Payroll processing consists of the steps needed to pay employees each period, and involves tracking hours worked, deducting money for employee benefits, and remitting payroll taxes. Establishing a solid payroll process helps employers avoid penalties for breaking Department of Labor laws (minimum wage, unpaid overtime), and payroll software makes it easy.
You can reduce the risk of expensive legal penalties by using Paychex, an all-in-one payroll and HR service. It provides a tax accuracy guarantee, meaning you won’t have to pay any penalties if the service makes a mistake managing your payroll taxes. There are experts on the team who stay abreast of all payroll tax and HR compliance laws, and it’s easy to pay employees via direct deposit, check, or paycard. Call for a free quote today.
Disclaimer: Fit Small Business does not provide legal or tax advice to our readers. If you have questions about legal requirements or payroll tax status in your business location, please seek the advice of a labor law attorney or payroll vendor.
The Payroll Process
The payroll process begins after you hire your first employee. Each pay period, employees work and must be paid based on a calculation of the hours they work and their pay rate. Before giving the employee a paycheck, however, you need to withhold money for expenses like state and federal taxes, unemployment, and insurance.
The result of subtracting an employee’s tax withholdings and benefit deductions from their gross pay (hours worked x hourly pay rate or salary per period) is net pay. Once net pay is calculated, you should pay your employees in the form of a paper check, direct deposit, or payroll card.
Be mindful that some states require you to document the payment information, including hours worked, earnings, and deductions on an employee pay stub. And if you violate state pay stub laws, you can be held liable for numerous penalties and fines—some are from $50 to $100 per infraction.
On the surface, payroll processing might seem complex; check out a simple payroll process flow shown below:
How to Process Payroll: Manual, Software, or Service
The length of time it takes to process payroll depends on the way you process it. Some small businesses manually track employee hours and earnings on a spreadsheet, which is both time-consuming and likely to produce errors. Others use free software or an online payroll calculator.
For example, if all your processing is done manually, it may take you a day or so to process payroll for just a few employees. That’s because you have to add up time cards, calculate pay and overtime, and process deductions manually. You also have to set aside taxes that have been deducted for each employee so they can be paid.
Because of the numerous steps required to process payroll the right way, we recommend using payroll software or a service to ensure that your employees’ paychecks are processed quickly and correctly based on federal, state, and local laws. The best payroll services pay your employees and your payroll taxes automatically, saving you hours of manual work each pay cycle.
Here’s an example of how the payroll process might work using payroll software.
Processing Payroll Each Pay Period
There are three basic steps to processing payroll each pay period: calculating total time worked, computing earnings, and paying employees. Overtime, taxes, and deductions must also be calculated, and net pay is the end result of the payroll process.
The time it takes to process payroll can vary from minutes to days, depending on the system you use for each of the three steps. If you opt to process payroll manually, of course, it will take longer, and you may need to download free payroll templates.
Step 1: Collect Time Worked
To process the correct payroll information, you have to start by collecting each employee’s time worked in the pay period. Most employers use a time sheet, time clock, timekeeping system, or scheduling system to capture employee time on paper time cards or electronically.
If you’re recording time worked manually, you may need to spend 15 to 20 minutes adding up time on each employee’s time card to determine the hours they worked over the time period—such as one week, 15 days, and so on. That may take you several hours or a full day if you have more than a handful of employees. So if you want employees to receive their paycheck on a Friday, you may need to start adding up their time cards as early as Monday or Tuesday for the prior pay period.
We recommend When I Work as a free timekeeping system that allows employees to clock in from their cell phone. The time card data from When I Work seamlessly integrates with top payroll systems, potentially saving hours of your time each pay period.
Step 2: Calculate Earnings & Deductions
Input the data (hours worked) into your payroll system or upload it electronically. The process to calculate paychecks will be the same whether you do payroll manually or use a payroll system.
If you’re using payroll software like Paychex, these steps may all be captured in a “run payroll” option or button. The exact steps, keystrokes, or calculations depend on the software you’re using.
However, if you’re doing this manually, it may take some time. Therefore, for example, if you added up time cards on Tuesday, you may need to input the hours worked on Wednesday into your payroll system, accounting software, or spreadsheet.
- Count the hours: Verify hours worked against the time card data to make sure you’re paying each employee for the correct number of hours worked in the pay cycle. Each payroll system will have a different way to verify this data.
- Determine overtime: If you’re doing this manually, you’ll have to watch for any employees who worked over 40 hours a week, and pay overtime (time and a half) for those hours. Most payroll systems do this automatically, and even account for payroll rules that vary by state, such as California, which calculates overtime by day (over eight hours in a day), rather than by week or pay period.
Overtime Is Paid at Time & a Half
- Calculate gross pay: Multiply the pay rate times the hours worked to come up with the gross pay. If you have more than one employee, this becomes a time-consuming activity. You’ll need to ensure you use the employee’s regular or straight-time pay rate for regular hours, and overtime pay rate for overtime hours. In addition, you’ll need to add any variable pay for bonuses, commission, and other similar payments.
Regular Pay + Overtime Pay = Gross Pay
Then add those two kinds of pay (regular and overtime) together to come up with the total gross pay. If you’re using a payroll system, you may be able to accomplish this calculation by pressing a button to calculate employee’s gross pay.
- Subtract deductions: If you’re processing payroll manually, you have to determine the amount of deductions, such as benefits, taxes, and insurance, that need to be taken out of the employee’s gross pay each pay period. However, if you’re using a payroll system, you simply need to verify that the correct deductions are set up—once.
Step 3: Pay Employees With Your Chosen Payment Method
Employee payment methods can be cash, paper check, direct deposit, or pay card. Some states don’t allow all of these payment options. In addition, many states have laws that require you to provide employees with a printed pay stub.
Once you process payroll, you’ll want to either write paychecks or forward employee payment information to the bank for direct deposit. Of course, your payroll account has to be funded. How long this takes depends on whether you’re using software or doing the work manually.
For example, ACH transfers from your business bank account to your employees’ direct deposit accounts may take one to three business days.
Let’s recap our payroll process in a timeline:
- On Tuesday, you calculate time cards and verify they’re correct for each employee.
- On Wednesday, you input hours worked and deductions to determine gross pay.
- On Thursday, you make sure there’s enough money in your payroll account.
- On Friday, you print and hand out paychecks or employees receive direct deposit.
Using Paychex, your employees will not only receive their direct deposit on time, but they’ll be able to view their pay stubs, pay history, and year-end W-2 and 1099 payroll tax documents online, saving you valuable time. You’ll also have access to 24/7 customer support.
Maintain Payroll Records
There are no federal laws that dictate what payroll records must be retained. However, there are requirements for what payroll information needs to be retained, such as full employee name, W-4 tax withholdings, full mailing address, and more. Most employers keep copies of the employee’s pay stub for this purpose after running the payroll process.
Payroll Processing: State-by-State Rules
As far as the timing of your payroll processing goes, it varies by state. For example, some states allow monthly pay cycles, while others require non-exempt employees (who are paid overtime) to be paid weekly. In addition, some states require a paycheck to be provided immediately upon termination, requiring you to run an off-cycle payroll.
We’ve provided a table below to assist you in determining your payroll processing time frames, along with state-by-state payroll information and due dates. The link on each state name below takes you to that state’s wage and hour page for more information.
State-by-State Payroll Laws
Minimum Wage, Overtime, Max Length of Pay Period, Final Check Due
*Minimum wage increases are scheduled.
Risks to Avoid When Running Your Payroll Process
The risks of running payroll are many, which is why it’s best to leave payroll processing to the pros in terms of a payroll service or software. Here are some of the more common risks you may want to be aware of and avoid—from failing to calculate overtime properly to misclassifying an employee in the first place.
- Overtime miscalculations: Make sure overtime is calculated correctly for the state the employee works in. Your business office may be in Arizona, but if your employee works out of an office in California, you have to calculate and pay overtime using California’s stricter rules. It only takes one employee complaint to trigger a payroll audit—and potential fines.
- Retroactive pay: Mistakes happen. If you fail to pay an employee properly this pay period (e.g., incorrect hours, missed bonus payment, forgot a pay raise), process retroactive pay immediately—no later than the next payroll cycle. Document what you did, just in case.
- Misclassifying employees: Don’t guess at the employee classification. Identifying an exempt employee as non-exempt, or paying an employee as a 1099 contractor, can land you in hot water with the local department of labor. If you don’t know, ask your HR or payroll consultant.
- Pay stub violations: This is only a risk if you’re in a state that requires a pay stub to be given to employees. Most states specify exactly what is required to be printed on the pay stub.
- Delayed paychecks for terminated employees: This is a common mistake in states that require you give your employee a final check immediately if you fire them. In those states, you can’t wait until the next payroll cycle. Refer to the table above for state-by-state requirements on final paychecks.
- Paying employees too infrequently: Some states have laws regarding the minimum frequency that you can pay employees.
- Mismanaging payroll records: There are two sides to this risk. One is that you must protect confidential employee information, like employee Social Security numbers and I-9 documents. On the other hand, you must retain certain payroll information by law, and those laws vary at the state and federal level.
- Payroll audit: A payroll audit is a risk (and a huge headache). Any mistake that is reported to your labor board by an employee could result in an audit. A complaint like, “They didn’t give me my final check!” could result in a full payroll audit that uncovers other innocent errors, back pay, and penalties.
These risks within the payroll process are why many small businesses choose to outsource their payroll or even use a free payroll software provider. It’s challenging to manage payroll records and keep track of labor laws without any help.
Frequently Asked Questions (FAQs) About Payroll Processing
Below are some common questions you may have while running your payroll process.
What should I do if I make a mistake on an employee’s paycheck?
In most cases, if you make a mistake on an employee’s paycheck, you can fix it on the next pay cycle using what’s called retroactive pay. However, some states require you cut the employee a check immediately if you owe them money.
How should I pay terminated employees?
This varies by state. At the federal level, you’re required to pay a terminated employee by the end of the next pay period. However, some states, like Minnesota, Missouri, and Nevada, require immediate payment upon termination if the employee was fired. Other states require terminated employees to be paid in time frames starting from the same day, up to 30 days (or the next pay period), whichever is sooner. Refer to the table above for what’s required for final paychecks in your state.
How should I manage payroll taxes?
One of your responsibilities as an employer is to make state, federal, and local tax and other payments to agencies such as Social Security, unemployment insurance, and workers’ compensation on behalf of your employees. You can do this with accounting software like QuickBooks. However, most payroll software, including Paychex, also do this for you.
If you’re doing payroll manually, you’ll need to plan to pay the taxes calculated and deducted from employees’ paychecks each quarter or more frequently, depending on the size of your payroll. At year-end, you’re required to report those payments on an employee’s W-2.
While the payroll process itself is pretty basic—count how many hours employees work and pay them for those hours—the labor laws affecting payroll are complex and vary by state, and, at times, by city. Therefore, we recommend business owners find a payroll provider that can manage those complexities, link to tax tables, and ensure labor law compliance. A good payroll provider frees a business owner to focus on what they do best—manage their business.
Paychex simplifies payroll processing because it has all of the state and local tax tables, pay period, and overtime rules built into its payroll system. The service scales well—you can add on additional services whenever you need them—and you can request a free quote anytime.