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 Gusto, an all-in-one payroll and HR software. Gusto’s payroll software provides payroll and labor law compliance in all 50 US states, and makes it easy to properly manage PTO in addition to regular pay. Try it free for 30 days.
Disclaimer: Fit Small Business does not provide legal or tax advice to our readers. If you have questions about legal requirements or the payroll tax status of 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 you must pay them 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.
Net pay is the amount employees receive after you subtract their tax withholdings and benefit deductions from their gross pay (hours worked x hourly pay rate or salary per period). 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.
“Software” and “service” are not the same thing. A “software” is a platform that you manage your payroll operations through; “service” references customer, IT, and other related support that can come instead or in addition to a software package. The best payroll services pay your employees and your payroll taxes automatically, saving you hours of manual work each pay cycle.
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. You must also calculate overtime, taxes, and deductions, and net pay will be 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, it will take longer, of course, and you may need to download free payroll templates to help streamline each step.
1. Collect Records of 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 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.
If you’re looking for a way to automate your time-tracking process, consider using When I Work, 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.
2. Calculate Earnings & Deductions
Input the data (hours worked) into your payroll software, 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 Gusto, these steps may all happen with the click of a “run payroll” option or button. The specific steps, keystrokes, or calculations depend on the software you’re using.
However, if you’re doing payroll manually, it may take some time. For example, if you add the hours reflected on the time cards on Tuesday, you may need to input the hours worked into your payroll system, accounting software, or spreadsheet by Wednesday.
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.
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).
Again, many payroll rules vary by state, such as California, which calculates overtime by day (over eight hours in a day), rather than by week or pay period. Make sure you are partnering with a solid third-party payroll provider or are referencing all of the critical resources needed to actively manage overtime rules.
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 will be 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. As a rule, think of gross pay as the following: Regular Pay + Overtime Pay = Gross Pay.
You’ll need to add both pay types (regular and overtime) together to come up with the total gross pay. If you’re using a payroll system, you may be able to calculate this by simply pressing a button to compute the employee’s gross pay.
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.
3. Pay Employees With Your Chosen Payment Method
Employee payment methods can be cash, paper check, direct deposit, or paycard. Some states don’t allow all of these payment options, so be sure to check your state’s website for guidance. 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 from one to three business days.
Let’s recap our payroll process in a weekly 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, make sure there’s enough money in your payroll account to fund the payouts.
- On Friday, print and hand out paychecks, or ensure employees receive their direct deposit (some payroll services require you to submit and approve payroll information by Tuesday or Wednesday for it to be deposited by Friday).
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. To be safe, most employers keep copies of the employee’s pay stub 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 that you issue a paycheck 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.
Minimum Wage, Overtime, Max Length of Pay Period, Final Check Due
Although the IRS and the Department of Labor (DOL) govern how most aspects of payroll are processed, there are state-by-state regulated laws that also speak to what can and cannot be done within the payroll process. Using this tool will assist you in quickly accessing the state laws that you need to know.
Average Bookkeeper Salary/Hourly Rate per State
Risks to Avoid When Running Your Payroll Process
When you’re learning how to do payroll, you may find that there are many risks with the process, which is why it’s best to leave payroll processing to a quality 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.
Make sure overtime is calculated correctly for the state in which the employee works. 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.
Mistakes happen. If you fail to pay an employee properly this pay period (for example, 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.
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 be given to employees. Most states specify exactly what is required to be printed on the pay stub.
Delayed paychecks for terminated employees are 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 that state the minimum frequency at which you can pay employees, and it is essential that you know what the minimum payroll cycle is for your state. Not paying employees on time can result in steep fines from the Department of Labor.
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-proof Your Practices
A payroll audit is a risk (and a huge headache). Any mistake that your employees report to your state labor board 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 resulting in back pay and penalties. These risks within the payroll process are why many small businesses choose to outsource their payroll or 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. However, not all questions, nor their answers, are mentioned here. You may want to start with payroll software reviews.
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 retroactive pay. However, some states require you to cut the employee a check immediately if you owe them money. If you are unsure of what to do, or what your state requires you to do, cut an internal check for the amount owed to your employee right away. It’s better to be safe than sorry.
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, immediately following their last day. However, some states, like Minnesota, Missouri, and Nevada, require immediate payment upon termination if the employee was fired. Other states require that terminated employees are paid in time frames starting from the termination 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.
Can employers give paid time off (PTO) instead of overtime pay?
Within the U.S., the general rule is that you may not offer paid time off (PTO) in exchange for overtime compensation. When an employee works more than 40 hours in a work week (although there are other calculations that determine when time worked involves overtime), employers must pay the employee 1.5 times their hourly rate within the same time period. The DOL offers a clear outline for how to manage overtime obligations.
How should I manage payroll taxes?
One of your responsibilities as an employer is to make state, federal, and local tax and other payments, such as Social Security, unemployment insurance, and workers’ compensation, on behalf of your employees. If you’re doing payroll manually, you’ll need to plan to pay the taxes deducted from employees’ paychecks, which includes completing Form 941 (identifies the employer’s quarterly tax withholding amounts for estimated income tax payments as well as employer payments, FICA taxes, and so on).
While the payroll process itself is straightforward—that is, you count how many hours employees work and then pay them for those hours—the labor laws affecting payroll are complex and vary by state, and, at times, by city (minimum wage). Therefore, we recommend business owners find a payroll provider that can manage those complexities, link to tax tables, and ensure compliance with labor laws. A good payroll provider frees a business owner to focus on what they do best—manage their business.