On average, small businesses pay $45,000 in payroll per employee, according to a 2017 report by JPMorgan, Chase & Company. Since the COVID-19 pandemic began, 32% of small business owners laid off employees and 30% spent their reserves by the end of the year. Even with government loans like the Paycheck Protection Program, many small businesses have struggled. As the nation recovers, it’s more important than ever to keep payroll costs down.
Here are obvious and not-so-obvious payroll costs every employer should consider and how to minimize them.
1. Payroll Tax Costs
Employers are bound by law to file and pay taxes on their employee wages, including unemployment and disability insurance. While employees pay annually, employers need to keep up a quarterly, sometimes monthly, schedule of payments. Even nonprofits are not exempt from paying payroll taxes. In general, employers should plan on setting aside 30% of their net business income for payroll taxes.
How Do I Minimize My Payroll Taxes?
Payroll taxes are set by the federal, state, and sometimes local governments. They can’t be negotiated. However, there are things you can do to keep them to a minimum.
- Be proactive: In my years working with payroll taxes, I’ve seen many employers wait until the last minute to pay taxes or put off paying taxes until the next quarter only to be surprised by the amount they owe. This can lead to financial burdens or the need to take out a loan, which adds the expense of interest.
- Be accurate: Payroll taxes are reasonably straightforward but accuracy and application of all the pertinent info is key. Know the laws. Be sure you have the correct information in your payroll software, from hours and garnishments to accurate W-2s. Also, make sure you calculate state and federal unemployment taxes and disability insurance correctly.
- Be prompt: The federal penalties are 2% to 15% for paying payroll late.
2. Worker Pay Costs
Worker pay includes wages, overtime, tips, and bonuses. How much you pay is largely decided by you, although there are minimum wage requirements you have to meet (unless you’re paying independent contractors). The minimum amount you’re required to pay each employee per federal law is $7.25 per hour; you can pay tipped employees $2.13 per hour, with the caveat that they receive enough in tips to earn the regular minimum wage amount ($7.25 per hour).
Although it’s been more than a decade since the federal minimum wage increased, a growing number of states are starting to raise theirs more often—with some setting $15.00 an hour as their target. This could increase payroll costs significantly for businesses that are accustomed to paying much less.
How often you pay can also affect your payroll costs, specifically their timing. Employees are usually paid semi-monthly (First and 15th), bi-weekly (every two weeks), or weekly. Less common, although it happens, is monthly pay. Overall payroll cost is generally not affected by how often employees are paid; however, depending on your cash flow, it could be more beneficial to pay one way over the other to avoid risking insufficient funds.
Another factor to consider are the types of workers you have employed. Hourly and salary workers incur extra expenses like taxes, and some may need to be paid extra for overtime work (usually at the time and a half-rate). You also need to calculate paid PTO and paid non-work time like travel.
Hourly vs Salary vs Contractors: Differences in Payroll Costs
Full-time >30 hours of work
✔ If they earn <$23,660/year
Independent project rates
Tracking hours worked
High-risk of losing money due to buddy-punching, time-tracking fraud
Payroll software and services
Usually cheaper; Less common
How to Save Money on Payroll Costs and Maintain Fairness
- Keep good records: Make sure your employees track hours, tips, and expenses and that they submit these numbers to you on time. Establish a structured system and maintaining good payroll records can help you avoid late fees, penalties, and fines.
- Avoid paying overtime for hourly workers: Overtime costs involve not only pay but taxes on that pay. If you find you are paying a part-time salary’s worth of overtime, it might benefit you to hire another employee instead.
- Hire interns: If you have certain jobs that require skill but not a lot of experience, check with your local universities or chamber of commerce about hiring interns. Often, these workers are less expensive because they are getting valuable experience. Some programs will pay their salaries for you. Plus, if the intern does well, you can hire them later and have a trained employee who is already familiar with your company.
- Consider non-wage reimbursements: Wages are only one of the ways to pay an employee. Stock options and intangible benefits, like work time for independent projects, may incur some costs, but not as much as a higher wage. In the meantime, they can add to making your workplace somewhere people enjoy.
- Hire contractors: 1099 contract employees are hired usually by the project (or contract). Their obligation to you is to finish the work to your specifications, while you agree to pay once the project is complete. Contractors often charge more than an hourly wage, but you are not responsible for payroll taxes or benefits, so it can be a cost-effective way to cut your payroll expenses.
- Hire temps: If your business is surging but will likely drop back to a lower level of activity, look into using a temp service to carry you through the busy season.
3. Reimbursement Costs
Reimbursements for employee expenses include travel expenses, like hotels and meals, fuel costs, work supplies, or even the run to the coffee shop. These can get costly and are subject to payroll fraud. You don’t typically pay taxes on these amounts, but you will need to devote time to establishing an organized process to gather and verify these expenses before paying them out.
How to Minimize the Cost of Employee Reimbursements:
- Have clear policies: Make sure employees know what qualifies for reimbursement.
- Keep accurate records: Track employee expenses that you can reimburse in an employee expense report or in your payroll software.
- Have managers review and approve requests for reimbursements to ensure they are allowed and accurate.
- Pay promptly: Set deadlines for filing reimbursement requests and pay them promptly such as in the next paycheck. This can help prevent errors caused by an employee forgetting details over time and guessing instead, for example.
4. Benefit Costs
Benefits are the extras you provide employees. On average, private employers spent an average of $10.74 per work hour on benefits in 2020, according to the Bureau of Labor Statistics. Some, like health insurance, are required by law for full-time employees. but others, like stock options, can make you more competitive with prospective candidates. There are also benefits you can offer to help better reflect your company culture, such as a cappuccino bar or pet-friendly workplace policies.
According to a Glassdoor study, 80% of employees would prefer an increase in benefits to a raise, and 60% of candidates consider benefits important to their decision to apply to a company.
According to a study published in 2020 by Fractl, employees prize health, dental, and insurance benefits most; and per the Bureau of Labor Statistics (BLS), insurance is the most expensive benefit employers pay out—an average of $2.81 per hour worked for each employee. The study did not ask about financial benefits like a 401(k), although other studies say it’s one of the most asked-for benefits. Retirement benefits tie with supplemental pay (like bonuses and shift differentials) as the third most expensive benefit employers choose to pay out—totaling an average of $1.25 per hour worked, per employee.
How to Minimize Benefits Costs:
- Decide ahead of time what benefits to offer: Know what is required by law, what your competitors offer, and what additional benefits reflect your company values.
- Shop around: Not all benefits packages are created equal. Look for packages that give you a good price and an attractive offering for your employees and candidates.
- Consider a broker: Brokers have more experience in finding good benefits packages for small businesses. Many payroll software companies work with brokers and can help you find a good package.
- Get your package through a PEO: If you are looking into getting payroll and HR assistance anyway, a Professional Employer Organization (PEO) can handle these tasks and get you enterprise-level benefits packages at small business prices.
- Consider inexpensive or intangible benefits: According to a study by Eagle Hill Consulting, 77% of employees polled agreed a strong culture allows them to do their best work, while 76% see the impact on productivity and efficiency. According to Harvard Business Review Writer, Lily Zeng, employees are increasingly looking for companies with a culture of social responsibility that includes “social issue marketing, philanthropic efforts, employee volunteer initiatives, and diversity and inclusion work.”
5. Workers’ Compensation Costs
Most employers are required to purchase workers’ compensation insurance—unless your business is in Texas. The insurance covers your business in the event that an employee is off from work due to work-related injury or illness. On average, small business owners pay $450 in annual workers’ compensation costs for each employee or $0.45 for each hour of employee work.
To learn more about workers’ compensation, costs, and where you can purchase it, check out our workers’ compensation guide.
6. Garnishment Costs
Garnishments are parts of an employee’s paycheck you withhold to pay to other agencies to cover a past-due debt—always as a result of a court order. Usually, these go to child support, levies such as for unpaid taxes, or for delinquent student loans. While the money comes from the employee’s pay and not your operating funds, you still are liable for executing the process; if you don’t manage this in a timely manner, you can be charged for the cost of the debt plus penalties. Many payroll services and software can handle garnishments, but a few charge for this service.
How to Minimize Garnishment Expenses
- Respond promptly to the order: Garnishment orders typically have a deadline for a response, and if you don’t meet that deadline, you could be liable for the debt, increasing your payroll expenses unnecessarily.
- Verify the debtor is on your payroll before complying: Although garnishments may not seem to automatically increase your payroll costs, they do; the time you spend processing garnishments could be spent on money-generating activities.
- Determine how much to remove per paycheck: Often, garnishments don’t specify the amount to pay out. You’ll need to calculate it, keeping in mind that your employee needs enough to live on as well. Taking out too much may drive your employee to find another job while taking too little could put you on the wrong side of the law.
- Charge employees the processing fee: If you must pay a processing fee to handle the garnishment, then by law, you can pass this on to your employee.
7. Payroll Software and Service Costs
Payroll software makes the process of calculating payroll easier. The software does not only calculate payroll but also taxes, benefits, garnishments, and sends payments. However, there is a cost, but for many, the cost outweighs the benefits and saves money overall in the long run.
Ultimately, you can save money in terms of work hours (and headaches). They usually cover fines, penalties, or late fees you incur if their reps make a mistake. And overall, it may cost less than hiring someone to do the job part- or full-time.
How to Minimize Payroll Software or Service Expenses
- Invest in the right payroll software for your business: Consider not only how it calculates payroll but also how it pays employees, whether it files taxes, what it charges for checks, and whether it charges by pay run or month. If you can find a solid payroll software with unlimited pay runs that meets your needs, it could prove to be more affordable, especially if you’re running weekly.
- Consider free payroll services: If you have a very small, straightforward payroll process, you might be able to use a free payroll service. Many will calculate the taxes and charge a small amount to file them.
- Test drive first: Many payroll software products come with month-to-month subscriptions but give discounts for annual subscriptions. Make use of free trials or try it for a month to be sure the software does what you need and that it’s easy to use. You may even discover that running payroll on your own is more appropriate and affordable for your business at this time.
To see a list of the best payroll solutions, check out our payroll services buyer’s guide.
8. Costs of Sending Pay to Employees
In addition to cash, there are three common ways to pay your employees: checks, direct deposit, and pay card. Direct deposit is the most popular and easiest, and most payroll software do pay runs this way at no extra cost; some free payroll software charge a small fee, like $25 monthly.
Pay cards are debit cards assigned to your employee into which you deposit their pay. They are especially good for employees without bank accounts, but your employees often have to pay transaction fees.
Checks are the least popular choice, although some businesses prefer them, especially if they do not pay on a regular schedule. If printing yourself, you’ll incur costs for check stock, a printer, ink, and MICR toner. If you’re not paying for a payroll solution and you have a handful of employees, you can save on payroll costs by using a free check printing solution.
Average Payroll Costs Employers Incur
80 cents to $2 per paycheck, plus stamps
$1.50–$1.90 per individual payment
$0–$2 per card
w/bank or payroll service
w/bank or payroll service
$1.50 (per transaction, not individual)
Usually passed to the employee
How to Minimize Costs of Paying Employees
- Encourage direct deposit: In the long run, direct deposit is considered the best and least expensive alternative for employers and employees.
- Reduce checks: Checks are the most expensive alternative, not only because of the paper and mailing involved but because they can be easily lost and may not get cashed right away, creating cash flow issues. However, they may be more cost-effective for paying contractors or temporary workers, or if you are not sure you’ll have enough money to make payroll all at once and want to take advantage of the time between issuing the check and it being cashed.
- Pay monthly or semi-monthly. By paying less often, you can cut down some of the administrative costs of payroll. Keep in mind, however, what is common for your industry. Most people prefer bi-weekly or semi-monthly (every First and 15th).
9. Payroll Fraud Costs
An Association of Certified Fraud Examiners study says that payroll fraud cases cost its victims a median of $63,000 a case. Small businesses are more likely to be at risk than larger ones because they place a higher level of trust in their employees and often have fewer safeguards in place. Payroll fraud includes buddy punching, padding hours, not paying back advances or overpays, and faking commissions.
How to Prevent Payroll Fraud
Time tracking software with geofencing or biometrics can cut down a lot of timecard issues, but clear policies and careful double-checking of expenses and hours by management are often the best ways to catch payroll errors, whether accidental or deliberate. Check out our article on preventing payroll fraud for best practices.
Payroll can account for 15% to 50% of your gross revenue. Keeping costs down gives you extra income to put back into recovering from the pandemic, growing your business, or pouring back into your employees. Good record-keeping, periodic reviews, and making smart decisions can help you keep the price of payroll costs down.