Paying Your Employees: Understanding & Processing Payroll

Let’s chat about a fundamental small business concept that only sometimes gets the spotlight it deserves: payroll.

What is payroll?

Most small business owners – whether they operate a sole proprietorship, within a partnership, an LLC, an S corporation, or a C corporation – look forward to making a return on their business. Depending on your structure, you may even be considered an employee yourself and receive a paycheck. If your business is growing, you may employ other workers as well. Paying employees is done via your payroll system. In a nutshell, these systems calculate, manage, and distribute employees’ salaries and wages. 

Payroll is not just about doling out money; it’s a major part of your small business’s financial processes. It involves everything from tracking employee hours and factoring in overtime or bonus pay to deducting taxes, insurance, benefits, and other deductions as required by federal and state law. In addition, it covers required federal and state report filings. 

Behind this seemingly simple concept is a complex orchestra of moving parts, such as: 

• Inputting hours and employment data 
• Number crunching to arrive at the proper amount 
• HR expertise to make sure you’re aligned with the right employment rules 

Payroll journeys can differ from employee to employee. They can also vary from one pay period to another because of overtime, sick pay, and other benefits. Often, final payroll paychecks come out in different amounts for each employee, depending on their role, seniority, and benefit elections. 

Payroll can be a significant business expense. Fortunately, the cost of prep is almost always tax deductible. This means the expense can be deducted from the business’s gross income, lowering taxable income. However, there may be specific rules and limitations based on the type of business entity and local tax laws. 

What is payroll withholding?

Payroll withholding is the slice of an employee’s paycheck that you, as their employer, take out for taxes the employee must pay. When an employee is paid, it’s not just a simple salary transfer. Small business owners must withhold a portion of an employee’s payroll to cover: 

• Federal income taxes, state taxes, and municipal taxes (if applicable) 
• The employee portion of FICA tax (Social Security and Medicare) 

The Form W-4 is a key document that helps you determine payroll withholding amounts because it shows the employee’s filing status and withholdings. Withholding is required by law, including the above taxes and any other legally mandated withholdings. These subtractions are non-negotiable and are determined by regulatory bodies like federal and state governments. 

What is a payroll deduction? 

A payroll deduction is also an amount subtracted from an employee’s paycheck to cover various expenses or obligations. Payroll deductions cover a range of items, such as various types of benefits and retirement plan contributions.

These deductions are generally voluntary or optional and depend on the choices made by the employee. They may include health insurance premiums, retirement plan contributions (ex. 401(k)), life insurance, charitable contributions, flexible spending account contributions, etc. Employees can participate in these programs or opt out based on their preferences and needs.  

• NOTE: 401k deductions are exempt from federal, state, and local taxes but not from Social Security & Medicare withholding. 

But you may still wonder, “What is a payroll tax expense?” To clarify, Payroll tax expenses are those costs that the employer covers, such as the employer portion of the FICA tax. Learn more in our Payroll Tax Guide. 

Why does this matter? As a small business employer, you are responsible for accurately calculating amounts to withhold or deduct from each paycheck. The amounts are then allocated to the appropriate recipients, such as the IRS, for withheld federal taxes and other designated entities, such as the plan administrator for 401(k) contributions.

The payroll process

Calculating payroll tax for small businesses requires two figures: salaries and deductions. When subtracting the two, you arrive at an employee’s net pay. Learn more about how to calculate payroll taxes step-by-step. 

The different ways to run payroll 

There are several methods to calculate payroll taxes. Here are some common ways:

1. Manual calculation: This involves crunching the numbers yourself using tax tables provided by the IRS. Based on each employee’s earnings and withholding allowances, you can determine the federal income tax, Social Security tax, Medicare tax, and state and local taxes to account for. A word of caution if you’re calculating and running payroll yourself: You must stay current with tax laws and changes affecting the tax calculations. Tax rates and regulations change yearly. So, do your research to ensure your knowledge is current. Taking care to get your numbers correct may help you avoid complications down the line.  
2. Payroll software: Software programs streamline the payroll tax calculation process. They usually factor in current tax rates, deductions, exemptions, and credits based on the employee’s details. Then, the software will generate the necessary deductions for each paycheck. However, often, software won’t provide you with hands-on support when you run into questions or issues. 
3. Payroll services: Many small businesses outsource the payroll process to accounting firms or other service providers. Small business owners may find peace of mind knowing they have a real human expert to rely on to handle tax calculations and filings. Furthermore, these experts make a point of staying current with tax laws so they can serve their customers well. Handing off your payroll to an external service can put your mind at ease so you can focus on other mission-critical responsibilities. 

Whatever path you choose, remember that payroll taxes require accuracy. Mistakes can lead to penalties, fines, and unhappy employees. Whether you’re interested in managing this responsibility on your own, using an online payroll software service like Wave, or getting external help from a small business payroll expert at Block Advisors, you have options that will allow you to eliminate the hassle and keep your focus on what you love.  

What else do employers need to do? 

The information above will help you navigate payroll for your employees’ paychecks. But there are more duties on your plate as a small business owner. Learn about other employer payroll tax responsibilities.  

Navigating paying employees with expert guidance 

Understanding payroll basics can help you track business finances, organize your books, and comply with tax obligations. 

Let our experts lighten your load, in person or virtually, year-round. Our taxes, bookkeeping, payroll preparation, and incorporation services are designed with small business owners like you in mind.

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This article is for informational purposes only. The content may not constitute the most up-to-date information and should not be construed as legal advice.