at dealing with overtime. The main problem with overtime is tracking it in the first place.
To start, you may owe employees overtime if they work more than a certain number of hours in a certain week (the specific number varies from state to state).
Most companies in America are required to pay employees 1.5 times per hour for overtime pay.
If your company is covered under federal labor laws (federal labor laws cover companies with over $500K in sales and/or companies involved in inter-state commerce), then you’re required to pay 1.5 times the employee’s hourly rate for every hour that employee works per week over 40.
For example, an employee who gets paid $30 per hour would get paid $45 per hour for every hour they work past 40 hours in a given week.
Certain states also have daily overtime pay, where employees who work over 8 hours per day are eligible for overtime pay after 8 hours. California, for example, works this way.
Instead of explaining every state’s overtime laws, I’ll reference this guide that explains each state’s unique overtime laws.
Generally speaking, employees who work over 40 hours per week in the United States are eligible for overtime pay. The main exceptions to this rule are employees with managerial duties who have a fair degree of decision-making power. These employees are typically exempt from overtime pay requirements.
There are plenty of specific differences between employees and their overtime classifications. For example, executive employees must make at least $455 per 40 hour work week to be considered “executive employees”. The best way to learn about exempt and non-exempt employees is to read this guide from a CPA.
How Do Vacation and Sick Days Work When Doing Payroll?
Employers vary widely in terms of the way they handle vacation days and sick pay. It’s up to each company to define their company-wide vacations and sick days and then stick to that system.
Most payroll systems let you record vacation and sick days over time. Once an employee goes over their allotted number of vacation and sick days, then they may start receiving deductions from their pay.
One of the most important jobs performed by payroll systems is calculating deductions. When calculating payroll, American employers must deal with both mandatory deductions (income taxes and FICA) as well as voluntary deductions. Here’s how those deductions work:
Employers must deduct federal income tax from employees’ wages. The amount of income tax deducted depends on how much that employee earns. You can determine how much income tax to deduct from your employee using their IRS form W-4, which lists things like the marriage status and exemptions. You withhold either a percentage of your employee’s wages or a set amount based on the tax tables found in IRS Circular E, Employer’s Tax Guide. You can view a detailed explanation of how much payroll tax you can be expected to pay at this guide at BeBusinessed.com.
Social Security taxes are another critical part of US payroll tax deductions. The Federal Insurance Contributions Act (FICA) requires these payroll taxes to be collected to fund various Social Security initiatives (primarily retirement and disability programs). Both the employer and the employee are required to pay Social Security for each employee. The tax rate as of 2015 is 6.2% for the employer and 6.2% for the employee for a total of 12.4%. You only have to pay Social Security up to a certain wage limit. As of 2015, that wage limit was $118,500. Income earned beyond that amount is not subject to the 6.2% charge.
In addition to paying 6.2% as part of FICA, you’re required to deduct an additional 1.45% from each employee for Medicare. Once again, this 1.45% is covered by both the employer and the employee for a total of 2.9%.
Federal Unemployment Taxes (FUTA)
Employers are required to report and pay FUTA, which is used to finance state unemployment programs. Employers are required to report and deposit employment taxes quarterly using Form 941 Employer’s Quarterly Federal Tax Return.
Voluntary deductions vary from company to company. Some sample voluntary deductions include:
- Contributions to an IRA, 401k, or other retirement plan
- Health insurance premiums
- Job-related expenses, like employee equipment, meals, uniforms, training fees, or union dues
- Life insurance premiums
Depending on the type of deduction, these can be deducted before or after the rest of the taxes. Payroll solutions can easily handle a diverse range of voluntary deductions and categorize them into the appropriate categories.
Payroll Reporting Requirements and Payments
After calculating payroll, your job isn’t over yet. You need to meet certain reporting requirements and payment submissions. You also need to report and submit in the required timeframe. Required paperwork includes:
- Annual federal unemployment tax return (form 940 or 940EZ)
- Employer’s quarterly payroll tax return (form 941)
- Annual Return of Withheld Federal Income Tax (Form 945)
- Wage and Tax Statements (Form W-2)
Intuit actually has a very detailed article that tells you when you’re required to submit these forms. Check out that article here.
Three Most Common Problems When Doing Payroll
If you’re doing payroll for the first time, then you might run into some of these common payroll pitfalls, including:
1) Errors: You can get errors at every step of the payroll process. Maybe you mess up employee hours or wages, for example. Maybe you forget about health care deductions or incorrectly deduct taxes. Expect to deal with plenty of errors until you become more familiar with whatever payroll system you’re using.
2) Deadlines: Each business has a responsibility to keep up with federal and state tax deadlines. You can keep track of these deadlines at the IRS website or let your payroll software automatically submit everything for you on time.
3) Penalties: Eventually, it’s going to happen. You’ll make a small (or large) error and your business will be assessed a penalty. Some payroll software companies are actually so confident in their payroll abilities that they will guarantee you protection from any tax penalties. They’ll even pay those tax penalties for you up to a certain amount!
Which Payroll System is Best for You?
So far, we’ve talked about three main types of payroll systems. However, there are really five main types of payroll methods available to businesses today. Here’s a brief overview of all those methods along with their unique pros and cons:
When you calculate payroll manually, it’s just you using a pen and paper (or more likely, spreadsheet software on your computer).
Pros: Manual payroll is the most affordable payroll method. It gives employers the greatest level of control over employee payments. It’s also the system that many employers are most familiar with.
Cons: It’s almost always the most time-consuming payroll method. It also requires more work and has the highest chance of errors.
Payroll software is desktop or web-based software that lets you run payroll through a software program every week to automatically calculate all deductions and payments.
Pros: You still have control because you’re doing it yourself, but the software takes away a lot of the hard work. You can have complex calculations performed with just a few clicks and it’s significantly faster than manual payroll processing.
Cons: All software comes with a learning curve, and some learning curves are steeper than others. You also need to make bank deposits and report and file taxes (although some payroll software does this for you). Payroll software varies widely from company to company. Some payroll software files electronic forms to the IRS on your behalf, while other software does not. You may also have to calculate local taxes independent of your payroll software (this is more common for cheaper, barebones payroll software providers).
We recommend Intuit Enhanced Payroll:
Payroll & Accounting Software Bundled Together
Companies like Intuit bundle their QuickBooks software with payroll software to make the lives of business owners significantly easier.
Pros: Total control over your business’s finances because you still do everything yourself – you just have the help of two software programs. Your payroll expenses update automatically in QuickBooks, which means you never have to worry about double entries. There’s also a shared liability with many payroll and accounting software bundles, which means the payroll company will take responsibility for any penalties you’re assed.
Cons: Steep learning curve and a higher price than just buying payroll software on its own (although some bundles make the price difference fairly small).
Paying an Accountant
You can pay an accountant (either part-time or full-time) to help with your payroll and payroll tax filings. Some smaller businesses contract this work out to an accounting firm, while other larger businesses have a full-time accountant or even a team of full-time accountants.
Pros: Payroll duties are delegated to someone else, along with the tax responsibilities. Accountants also know their business better than anyone.
Cons: Minimum control over your business’s finances. Accountants are also more expensive than any other method (even the cheapest, part-time accountants!).
Full Service Payroll
This is like having payroll software, except you also have a human payroll specialist who works with you to handle your payroll and tax responsibilities.
Pros: Most full service payroll providers will cover all tax penalties. You also have direct access to your account just like you would have if you were working with payroll software on your own. You can also save time while still handling all deposits and filings on your own. Basically, someone does payroll on your behalf with minimum work on your hand. You just give your payroll specialist the data (like employee hours and pay) and they do the rest.
Cons: Some vendors require you to give up nearly full control of your account (as much as you would give up when working with an accountant). This is also the second most expensive option behind only working with a full-time accountant.
Most Popular Payroll Software Available Today
There are dozens of free payroll software programs available today, but only a few are really worth your money. Here are the 5 most popular options you might want to consider for your small business:
Intuit Online Payroll
Intuit started out by dominating the accounting software industry and now they also dominate the payroll industry. Intuit Online Payroll synchs perfectly with Intuit QuickBooks. Since QuickBooks has an 85% to 90% market share, this is a very appealing solution to many business owners (although all other major payroll software also synchs perfectly with QuickBooks).
Some of the key advantages of Intuit Payroll include its low price tag ($20 to $99 per month plus $2 per employee). There are three different tiers of service depending on how comprehensive your payroll services need to be. You can also sign up for a 30 day free trial to check out Intuit for yourself.
Patriot Pay from Patriot Software is specially designed for businesses employing up to 50 employees. The company sells software packages that include all the bookkeeping services you need for your business, including tax services, hiring databases, and accounting software.
In recent years, Patriot Pay has built support for most operating systems and apps, including iPhone and Android devices. Like Intuit, Patriot Pay comes with a 30 day free trial. Plenty of add-on services are available for extra fees, including tax services and employee time tracking.
The software system is priced between $10 and $33 per month.
Priced at an affordable $89 per year, ezPaycheck Payroll claims to be the best system for people who have no professional accounting training and run a business with fewer than 10 employees. This is the most barebones payroll software on this list – so don’t expect anything too fancy. But if you want software that calculates payroll taxes, prints tax forms and paychecks, and supports customized wage systems, then ezPaycheck Payroll can do all of those things.
CenterPoint Payroll is the solution for larger businesses. Starting at $795, CenterPoint Payroll is a customizable system available for a one-time fee. That system offers direct deposit, electronic tax filing, and customized wage calculations among other features.
Businesses appreciate CenterPoint Payroll for its flexibility and ability to manage payroll for an unlimited number of employees and multiple companies for one flat price. You will need to pay an extra annual fee for customer support and there’s no free trial. There are also no mobile apps available.
Sage HRMS Payroll
Priced between $3 and $7 per employee per month, Sage HRMS Payroll is the ideal choice for businesses that use Peachtree Accounting Software. Sage HRMS Payroll seamlessly integrates with Peachtree and totally eliminates the need for double entry accounting.
The system is ideal for companies with fewer than 20 employees. You can receive a free demonstration on Sage HRMS Payroll by visiting the company’s website.
The main downside of Sage HRMS Payroll is that it won’t calculate local taxes, nor will it electronically file taxes. So you still have to do a lot of payroll work on your own (But what do you expect at this price range?).
Conclusion: How Should Your Business Do Payroll?
Payroll is the largest expensive for many businesses. Deciding between different payroll solutions may seem like a complicated task. However, if you invest a little bit of effort into setting up the right payroll system today, you can save yourself countless hours of frustration in the future.
A good payroll system is also accurate and helps you avoid costly penalties from the IRS. Whether you’re stuck doing manual payroll calculations or using barebones software, it’s in your best interest to spend time making your business’s payroll system as efficient as possible.
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