Demystifying Payroll: Answering Common Questions From Employers
When it comes to business operations, few tasks are as vital as payroll. Payroll keeps your company moving forward; it ensures your employees are fairly compensated for their time and effort while also keeping your business compliant with tax rules and labor laws. However, if you don’t specialize in payroll, it can be confusing to navigate.
To help make it all more straightforward, we’re answering some of the most common questions employers have about payroll, from the meaning of common terms and record keeping to tax obligations and the different types of supplemental pay. Whether you’re a seasoned business owner or just starting out, our goal is to demystify payroll and help you make more informed decisions.
What are some of the most important payroll terms to know?
There are a wide variety of terms used in payroll; while some of them are specialized to specific industries or situation, here are some of the most common—and important—terms every business owner should know:
Gross pay: Gross pay, also referred to as wages, is the total amount of money an employee earns before any deductions (such as taxes or health benefits) are taken out.
Net pay: Net pay, also referred to as “take home pay” is the amount an employee receives in their paycheck after all deductions have been subtracted from their gross pay.
Withholding: The amount of money taken out of an employee’s paycheck for taxes, including state and federal taxes, Social Security, and Medicare.
Deductions: The amount subtracted from an employee’s gross pay for various purposes, such as health insurance premiums, retirement contributions, and voluntary deductions like charitable donations.
Paystub: A document that summarizes how many hours an employee worked, the rate of pay, and the withholdings and deductions that were taken out during a specific pay period. If you offer paid time off, the paystub will also show employees’ time off balances.
W-4 Form: A federal form issued by the IRS (Internal Revenue Service) that employees fill out to indicate how much of their income they would like withheld from each of their paychecks for federal taxes.
Form W-2: An annual federal tax form employers provide to employees that summarizes employees’ annual earnings, tax withholdings, and other relevant financial data that’s vital for the employee’s personal income tax return.
Form 1099: A tax form used to report income earned by independent contractors or freelancers.
Minimum wage: The lowest hourly wage that employers are legally allowed to pay employees. Minimum wage varies by location and can be set at the federal, state, or local level.
Overtime: Extra compensation paid to an employee for working more hours than the standard workweek (typically 40 hours a week), as governed by federal and state law.
Worker classification: Workers are either classified as employees or independent contractors.
Payroll compliance: Ensuring your payroll processes adhere to federal, state, and local laws and regulations, including tax codes and labor laws.
What is supplemental pay?
Supplemental pay (also called supplemental wages) is any income you give an employee in addition to their regular wages. This includes bonuses, commissions, and severance pay. Since supplemental pay is separate from an employee’s regular earnings, tax withholdings are handled differently. Employers can choose to use the percentage method (withholding a flat rate of 22% from the employee’s supplemental wages) or the aggregate method, which combines the supplemental wages with the employee’s regular earnings and withholding taxes based on that total.
What’s the difference between an exempt and a nonexempt employee?
The key difference between an exempt and nonexempt employee lies in how they’re paid and their overtime eligibility. Exempt employees are typically salaried and don’t receive overtime pay, such as managerial or professional roles. Nonexempt employees are usually paid on an hourly basis and are entitled to overtime pay for working over 40 hours a week.
What is FICA?
“FICA” stands for the Federal Insurance Contribution Act, a payroll law that requires employers and employees to contribute to Social Security and Medicare each pay period. For employees, 6.25 of their gross wages go to Social Security tax and 1.45% goes to Medicare tax. Employers match these percentages for a combined contribution of 15.3%.
Which taxes am I required to withhold from an employee’s paycheck?
All businesses must withhold federal income, Social Security, and Medicare taxes; California employers also need to withhold State Disability Insurance (SDI) and Personal Income Tax (PIT). Depending on your locality, you may also need to withhold local income taxes.
Which taxes do I need to deduct from my income?
Your tax responsibility as an employer will depend on how your business is structured:
Incorporated individuals who receive a salary have payroll and income taxes deducted from their gross wages.
Self-employed individuals are required to pay estimated taxes, which include income tax and self-employment tax. In place of FICA, self-employment tax covers the full 15.3% contribution for Social Security and Medicare.
What is unemployment tax?
Unemployment tax is a tax paid by employers to fund unemployment benefits for workers who have lost their jobs. Employers are responsible for paying two types of unemployment taxes: FUTA (Federal Unemployment Tax Act) tax and SUTA (State Unemployment Tax Act) tax. As of 2023, the FUTA tax and California SUTA tax rate are only applicable to the first $7,000 of each employee’s earnings.
What is an EIN, and where do I find it?
A federal Employer Identification Number (EIN), is a unique nine-digit identification number assigned to businesses by the IRS for tax reporting purposes. It’s also commonly referred to as a Federal Tax Identification Number (FTIN). Once the EIN is assigned to your business, you should receive a letter from the IRS confirming the number.
How long should I keep payroll records?
Business owners are required to keep payroll records for three years, according to the Fair Labor Standards Act (FLSA), and for at least four years after filing the fourth quarter of the year according to the IRS.
How often should I run payroll?
Most employers in California are required to pay employees at least twice a month by the 10th and the 26th. In terms of exempt employees, employers are only required to pay them once per month (by the 26th of the month). Some businesses may have set pay periods based on union agreements; beyond these and state requirements, most employers pay their employees weekly, bi-weekly, and semi-monthly. Click here for more information on pay periods and how to choose the best one for your business.
Am I allowed to pay employees in cash?
While it’s perfectly legal to pay your employees in cash, it can cause your business to come under scrutiny from the IRS, as it’s often associated with tax avoidance. For this reason, it’s not recommended.
Which tax forms will I need to submit?
Tax reporting requirements can vary depending on the size of your business and how it’s structured, so it’s best to consult with a CPA to ensure you understand and meet all necessary tax obligations. Some examples of common forms that are required include:
Do I need to do payroll in-house?
This depends on what you’re most comfortable with and your business needs. While some certainly can handle payroll in-house, outsourcing payroll offers multiple benefits, including expertise, time savings, accuracy, compliance, and scalability. Overall, outsourcing your payroll can provide better peace of mind and be more cost-effective than employing payroll specialists in-house.
If you’d like to learn more about outsourcing your payroll, contact Payroll Boutique at (707) 860-8510 or email us at hello@payrollboutique.com. We provide personalized full-service payroll processing and management for start-ups and small to medium-sized businesses in Sonoma County and throughout California. We also partner with Denegri & Associates to offer bookkeeping, accounting, and tax planning and preparation. Schedule a free consultation today!
Please note that this article is for informational purposes only and is not intended as business or financial advice. As every client's situation is different, the views expressed in this blog may not apply to you; for specific advice regarding your business, please consult a qualified CPA.
