Long gone are the days when DIY payroll meant sitting huddled in a spreadsheet hellscape with only an abacus to guide you through the proper withholdings.
Okay, that’s a slight exaggeration, but in the Roaring Twenty-Twenties, the options for DIY payroll are no longer archaic and mind-numbing, and many small business owners are switching over to cloud-based payroll software. This modern update to payroll systems has made a once tedious task a bit less troublesome and a bit more, dare I say, fun. (My employer Merchant Maverick uses the payroll company Gusto to manage our payroll and every month they tell me how many bananas my paycheck is worth. See? Fun.)
With the right software, DIY can sometimes be as simple as uploading information into the cloud and clicking a button. Even so, small business owners should take the time to understand the various components of payroll. Think of it this way: If an employee comes to you with a question about their paycheck, you should be able to help and explain any payroll documents in a teachable manner.
If payroll is new to you, that’s okay! We’ve got you covered. Use our guide to brush-up on the terms you might encounter (and should be familiar with), while processing payroll as a small business owner:
The Affordable Care Act (ACA) was signed into law in March 2010 and includes health coverage mandates for business owners. Research whether your small business needs to provide health coverage and what your state requirements look like.
The Automated Clearing House (ACH) is an electronic funds transfer system.
Compensation is the pay (money) made to employees as salary or wages.
Payroll deductions are payments withheld from an employee’s paycheck each pay period. These can be voluntary amounts that the employee chooses (like retirement contributions) or involuntary deductions (like child support/garnishments; health insurance premiums). Some deductions can be made pre-tax or post-tax.
This is when funds/money is transferred electronically into a checking or savings account.
An employee is a person who receives a salary or wage for a job. However, for the purposes of payroll, taxes, and the government, an employee is a person you employ, over whose time and work you have control. It sounds reminiscent of archaic work-systems, but control is defined as:
- Work/Behavior Control: Do you assign this person a schedule? Do you manage their workload?
- Financial Control: Do you pay a consistent salary? Do you contribute to a retirement fund? Is this person granted reimbursement for tools and supplies?
If workers are not employees, they might be independent contractors.
See: Independent Contractors
Exempt means “exempt from overtime” and is a reference to the type of work someone performs for your business. Exempt employees typically include managerial, professional, and executive positions.
The acronym FICA stands for: Federal Insurance Contributions Act. This is a mandatory federal payroll deduction in the form of taxes that you, as an employer, send to the IRS. The FICA tax rates are 6.2% for Social Security tax and a 1.45% Medicare tax.
The Federal Unemployment Tax Act (FUTA) covers the costs of unemployment insurance and state-run job programs. These taxes are based on employees’ gross earnings — that means they are not withheld from their wages. Instead, these are a financial obligation that employers cover.
This refers to a court order from a judge which allows an employee’s wages to be seized and paid to a creditor to settle a debt.
This is the total amount of money paid to an employee. Gross pay is reported to the IRS and the employee pays income taxes on that amount. For salaried employees, gross pay is a stated annual amount. For hourly employees, gross pay is their hourly rate multiplied by hours worked.
See: Net pay
Hourly employees are paid by the hour; their hourly rate is how much they are paid per hour.
Income tax is a tax that varies based on income or profits (taxable income) and is generally decided upon by a pre-determined tax rate. Taxation may vary by type of taxpayer. This type of tax is withheld from employees’ paychecks.
An independent contractor is a person who is hired via contract to do work for your business. Contractors are not employees.
See: Employees, 1099
This is any non-monetary compensation given to employees in the form of fringe benefits. Employers must recognize imputed income in employees’ paychecks as it is taxable income. Imputed pay is subject to Medicare and Social Security taxes but not to federal income tax.
This is the amount of take-home pay an employee receives after deductions and withholdings.
See: Gross pay
A nonexempt employee is not exempt from overtime provisions and is entitled to overtime pay.
An off-cycle payroll is run during a time when payroll isn’t usually offered. Off-cycle payroll may be used to handle holiday or bonus pay, termination pay, fixing an error, or any other unusual situation.
Overtime is the number of additional hours an employee works. Unless an employee is exempt, employees must receive overtime pay if they work more than 4o hours in the workweek.
A payroll is a list of a business’s employees and the amount of money paid as wages and salaries.
A paystub, sometimes referred to as a payslip, is a document that comes with or is attached to a paycheck. It is a record of gross earnings, net earnings, deductions, and withholdings. Some states have laws requiring an employer to provide a paystub; check your state’s local guidelines. You can also check out our article Payroll 101: What Is A Paystub for a more detailed look at what a paystub includes.
A pay period is a recurring schedule that determines when you pay your employees for their time worked. The most common pay period frequencies are weekly, bi-weekly, semi-monthly, and monthly. Read our article Choosing The Right Pay Schedule For Your Business for a more detailed breakdown of pay periods.
Payroll processing refers to the process of managing a business’s payroll. Steps include gathering employee timecard information; managing benefits, deductions, and taxes; distributing and recording pay.
Quarterly Federal Tax Returns
Form 941 is a company’s quarterly federal tax returns and the form is used to report income taxes, social security tax, or Medicare tax withheld from an employee’s paycheck. The form is also used quarterly to pay the employer’s portion of social security or Medicare. These are estimated payments made to the IRS for the business year and you are required to make these payments if:
- You expect to owe at least $1000 in federal taxes
- You expect federal withholding/refundable credits to be less than:
- 90-100% of the tax to be shown on your 2020 federal tax return
Dates for payments during a typical tax year fall on April 15, June 15, September 15, January 15.
Expense reimbursement occurs when you pay an employee back for payments/purchases made for the company with their own money. Small businesses should employ a reimbursement policy. Reimbursement via payroll should not be reported as taxable income.
See: Taxable income
This is your employee’s fixed income expressed as an annual amount.
Social Security started in the 1930s as government assistance for retirees, veterans, disabled persons, workers, or their families. Today’s workers are paying for current social security recipients and these contributions are mandatory. Paying social security is part of an employee’s FICA taxes.
The list of types of taxable income can be long! In general, taxable income includes wages, salaries, bonuses, commissions, and tips. It can also include fees, interest and dividends, assignment of income, or profit on a sale. The IRS Publication 525 lists full types of taxable and nontaxable income.
A workweek is the number of hours or days an employee is scheduled to work during a seven-day period. The Department of Labor and the Federal Government have this technical definition of a workweek for the purposes of overtime and tax purposes:
An employee’s workweek is a fixed and regularly recurring period of 168 hours â seven consecutive 24-hour periods. It need not coincide with the calendar week, but may begin on any day and at any hour of the day. Different workweeks may be established for different employees or groups of employees. Averaging of hours over two or more weeks is not permitted.
Withholdings are the federal, state, and local taxes taken from an employee’s paycheck and delivered to their appropriate agencies by an employer. Withholdings reduce an employee’s pay but also decrease taxes owed at the end of the year. There are a few things that determine an employee’s withholdings, including the employee’s income, marital status, number of dependents, and number of jobs. The number and type of withholdings for an employee are determined by the information listed on an employee’s W4.
A W2 is a standard tax form called the “Wage and Statement” document that shows wages and taxes withheld during a calendar year. This document is prepared by the employer for the employee and must be sent to employees by Jan. 31 every year. Employers also send copies of W2s to the IRS.
The W4, also called an Employee’s Withholding Allowance Certificate, is an IRS form that an employee uses to show their tax situation (exemptions and marital status, etc.). This form tells the employer the amount of taxes to withhold from a paycheck. A W-4 is based on allowances; the more allowances, the less money an employer withholds.
A 1099 is an information return for independent contractors. Payers use this form, also referenced as a Miscellaneous Income form, to report payments to a person who is not an employee.
Learn More About Payroll
Paying your employees is not an optional part of running a small business, and you need to find a payroll system and a method of running payroll that adds quality to your business, not chaos. You will want this not only for yourself but also for your employees. After the first step — knowing the ins and outs of payroll in general — the next step is to have a concrete understanding of what payroll systems work best for you and your business.
Research and understand what you need, know your business, and take the leap into organizing your systems with seamless payroll. The IRS and your employees will thank you. Want to know more? Merchant Maverick has put together a handy Small Business Payroll Guide to assist small business owners through decisions related to payroll and payroll systems. No abacuses needed.
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