Employee payroll: understanding and implementing

As your startup grows, you’ll start hiring employees. And with that, you’ll have to navigate employee payroll which, unfortunately, isn’t quite as simple as just writing a check every two weeks. 

When you begin hiring for your startup, you’ll need to differentiate between employees and contractors, accurately calculate both hourly and salary wages, make the appropriate deductions for state and federal taxes as well as benefits contributions, and a host of other tasks—all in a timely and consistent manner. 

Depending on the nature of your business, employee payroll may be your greatest overhead expense, but regardless of the size of your company or the industry in which you operate, payroll is a process that every business owner needs to understand. 

Here we’ll explain payroll meaning (hint: It’s easy to define but harder to implement), show you how to calculate it, and walk you through the step-by-step process. 

It is, however, important to note that federal, state, and local laws determine many of the specifics of employee payroll, so it’s important to ensure you’re performing them in accordance with these laws, as there can be penalties for non-compliance.

What is employee payroll?

You might be wondering, “What exactly is a payroll definition?” Generally speaking, payroll is “the process of paying your employees,” and all that entails. Depending on the context, though, payroll may refer more specifically to a variety of related meanings, including:

• Your register of employees and all information related to their compensation
• The distribution of employee paychecks 
• The amount you pay employees either per pay period, or annually
• Historical records of the wages you’ve paid employees

Employee payroll: Essential information

Before you’re able to calculate your employee payroll, you’ll need to have several crucial pieces of information on hand, all of which fall into one of three categories: employee information, salaries/wages, and deductions. Here, we’ll explain what each one entails.

Employee information

Any time you hire an employee, they’re required to give both you and the federal government the information you need to pay them by filling out IRS Form W-4. An employee’s W-4 includes personal info like their full name, address, and Social Security number, as well as federal income tax withholding information—all of which you’ll use when processing payroll and distributing checks or electronic payments. While the federal government doesn’t require employees to submit a new W-4 every year, the IRS does recommend workers review their W-4 annually and fill out a new form should any of their personal or withholding information change. 

Salaries, wages, and other compensation     

For each employee, you’ll pay either an annual salary or an hourly wage. A salary is a fixed annual amount that you then divide and distribute by pay period. An hourly wage is the amount you pay an employee per hour—or fraction thereof—worked during a pay period. 

Pay periods are most commonly weekly, every two weeks, twice per month, or monthly.  

Additionally, the Fair Labor Standards Act (FLSA) requires that most non-exempt employees receive overtime pay for hours worked over 40 hours in the course of a workweek. 

While state labor laws on overtime compensation may differ, according to the FLSA, non-exempt employees are those who meet at least one of the following criteria: 

• Receives an hourly wage
• Earns below the threshold of $684 per week or $35,568 per year
• Doesn’t have executive, administrative, or professional job duties

While most nonexempt employees are hourly wage earners, some salaried workers—specifically those with annual salaries under the threshold mentioned above—are also entitled to overtime pay. 

For hourly workers and others entitled to overtime pay, you’ll need to keep records of the number of hours worked during the pay period.       

Benefits (also known as “fringe benefits”) are forms of compensation to which an employer contributes in addition to salaries or hourly wages. These often include health insurance, retirement plans, and paid leave. 

Finally, an employee’s compensation may also include additional forms of income, including tips, commissions and bonuses. These forms of compensation may be regulated and taxed differently than other income, depending on local, state, and federal laws.

Deductions

Deductions are any amount you subtract from an employee’s total wages. 

Payroll taxes are the most common form of deduction and include Social Security taxes and Medicare taxes, often referred to as “FICA tax,” after the Federal Insurance Contribution Act that established them.

Payroll withholdings are deductions for income and unemployment taxes. An employee’s income tax deduction is determined by the amount they chose to enter on their W-4. Federal and state laws dictate unemployment tax rates. State and local income tax rates, as well as state unemployment tax rates, will differ based on the location.

Benefit deductions include employees’ contributions to fringe benefits, such as health insurance, life insurance, and retirement plans. Depending on local, state, and federal laws, some benefit deductions are taxable, while others may be “tax deferred,” meaning they’re deducted before the calculation and deduction of taxes. 

Before you’re able to calculate your employee payroll, you’ll need to have several crucial pieces of information on hand, all of which fall into one of three categories: employee information, salaries/wages, and deductions.

How to calculate employee payroll

Now that we’ve answered the question, “What is payroll?” let’s consider the calculation process. Once you’ve gathered all the necessary information, you’ll be able to calculate how much you owe each employee, as well as the other amounts on their pay stubs. To do so, follow these steps for each employee:

1. Calculate gross pay.

Gross pay is the total amount you pay an employee before you subtract deductions; it is often referred to as “pre-tax.” You’ll determine this amount slightly differently depending on whether an employee is hourly or salaried. You can calculate an employee’s pay rate (salary or hourly wage), pay period, and—in the case of hourly employees—number of hours worked. 

For hourly employees, calculate gross pay by multiplying hours they’ve worked per pay period by their hourly wage, as indicated in the following equation:

Gross Pay = Hours Worked During Pay Period x Hourly Wage

For salaried employees, calculate gross pay by dividing their yearly salary by the number of pay periods in the year, as indicated in the following equation:

Gross Pay = Annual Salary ÷ Number Of Pay Periods Per Year 

2. Subtract pre-tax deductions.

If pre-tax deductions like those for health insurance and 401(k) plans apply to the employee, subtract them at this point.

3. Subtract taxes.

After you’ve subtracted any applicable pre-tax deductions, the remaining amount is subject to FICA, unemployment, and income taxes, as well as any other applicable local, state, and federal taxes.

The current FICA tax rate is 7.65%, 1.45% of which goes to Medicare and 6.2% of which goes to Social Security. Other tax rates you’ll need to deduct at this point will depend on information contained in the employee’s W-4, as well as local, state, and federal laws. 

4. Subtract post-tax deductions.   

After you’ve subtracted both the employee’s pre-tax and tax deductions, subtract any applicable post-tax deductions from the remaining amount. These may include, but are not limited to, wage garnishments, union dues, and Roth 401(k) contributions.

5. Arrive at employee’s net pay.

After subtracting all applicable taxes and other deductions from the employee’s gross pay, the remaining amount is the employee’s net pay—the amount you as an employer owe them and which will appear on their paycheck.

Additional Employer Responsibilities Related To Employee Payroll

While following the above steps will allow you to calculate and distribute an employee’s net pay, you also have a responsibility to both report and submit taxes and other withholdings—both those you’ve withheld from employees’ paychecks during the payroll process and your company’s contributions as an employer—to the appropriate agencies, including tax authorities, retirement plan firms, and insurance companies.

3 Ways to process employee payroll

When it comes to processing employee payroll, you have three options as a business owner: do it manually, do it yourself with a payroll software, or outsource the process to a payroll service provider. Here’s a brief explanation of each option, highlighting their advantages and disadvantages:

1. Do it yourself manually.

While this is the cheapest option for your business (in theory), the reality is that it’s extremely complex and time-consuming. As we mentioned above, in addition to all the steps required to calculate how much you actually owe your employees, you’ll also be responsible for all related record-keeping and tax filing, as well as keeping abreast of ever-changing tax laws. Making mistakes or missing deadlines can cost your company significant amounts of money. In most cases, doing your own payroll manually will result in more headaches than it’s worth.

2. Do it yourself with payroll software.

Purchasing a payroll software like Gusto can help you streamline many of the most time-consuming parts of doing your own payroll. This choice, however, still means that you are ultimately responsible for any mistakes or missed deadlines, as well as whatever penalties you incur as a result.

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Explore your payroll software options further in our head-to-head comparison of the best payroll for startups.

3. Outsource it to a professional.

Outsourcing your payroll processing to a professional will save you enormous amounts of time and effort, but it will likely be the most expensive of the three options. Using a trusted professional accountant or bookkeeping firm for your payroll needs will also give you the peace of mind that comes with knowing your payroll is processed properly—and timely.

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Forward-thinking finance firms like Zeni are utilizing best-in-class payroll software in conjunction with technological advancements like artificial intelligence to automate processes and offer their services to customers at lower costs than a traditional accountant.

Zeni provides startups with affordable, reliable, scalable payroll services.

With Zeni, your business can access all the benefits of a traditional accounting firm—including payroll services—at lower costs, thanks to our seamless blend of automation and human expertise. 

Utilizing new and emerging technologies, we’ve managed to eliminate many of the inefficiencies plaguing traditional accounting firms. As a Zeni customer, you’ll have unprecedented access to all your business’s financials, anytime and anywhere with the Zeni Dashboard. And, in contrast to the standalone payroll service software options on the market, you’ll also have an experienced team of finance professionals, including accountants, bookkeepers, tax experts, and CFOs, working for you.