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Grow Your Business Technology

How Does Payroll Work?

payroll
Credit: vinnstock/Shutterstock

Payroll is an essential function of any business. As an employer, it's your job to make sure your workers are compensated. That means you need to have some kind of payroll methodology to track hours worked, issue tax deductions and pay your workers. Despite being the backbone of many businesses, what payroll system you choose, as well as how it works, can sometimes go overlooked.

Understanding why a payroll system is necessary, the costs associated with payroll, how to set one up and how to find the best solution can be the difference between an intuitive cloud-based system and a confusing platform that causes headaches.

If you pay your workers, you need a payroll system. Whether that's a cloud-based solution or manual process, you need a system in place to track hours, understand deductions and issue payments to your workers. Adopting a manual process can be a huge time suck for a growing small business. If you have several employees, you'll have to manually track their hours and rates. Then you'll have to research both federal and state tax law so you're deducting the correct amount for taxes from each paycheck.

After all this, you'll have to pay employees, track year-to-date spending and keep an eye on time off payouts. There are several responsibilities and factors to juggle when processing payroll manually. If you're trying to work on payroll and run your business, it's easy to become overwhelmed.

Payroll technology automates a lot of these processes and even provides online portals for your employees to view important payment information, like tax deductions, 401(k) withdrawals and other breakdowns of benefits. More importantly, it helps business owners focus on running their business rather on administrative tasks, like payroll.

Finding the right payroll solution means assessing your revenue and understanding what kind of system you need and can afford. There are two standard cost structures when it comes to payroll: monthly payments and per-payroll payments. Monthly pay structures entail a base monthly fee and then a fee per employee. These base fees range from $30 to $150 per month, and the employee fees range from $2 to $15 per month. A flat monthly fee allows for unlimited payroll runs at no extra cost.

If you have a lot of contract or 1099 employees, this means you can pay them at no additional cost to your business. Per-payroll price structures mean you pay a fee every time you run payroll, plus a per-employee fee. These per-payroll fees can vary between $10 and $100 per run. The employee costs are usually between $2 and $15. As an employer, these costs can mean the difference between spinning your wheels on employee payroll and spending time running your business.

As with choosing any business service, you have to start by assessing your business's needs. There are several important things to consider before choosing a payroll service:

  • What features do you need? This can include features like multiple payment options, garnishment payments, paid time off management, workers' compensation administration, unemployment insurance and detailed payroll reports. One of the most important features, multiple payment options, means you can pay employees through direct deposit, paper checks or pay cards.
     
  • What kind of cost structure works best for your business? If you're only going to run payroll on a biweekly or semimonthly basis, paying per payroll run may make sense for your business. If you need to run payroll several times in a month, it may be better to opt for a monthly fee.
     
  • Do you need to integrate your payroll software with time and attendance or HR software? Some solutions integrate better than others.
     
  • Does the payroll solution provide employees with self-service access? Employees should be able to log in and view pay stubs, end-of-year tax forms and some payroll reporting features.
     
  • Do you need your payroll provider to manage time off for your employees?
     
  • Do you need your payroll provider to report new hires to the government on your behalf?

Once you have a better idea of the type of service you need, you can check out some of the major players. Business News Daily reviewed more than 70 payroll providers to determine which were the best for small business. Based on our research, OnPay, Intuit, Gusto and SurePayroll are the best companies for small business. You can view a full breakdown of the best picks here, as well as reviews of other top payroll service providers on our sister site Business.com.

While the best companies charge small businesses for their services, there are some free solutions that are ideal for small business. There are several online options like Payroll4Free.com, Wave and eSmart Paycheck. Before deciding to use a free payroll provider, it's important to assess your own needs and pick one that gels with your business. Many free providers are situation-specific, providing services to international companies, companies employing independent contractors and very small companies.

Payroll software automates all the necessary requirements of accurately running payroll. They automatically calculate the correct amount your employees should be paid each pay period based on the number of hours they've worked. If you have salaried employees, payroll software also tracks salaried employees and pays them accurately. The biggest advantage of using payroll software is having taxes automatically deducted from employee paychecks. You won't have to worry about paying payroll taxes or misreporting employees' wages. Many payroll companies will give you a 100 percent guarantee, so if there is a mistake, the payroll company will take responsibility, and your business won't be on the hook with the IRS. Because payroll systems work through an automated process, you can focus on running your business.

As an employer, the first step to setting up a payroll system for your business is contacting the company with the services you're interested in. You can work with a salesperson to get the right plan for your company. Your employees will have to fill out necessary forms and be onboarded, and your business will have to establish important tax information. Once you handle the necessary paperwork, you can work with the company to establish the type of pay period for your business as well as outline employee compensation information. Keep in mind that some companies may charge you to set up the system.

Much like setting up your software, learning to use the system falls on the company you're partnering with. Running payroll through a software application usually involves basic tasks like manager (or owner) approval of time cards and then establishing a day or time to run payroll. If you work with a company that fits your needs and is a reputable industry player, these payroll services are intuitive and fairly easy to use. Many companies will also provide points of contact for basic questions and support.

Payroll software automatically calculates and deducts both state and federal taxes from your employee's wages. It will also handle payroll tax payments to the government. Make sure you ask the company you're considering partnering with about this feature. Most companies provide payroll tax payment support, but some may not. In any case, one of the major advantages of working with a payroll software provider is not having to worry about taxes. Tax law and employee taxation are always structured to change. Payroll companies have team members dedicated to monitoring these changes and implementing them in your business. This kind of attention can keep you compliant, and you don't have to spend time sifting through tax law.

Payroll functions both in an HR and finance capacity. It involves finance, because payroll is one of your business's overhead costs. Payroll is also a function of HR as it involves tracking things like hours worked, time off requests and benefits information. Many payroll companies will integrate seamlessly with existing time and attendance software and HR management tools. Some companies, like ADP, may provide their own versions of these services to bundle with your payroll offering.

If you already work with an online payroll provider and you want to switch to a new service, it's possible to do so with minimal headaches. The best time to switch is usually at the end of a quarter or the beginning of the year, but this is not a requirement set in stone. Before preparing to switch, talk to your new payroll provider (or prospective new service), and ask for advice. Based on your business's specific situation, it could make sense to ask your new payroll provider when the best time to switch is, what information should be prioritized in the move and how long the switch will take. According to Insperity, there is some basic information you should have ready when you switch:

  • Employees' names, addresses and Social Security numbers
  • Deduction information or W-4 information
  • Employees' bank account information
  • Your federal, state and any other tax ID numbers
  • Year-to-date and quarter-to-date totals
  • Voided checks
  • Copies of your tax forms from the previous quarter

There may be additional information, or additional circumstances, that are specific to your business's situation. Talk with your new payroll provider to make the switch as seamless as possible.

Matt D'Angelo

Matt D’Angelo is a Tech Staff Writer based in New York City. After graduating from James Madison University with a degree in Journalism, Matt gained experience as a copy editor and writer for newspapers and various online publications. Matt joined the staff in 2017 and covers technology for Business.com and Business News Daily.