Payroll for Dummies

Payroll for Dummies – The Ultimate Guide to Calculating Payroll

What is the first thing that’s on your mind when you hear the word, “payroll”? Many business owners tend to associate it with issuing paychecks to their employees. However, that’s only one aspect of payroll. Apart from that, payroll is also responsible for other things like filing and withholding taxes. Handling paycheck deductions like garnishments and other benefits are also part of payroll.

As you may have figured out by now, payroll consists of many different things. That’s why it pays to take a close look at this part of business management and get familiar with everything that it covers.

Payroll is an extremely important part of the business for both financial and legal reasons. In fact, a 2014 survey by the National Small Business Association (NBSA) of America claims that payroll taxes were ranked as the number on most burdensome financially. At the same time, it also ranked number two for most burdensome administratively for federal tax among small businesses.

If you want your small business to flourish, you need to become a payroll expert – or, at least, get familiar with the entire payroll system. This comprehensive article will help you get there. In this guide, we will go over what payroll is, why it’s important, where can you learn about it, how to setup a payroll system for your business, and so much more.

What is Payroll?

You may already have an idea of what payroll means. But that doesn’t necessarily mean it’s an accurate description. That’s why this section will define what payroll is to make sure you have the right information about the meaning of this word and what it entails.

Payroll is the total sum of all compensation that a business is obligated to pay to its employees for a set period or on a given date. It comprises of salaries, wages, net pay, and bonuses. In most cases, the payroll is managed by the accounting department. However, if you’re a small business, you can have your payroll managed by dedicated in-house employees or by an associate.

The Importance of Payroll

Payroll is considered as one of the most important financial parts of a business. The reason is that has a serious impact on the net incomes of your company. In addition, payroll is also subjected to several factors like ethics and the law. Due to these factors involving payroll, it’s crucial for any business to keep a precise record of its payroll.


Due to the expenses that it takes to compensate each employee’s wage or salary, payroll typically makes up the largest deductible for any business. Periods for payroll can vary due to situations like sick leaves or overtime pays.


Apart from compensating employees for their work, payroll also comprises of settling tax obligations. At the same time, it’s also responsible for the taxes that the employees are required to pay. A good example of this is withholding tax. These are taxes that the employer withholds from the wages of every employee. Another one is income tax, which are assigned by the federal state and local governments.

Both the employee and employer are required to also pay for payroll taxes such as Medicare and Social Security. According to the recent statement from the IRS, “the current tax rate for Medicare is 1.45% for both employee and employer, or 2.9% in total. One the other hand, the current tax rate for Social Security is 6.2% for both the employer and employee, or 12.4% total.

Unemployment tax is another required payroll to compensate employees who lost their jobs. There are state and federal-level systems in place to assess and collect payroll taxes here in the U.S.


Payroll is also used to provide important feedback for your business. The most common feedback that payroll can show is whether or not the business is making profit. Payroll could determine that a business is earning a profit or losing money.

If it’s the latter, it would indicate that the company is spending too much on paying employees. If that’s the case, then the business may have to consider laying off some of its employees to become more profitable. It may not sound right; but for a business standpoint, it makes a lot of sense.

As a business owner, you must have an accurate and consistent payroll. That way, you can pay your employees correctly, withhold the right amount of taxes, and have a better understanding of your company’s overall cash flow.

Where to Learn Payroll

There are a lot to learn before you’ll be able to start understanding the importance of payroll. For you to become a master at payroll, it’s essential for you to learn the following:

  • Your tax account numbers – This should include your state withholding and unemployment accounts, Federal Employee Identification Number, and local income and school district taxes.
  • Applicable tax rates for your business – it could be something like a starting unemployment rate for your business.
  • Calculating paycheck, subtracting tax withholdings
  • Calculating federal payroll tax deposits, e.g., FICA and federal income tax.
  • Federal tax deposits – Your business could start as a monthly depositor. Keep in mind that the IRS may revise that schedule.
  • How to make federal state and local tax deposits via systems like EFTPS.
  • How to file, process, and complete all federal and state taxes.

Other helpful areas in learning payroll would include the following:

  • Minimum wage and overtime laws and regulations in your respective state.
  • Requirements for IRS recordkeeping.
  • Handling deductions like compensation and health insurance.
  • Handling wage garnishes, e.g., child support.

Setting Up Your Payroll System

At this point, we’d like to assume that you should be well aware of the responsibilities and factors regarding payroll. Paying your employees, filing the correct forms, and settling taxes are some of these factors. With the information that you already have now, it’s time to start setting up your payroll system. Typically, you have a total of four choices to choose from:

  • Manual DIY – a do-it-yourself system keeps your payroll in your hands. However, it’s extremely time-consuming.
  • DIY Payroll Softwarea software for doing payroll will give you the ability to pay your employees quickly, as well as manage taxes on a whim. However, you will need to learn how to use the software properly and effectively.
  • Hire a Professional Accountant – the main benefit of getting an accounting to oversee your payroll duties is convenience. Accountants are familiar with payroll responsibilities. However, the downside is that it can be costly, and you’re giving up control over your payroll.
  • Outsource your payroll – you also have the option to just outsource your payroll duties and have a dedicated agency process it for you. Doing so can alleviate some of the workloads that you have on your plate. However, it can be expenses, and you’re putting your payroll in someone else’s hand. This one isn’t advisable unless you’re 100% trust the firm you’re hiring to handle your payroll.

Whatever system you’ll go for, it’s also important to have the following in place:

  • A completely filled-out I-9 form – this form will verify the legal status of your employees. At the same time, you should also require your employees to fill out a W-4 form for their tax withholdings.
  • Payment options – give your employees the choice to get paid either by check or through direct deposit.
  • On-time Reports – report your earnings and withholding of each employee, as well as total withholding amounts, to the correct tax agencies. Make sure that you send your reports on time.

Are you planning to establish your own system? Here’s what you’ll need to get started:

Employer Identification Number (EIN)

To apply for your employer identification number, contact IRS, or schedule an appointment with them online. Your Employee Identification Number, also known as Employer Tax ID or Form SS-4, is essential since it’s required when you report taxes to the IRS.

State/Local IDs

Depending on your business, you may need a business ID in certain states to start paying process taxes. To determine if your state required an ID, visit the official website of the Small Business Administration and check out their State Tax Guide. This comprehensive guide will provide the information you need, as well as details on taxes like worker’s compensation, business tax registration, or unemployment taxes.

Employee Vs. Independent Contractor

Note that there are differences between how you pay your in-house employees and how you pay independent contractors. That’s why it’s crucial to know how both of these employees can affect your payroll. Again, consult with the IRS and have them help you understand how employees differ from independent contractors.

Payment Period

The next step would be to settle on a payment period for your company. In the U.S., the most common type of payment period is at the end of the month. There’s also semi-monthly (twice a month – one on the 1st and one on the 15th, or one on the 15th and one on the 30th). There is also weekly and bi-weekly (every two weeks).

Since accountants run monthly reports, they often prefer semi-monthly periods, which would total to 24 pay periods throughout the year. The benefits and other aspects of payroll are also monthly. That means a semi-monthly pay period makes these deductions easier to manage. Again, you decide on which pay period is more convenient for you and your employees. Make sure you do research and consult with other businesses.

Employee Compensation

Having accurate payment records are necessary. That’s why you should make sure to have a solid system in place to accurately track employee hours. It should also include how you handle paid time off, employee compensation, and other business deductibles.

How to Calculate Payroll for Employees

Now that you have a solid idea about what payroll is and what it comprises, it’s time to learn how to calculate it. When you know the details about all your employees’ withholding allowance and benefit costs, you can calculate the final payroll for your business and post it to the books.

For Hourly Employees

Keep in mind that calculating payroll will vary on their rate. For hourly employees, the first thing you need to do is to collect time records from each person that’s being paid hourly.

Some companies make use of time clock, while others use time sheets to produce the required time records. In most cases, the manager of each department reviews the time records for each employee before sending their time records to the accountant or bookkeeper.

With the records in hand, the one responsible will now have to calculate gross pay for each employee. For example, if an hourly-rate employee worked for 45 hours and is paid $20 an hour, you can calculate gross pay in the following manner:

  • 40 regular hours x $20 per hour = $800
  • 5 overtime hours x $20 per hour x 1.5 overtime rate = $150
  • $800 regular pay + $150 overtime pay = $960 total pay

For Salaried Employees

You should also prepare payroll for salaried employees. The pay for salaried employees is relatively easy to calculate. All you need to determine is their base salaries and calculations for their pay period.

For example, if a salaried employee makes $40,000 per year and is paid in a semi-monthly format (which totals to 24 per day periods), that employee’s gross pay will be $1,667.H

Here’s an infographic of what we discussed in this article:

Payroll for Dummies Infographic

Wrapping Up

So, there you have it. Payroll is extremely crucial and involves many aspects. It’s not just paying your employees the money you owe them. It involves taxes, deductions, bonuses, and many other factors. We hope you learned a lot about payroll. If you’re interested in acquiring our top-of-the-line invoicing services, create an account with ReliaBills today.

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