Learning payroll terminology helps prepare employers for the intricacies of running payroll. It’s full of terms fraught with legal implications and mathematical calculations. By definition, payroll is a business’ employees and how much they should be paid; taxes and government agencies are also significant components.
Here is a look at the top 20 payroll terms you should know.
Benefits (or employee benefits) refers to the additional compensation and perks that businesses provide to their employees. These are usually offered as an incentive to attract and retain the best job candidates. In a 2015 Society of Human Resource Management (SHRM) study, 60% of employees reported benefits as the third top contributor to overall job satisfaction, falling closely behind the 63% who rated pay as most important.
Some businesses only make the benefits accessible, meaning employees have the option to purchase them using their own money. Others contribute to a portion (and sometimes all) of the cost, so employees don’t have to foot 100% of the bill.
Here are a few employee benefits that some companies offer:
- Insurance: Insurance can include health, dental, vision, and life insurance. Employees can start a plan that only covers themselves or their entire families (kids and/or spouses).
- Retirement: Retirement benefits allow employees to save for their retirement with pretax dollars (similar to insurance benefits). There are numerous types of retirement plans, including 401(k), 403b (for nonprofits), individual retirement accounts (IRAs), pensions, and so on.
- Flexible spending & health savings accounts: These are both benefits that help lower employee taxes. Each time employees are paid, they can contribute money to these accounts that can be used to reimburse them for eligible expenses later. Money in flexible spending accounts (FSAs) can be used to reimburse medical and child care expenses while health savings accounts (HSAs) can only be used for healthcare expenses.
- Commuter: Commuter benefits operate similar to the flexible spending and health savings accounts, with the exception that the pretax dollars must be used to reimburse expenses incurred in commuting to work. This can include parking fees, public transit passes, and bicycling maintenance costs.
If you’re interested in offering your employees insurance, retirement, and other pre-tax benefits, consider Gusto. You can offer insurance if you’re in one of the 24 states Gusto services, and retirement benefits by paying a one-time $500 fee plus $8 monthly per employee. See the map below to verify if Gusto offers insurance in your state and sign up for a free trial today.
A bonus is additional money employers offer to motivate and reward employees. They can be specific dollar amounts or percentages of a metric, such as 5% of sales. Bonuses can be given when employees meet their goals for the year, as a standard perk during holidays, like Christmas, or to celebrate company growth.
$10,000 (sales) x 2% (bonus rate) = $200 bonus
A deduction is money that is withheld from employee gross earnings to pay for benefits and other expenses. Some deductions are made before taxes are calculated, such as those for medical insurance premiums, flexible spending accounts, and 401(k) contributions, so it reduces the total employees pay in taxes. Garnishments and voluntary insurance deductions are made after taxes are calculated, which means the income used to fund them is taxed.
Employees are workers that are hired formally to fulfill a specific position within a company. Employers pay a reasonable wage and may offer benefits, especially if employees work at least 40 hours weekly. They also pay and withhold taxes on employee earnings. In exchange, these employees must abide by company rules, such as when and how to work.
5. Employer Identification Number
The employer identification number (EIN) is a unique nine-digit number assigned to all employers that submit an IRS EIN application; it helps identify businesses as they file taxes, apply for business loans, and open business bank accounts. In summary, it’s like a Social Security number for businesses.
6. FICA Taxes
Employers are required to withhold and pay FICA taxes, which are Social Security and Medicare taxes, on each employee’s earnings. Current rates are 6.2% and 1.45%, respectively. To comply with federal regulations, employers must reduce employee paychecks by the 7.65% (6.2% + 1.45%) in addition to matching the 7.65% from their business funds. For any employees who earn over $200,000 in the year, an additional 0.9% must be withheld for Medicare.
If you need a robust payroll service to help your business comply with tax laws, consider Paychex. Paychex offers services that include automatic payroll tax administration, both calculating and paying your federal, state, and local payroll taxes. Call for a free quote today.
Garnishments are court orders directing employers to withhold a certain amount from an employee’s paycheck to pay an outstanding debt. Employers are responsible for withholding and sending the money as directed on the garnishment notice; in addition, the notice will sometimes have an ending date that business owners can reference before stopping the collection process. It’s imperative to act quickly after receiving a notice because employers can be held liable.
8. General Ledger
A general ledger (GL) is a record of accounts, identifiable by unique numbers and names, that are used to track business transaction activities. This is more accounting than payroll terminology; however, it’s important to know, because each time you run payroll, the balances in select GL accounts change. For instance, when payday arrives and cash is transferred out of your bank account, the cash general ledger account should reflect the decrease.
Any amount you withhold from employee paychecks to cover FICA taxes that will be paid at a later time should be credited to a liability account, such as FICA taxes payable. It’s imperative that all GL account balances reflect current information so that you can make the best business decisions. This can be quite a bit to manage if you don’t have an accounting background, but the best payroll software usually integrates with top accounting solutions for seamless information transfer.
“The general ledger plays an important role to any payroll process for two main reasons:
1) Reporting: Every time payroll runs, the data needs to be entered into your accounting system. Most large payroll processors have a general ledger import feature. With the click of the button, you can import your payroll numbers into the GL accounts you specify.
2) Analysis: Breaking down your general ledger expense accounts into different categories is crucial for decision making and analysis. If you have a service-based business, you may want to break out your employee cost in several different departments (job-related payroll expenses, general and administrative payroll expenses, and sales and marketing payroll expenses). This will allow you to spot overspending easily in a certain department or the need to invest more.”
―Michael Kern, CPA & Founder, Talent Financial
9. Gross Pay
Gross pay is the amount of an employee’s paycheck before taxes and deductions are withheld. For hourly employees, this is their hourly rate multiplied by the number of hours they’re being paid for the period plus any overtime, bonuses, and additional pay. For salaried employees, gross pay is usually the same each payday. It’s their annual salary divided by the number of pay periods in the year.
How to Calculate Gross Pay
For instance, if an employee works 20 hours a week and earns $8 an hour or if a salaried employee who’s paid twice a month earns $4,160 a year, gross pay for the week is $160 total.
Hourly Gross Pay
$8 x 20 hours= $160 pay
Salaried Gross Pay
$4,160/ 26 pay periods = $160 gross pay
Once 7.65% for FICA Taxes are deducted, the remaining pay is $147.76.
7.65% x $160 gross pay = $12.24 FICA taxes
$160 gross pay – $12.24 = $147.76
After deducting FICA taxes, you’ll also have to deduct benefit costs, income taxes, and so forth; once you’ve made all of the necessary withholdings and deductions from gross pay, the amount remaining is called “net pay.”
10. Hourly Pay Rate
Unlike an annual salary, hourly pay is based on an hourly pay rate. Hourly employees are assigned an hourly pay rate at the time of hire, for example, $15 an hour. This is the dollar amount you should multiply by your employees’ hours worked to calculate how much money they’ve earned.
11. Independent Contractor
Independent contractors are workers who are hired to perform a specific job or project. They’re not protected by federal labor laws or the DOL’s minimum wage requirement. In turn, employers don’t pay payroll taxes on their earnings; instead, they complete a 1099-MISC for all contractors they paid over $600. It’s important not to confuse contractors and employees. Unlike employees, employers aren’t allowed to dictate how or when contractors complete their work.
Matthew Ross, Chief Operating Officer of Slumber Yard, discusses the importance of differentiating between independent contractors and employees:
“The most important rule to remember with independent contractors is that you cannot control when, how, or where they get work done. This means that you can’t give independent contractors a set schedule and demand they work “x” number of hours. Since employers give up control when working with independent contractors, they don’t have to worry about Social Security, Medicare, retirement plans, and so on. That’s why it’s so important you respect the when, how, and where rule. As soon as you cross this line, independent contractors become bonafide employees and now you’re on the hook for employer taxes and benefits.”
―Matthew Ross, Chief Operating Officer, Slumber Yard
12. Minimum Wage
Minimum wage is the lowest hourly pay rate you’re legally allowed to pay an employee. Per the United States Department of Labor (DOL), the federal minimum wage rate is currently $7.25 an hour, but state rates vary. There are exceptions, such as those for minors and interns. Tipped employees are another group you’ll find the law makes exceptions for. Federal tipped minimum wage is $2.13 an hour, but employers must ensure that employee tips make up for the differential.
13. New Hire Reporting
New hire reporting is a process employers undergo to report new hires to their state. Federal law requires that all new hires be reported within 20 days of their hire date, but some states are stricter (Alabama requires seven days). All information is stored in the National Directory of New Hires and helps child support agencies locate parents who owe money. Before you can begin reporting, you must register under your state’s new hire reporting program.
14. Overtime Pay
In most cases, overtime pay is the additional money paid for time worked more than 40 hours in a seven-day period. Per federal law, the hours are paid at time and a half, or 1.5 times the employee’s regular hourly pay rate. California law, however, requires double-time pay for all hours worked more than 12 in a day and for all hours worked over eight on an employee’s seventh consecutive day of work.
How to Calculate Overtime Pay
For example, if an employee works 50 hours a week (not in California) and earns $15 an hour, overtime pay is $225 and total gross pay is $825.
50 total hours – 40 regular hours = 10 overtime hours
40 regular hours x $15 hourly pay rate = $600
$15 hourly pay rate x 1.5 = $22.50 overtime rate
10 overtime hours x $22.50 overtime rate = $225 overtime pay
$600 + $225 = $825 total pay
If you need a simple way to schedule your employee’s work hours and track against actual hours worked, consider When I Work. The system calculates overtime automatically based on weekly and daily thresholds you set up. It can calculate weekly, daily, and daily double overtime, meaning your business is supported even if your state overtime laws vary from federal.
15. Pay Period
A pay period is the time frame that a paycheck covers. If you pay biweekly and on Fridays, the period could be from the prior two weeks, with the last day being on the Friday that’s also payday. Since payroll is usually required to be processed a few days in advance of the actual payday, hours worked must be predicted. Some employers don’t like this and prefer to push the pay period back a week (pay in arrears).
“When considering a payroll schedule for your business, you have a lot of choices, but base your decision on two factors, maximized efficiency and how it benefits employees. For example, processing payroll every week may be a great perk to your staff’s weekly cash flow, but it will add significantly more burden to your business, both from the amount of time you will spend processing transactions and the cost to do so. This is especially true if you are using an outside service to generate your payroll for you, and 52 processing weeks times their weekly fees add up very quickly.
Instead, choose the middle ground and process your payroll on semimonthly basis. This has become the norm in most industries, plus it manages to keep a good balance between the amount of time your department will spend processing payroll and limits your cost exposure to using an outside service. In addition, your salaried employees will appreciate a predictable, fixed, twice a month payment schedule which will help with individual budget planning, and eliminate wage fluctuations due to additional payroll periods experienced under a weekly or biweekly payroll schedule.”
―Bob Shoyhet, CFO, Melillo Consulting, Inc.
A timesheet is a paper or electronic document businesses use to track employee hours worked. It lists employee names, the time they clocked in, the time they clocked out, and the work date. Prior to running payroll, this needs to be reviewed and approved to ensure the correct hourly pay is processed.
17. Unemployment Taxes
Unemployment taxes are taxes employers pay out of their own money to fund their state and federal unemployment programs. The total paid is based on the first $7,000 of employee earnings. Rates depend on the length of time a business has been registered with the unemployment program—new employers have higher rates—and the number of claims that have been filed against the company. Fewer claims warrant a lower rate.
18. W-2 Form
The W-2 Form is a tax document that reports all employee earnings in addition to taxes and deductions withheld. Employers must send this document to all employees by January 31 following the year that’s being reported. A copy should also be sent to the IRS and state tax agency, if applicable. The information provided helps employees complete their tax returns with accurate information.
Withholdings refer to the taxes employers are required to withhold from employee paychecks for remittance to the appropriate agencies. This includes Social Security, Medicare, federal income, state income, and local taxes. Upon hire, all employees should complete Form W-4 to report the number of exemptions they plan to claim; this helps employers determine how much to withhold for federal and state income taxes. FICA taxes are based on a fixed percentage.
20. Workers’ Compensation
Workers’ compensation is insurance that helps employers provide wages and other benefits to employees who become hurt on the job. All states require it, except Texas, and some offer policies you can purchase. Rates are determined by the type of positions you need to insure, claim history, and total payroll.
If you want a payroll service that specializes in compliance, consider Zenefits. It partners with certified insurance brokers who offer a variety of insurance plans, including workers’ compensation. The online system will sync with your insurance carriers automatically and store all documentation in an online document library. Schedule a free demo today.
Understanding basic payroll terminology is essential to processing payroll successfully. You don’t have to be an expert to know that both you and your employees pay FICA taxes or that all W-2s should be mailed by January 31. By implementing payroll terms into your vocabulary, you make it easier to digest related laws and concepts.
Have you come across any useful payroll terms that would be a benefit for new employers? Let us know in the comments.