Payroll Basics Guide: Complete Processing Guide

What is Payroll?

Payroll is the process of calculating and distributing employee compensation. It includes wages, salaries, bonuses, and deductions for taxes, benefits, and other withholdings.

Proper payroll management ensures employees are paid accurately and on time while maintaining compliance with labor laws and tax regulations.

Key Payroll Terms

Gross Pay vs Net Pay

Gross pay is the total amount earned before any deductions. This includes regular wages, overtime, bonuses, and commissions.

Net pay (take-home pay) is what employees receive after all deductions are subtracted from gross pay.

Common Deductions

Deductions fall into two categories: mandatory (taxes, Social Security, Medicare) and voluntary (health insurance, retirement contributions, parking).

How to Process Payroll

Collect Time Records

Gather timesheets, timecards, or digital time tracking data. Use our Timecard Calculator to track hours and overtime.

Calculate Gross Pay

For hourly employees, multiply hours worked by hourly rate. Add overtime using our Overtime Pay Calculator. For salaried employees, divide annual salary by pay periods.

Calculate Deductions

Subtract federal, state, and local taxes, Social Security (6.2%), Medicare (1.45%), and voluntary deductions like health insurance and retirement contributions.

Process Payments

Distribute net pay via direct deposit, paper checks, or payroll cards. Ensure payments are made on time according to your established payroll schedule.

File Tax Reports

Submit quarterly tax reports (Form 941) and annual reports (Form 940 for unemployment taxes). Provide W-2s to employees by January 31st.

Worked Example

Let's calculate payroll for Sarah, an hourly employee who worked 45 hours at $25/hour in a bi-weekly pay period:

Sarah's Bi-Weekly Payroll

Regular hours (40 × $25):$1,000.00

Overtime hours (5 × $37.50):$187.50

Gross Pay:$1,187.50

Federal Income Tax (15%):-$178.13

Social Security (6.2%):-$73.63

Medicare (1.45%):-$17.22

State Income Tax (5%):-$59.38

Health Insurance:-$150.00

Net Pay:$709.14

Use our Overtime Pay Calculator to verify these calculations.

Choosing a Payroll Cycle

Common Options

Weekly (52 pay periods/year)

Best for hourly workers, construction, retail

Bi-weekly (26 pay periods/year)

Most common, balances cost and frequency

Semi-monthly (24 pay periods/year)

Good for salaried employees, consistent dates

Monthly (12 pay periods/year)

Lowest cost, but may cause cash flow issues

Compliance Requirements

Federal Requirements

All employers must withhold federal income tax, Social Security, and Medicare. File Form 941 quarterly and Form 940 annually for unemployment taxes.

State Requirements

State income tax withholding varies by state. Some states have no income tax, while others have complex rules. Check your state's labor department for specific requirements.

Record Keeping

Keep payroll records for at least 3-4 years. This includes time records, pay stubs, tax forms, and employment agreements. Digital records are acceptable if properly secured.

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FAQ

What's the difference between gross pay and net pay?

Gross pay is total earnings before deductions. Net pay is what employees actually receive after taxes, benefits, and other deductions are subtracted.

How often should I run payroll?

Most common cycles are bi-weekly (every 2 weeks) or semi-monthly (twice per month). Choose based on your business needs and state requirements.

What records do I need to keep for payroll?

Keep time records, pay stubs, tax forms (W-2s, 1099s), and employment agreements for at least 3-4 years for tax and legal compliance.

Do I need payroll software for a small business?

While possible to do manually, payroll software reduces errors, ensures compliance, and saves time. Consider it essential for businesses with 5+ employees.

Payroll Basics Guide