What is Payroll Processing & How Does it Work? | Paycom Blog
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What Is Payroll Processing?

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    Takeaway

    Payroll processing is how employers determine what workers earn, the taxes they may owe and the method of remitting pay. Failing to accurately process payroll could harm employees and a company’s ability to comply with federal, state and local laws. Read how payroll processing works, the essential steps of the task and how to simplify operations with the right single software.

    Payroll processing is a massive part of any successful business operation, from calculating and distributing employee wages to withholding and paying taxes. It’s a complicated process that takes meticulous attention to detail and a thorough understanding of federal, state and local law.

    But don’t worry. We’ll help you understand payroll processing by:

    • exploring the essentials of payroll
    • delving into the regulatory landscape that shapes it
    • outlining the vital documents you need to execute it seamlessly

    Let’s get started.

    How does payroll processing work?

    Processing payroll is a multistep process that requires accuracy, timeliness and compliance with regulations. Here’s a detailed explanation of how it works.

    Payroll processing cycle

    The payroll processing cycle is typically:

    • weekly
    • biweekly
    • semimonthly
    • or monthly

    It determines how often payroll runs each year and can impact the complexity and cost of payroll processing.

    Inputs

    Calculating an employee’s pay — and doing it accurately — requires a lot of data. An employee’s pay may depend on their hours worked and salary details as well as bonuses, deductions and any other compensation or benefit information.

    Accurate data input and monitoring ensures that employees are paid correctly and on time while also complying with payroll tax and compliance obligations.

    Processing

    The processing stage is the meat of the payroll processing cycle, when all compensation data is calculated and transformed into a paycheck or direct deposit. It requires careful attention to detail and adherence to current tax rates and regulations to ensure accurate and compliant payroll.

    Approvals

    This is when senior management or designated approvers examine the processed payroll for accuracy, ensuring that all calculations, deductions and payments are correct and comply with company policies and regulatory requirements. This layer of oversight helps preserve the integrity of the payroll process.

    Correction

    This step ensures that discrepancies — such as overpayments, underpayments or incorrect deductions — are promptly adjusted in the current or subsequent payroll periods. These corrections help maintain payroll accuracy, compliance and employee satisfaction by ensuring all workers receive the pay they’ve earned.

    Components of payroll processing

    Payroll processing has a variety of critical components to ensure accurate and timely payments that adhere to legal and regulatory standards. Here’s a breakdown.

    Pay periods

    Pay periods are the intervals at which an organization distributes wages to employees. Typically, they’re either weekly (52 pay periods), biweekly (26), semimonthly (24) or monthly (12). The frequency of these intervals affects the timing of employee compensation and the complexity of payroll calculations.

    Employee designations

    Employee designations — such as hourly, salaried, W-2, I-9 and part-time — determine how wages are calculated and the type of tax forms required. Understanding these distinctions is crucial for accurate payroll calculations, tax withholdings and compliance with labor laws.

    Time tracking

    Accurate time tracking is essential for payroll processing, especially for hourly employees. It helps record the exact number of hours worked, ensures compliance with labor laws, and provides valuable workforce management and budgeting data. This can be done manually or through intuitive time and attendance software.

    Benefits deductions

    Benefits deductions are subtracted from an employee’s gross pay for their chosen benefits, including:

    These deductions are important for payroll processing, affecting the employee’s net pay and contributing to their overall compensation package. Accurately managing benefits deductions ensures compliance with benefit plan rules and regulations.

    Tax withholdings

    Tax withholdings are the amounts deducted from an employee’s gross pay for taxes, which helps ensure the accurate collection and remittance of income taxes to the appropriate authorities. Proper management of tax withholdings is essential for compliance with tax laws, preventing the underpayment or overpayment of taxes, and the accurate net pay calculation for employees.

    Garnishments

    Garnishments are legal deductions from an employee’s wages to pay for debts like child support, alimony, unpaid taxes or loan defaults. When processing payroll, employers need to withhold the specified amounts from an employee’s pay and remit them to the appropriate entity or individual.

    PTO accrual

    Paid time off (PTO) is a system within payroll processing where employees accumulate a certain amount of PTO hours based on company policy. Tracking the accumulation and usage of PTO ensures that employees are accurately compensated for their time off, whether for vacation, illness or personal reasons.

    Payroll regulations

    Payroll regulations are the rules employers need to follow when paying their employees, covering areas such as:

    These regulations are enforced by various agencies to ensure fair treatment of workers and compliance with labor laws. Employers who violate these regulations could face legal penalties and damage to their reputation.

    Fair Labor Standards Act (FLSA)

    Enacted in 1938, the FLSA protects workers against unfair pay practices and labor conditions. It mandates that nonexempt employees receive at least the federal minimum wage for all hours worked and overtime pay at one and one-half times the regular pay rate for all hours worked over 40 in a workweek.

    Federal Insurance Contributions Act (FICA)

    FICA is a U.S. law mandating a payroll tax to fund the Social Security and Medicare programs. This tax is divided equally between employers and employees, where both contribute a set percentage of the employee’s earnings up to a specific limit for Social Security, with an additional percentage contributed by both parties for Medicare without a wage base limit.

    FICA ensures that workers and their employers contribute to a nationwide fund that provides benefits to:

    • retirees
    • people with disabilities
    • children of deceased workers

    Federal Unemployment Tax Act (FUTA)

    FUTA is a federal law that imposes a payroll tax on employers to fund state workforce agencies and unemployment insurance programs. These taxes — paid solely by employers — provide financial assistance to workers who have lost their jobs.

    Documents needed to process payroll

    To process payroll accurately and comply with legal requirements, employers need to collect and maintain these key documents.

    Form W-4

    Form W-4 is a document that employees fill out to determine the amount of federal income tax to be withheld from their paychecks. The form conveys an employee’s:

    • filing status
    • number of dependents
    • any additional income or deductions

    W-4s help businesses comply with tax laws and employees avoid owing significant amounts when filing their annual tax returns.

    Form W-9

    Form W-9 is a document used in payroll processing for independent contractors and freelancers. It’s used to obtain the contractor’s taxpayer identification number or Social Security number and ensure correct earnings reporting to the IRS.

    Form I-9

    Form I-9 is a mandatory document that verifies the identity and legal authorization to work of all paid employees. Employers are required to complete and retain a Form I-9 for each individual they hire for employment in the U.S., including citizens and noncitizens. This helps ensure they comply with federal laws and employ only people who are legally allowed to work, a process made simpler with E-Verify software.

    Bank information

    Bank information allows for the direct deposit of employee salaries into their bank accounts, providing secure and efficient receipt of payment. Automating payroll through bank account details streamlines the process, reduces the risk of lost or stolen checks, and offers easy access to funds for both employers and employees.

    Job application

    A job application provides essential information about a new employee, including their:

    • personal details
    • employment history
    • references

    This helps set up payroll records with accurate classification and compensation, a foundational record for new hires in the payroll system.

    Retirement plan documents

    Retirement plan documents contain vital information about employee participation in retirement savings programs, specifying contribution rates, employee eligibility and any employer-matching contributions.

    This information is necessary for the accurate deduction of contributions from employees’ paychecks and their subsequent allocation to retirement accounts. It also ensures compliance with tax laws, supports employee financial planning and facilitates retirement benefits management.

    How to create a payroll process

    Creating a payroll process involves several important steps to ensure accurate and timely employee payment while complying with legal requirements. Here’s a simplified overview.

    1. Define workweek

    Defining the workweek is crucial when creating a payroll process, as it sets the specific 7-day period used to calculate:

    • hours worked
    • overtime eligibility
    • employee pay

    This period can start on any day of the week and at any hour of the day. It serves as the basis for determining compliance with wage and hour laws, such as the FLSA. By establishing a consistent workweek, companies ensure that employees are compensated correctly for their regular and overtime hours worked within this defined time frame, which is essential for accurate payroll calculations and legal compliance.

    2. Ensure time and attendance

    Ensuring accurate time and attendance tracking is a crucial step in establishing a proper payroll process, directly affecting the calculation of wages, particularly for hourly employees. This involves implementing a reliable system — manual timecards or digital timekeeping software, for example — to record when employees work, take breaks and accumulate overtime.

    Accurate timekeeping helps businesses comply with labor laws, preventing disputes over pay and ensuring that employees are compensated fairly for all the time they’ve worked.

    3. Calculate pay and break periods

    Employers need to accurately determine the time worked by each employee, including regular hours, overtime and any paid or unpaid break periods, taking into account any company policies and compliance with labor laws. For example, the FLSA may dictate specifics about overtime pay and break entitlements. This ensures employees are paid correctly for their time and that employers meet their legal obligations regarding wages and hours.

    4. Include payroll deductions

    Payroll deductions are needed to account for various withholdings from an employee’s gross pay before issuing their net pay, including:

    • federal and state taxes
    • FICA contributions
    • health insurance premiums
    • retirement plan contributions

    It’s important to properly calculate and include these deductions to ensure legal compliance and accuracy in the employee’s final pay. This will reflect their actual earnings after all withholdings and help them understand how much they’re taking home.

    5. Have a defined pay structure

    Having a well-established pay structure is an essential step in creating a reliable payroll process, laying out specific and consistent criteria for how employees are compensated based on their roles, experience, qualifications and performance.

    The structure should include pay scales for different positions, overtime rates and criteria for raises and bonuses, ensuring transparency and fairness in compensation practices. A clearly defined wage structure helps maintain internal equity, which can motivate employees and ensure compliance with wage and hour laws.

    6. Payroll process bookkeeping

    Bookkeeping is a vital part of the payroll process that involves carefully documenting every aspect of it, from wages paid and deductions made to all the taxes withheld. This detailed record-keeping helps organizations maintain financial accuracy, comply with tax laws and prepare for audits. It also ensures that all financial transactions related to payroll are accurately accounted for, which makes financial analysis, reporting and decision-making much easier.

    Payroll processing software and technology

    Beti® is Paycom’s innovative tool that allows employees to do their own payroll. It works by automatically flagging payroll errors, then guides employees to fix them before payroll submission.

    Here are just a few of the many ways Beti helps businesses.

    Automate processes

    Beti automates the payroll process by allowing employees to engage directly with their payroll data, letting them check and update information like hours worked, earnings and deductions before payroll is finalized. This self-service approach automates the verification and approval steps, which used to require constant intervention by payroll staff.

    Beti streamlines the entire process by empowering employees to verify payroll’s accuracy, ultimately reducing errors and increasing efficiency for the process overall.

    Automate fail-safes

    Beti automates fail-safes by incorporating system checks and validations that prompt employees to review and confirm their payroll information for accuracy before submission. It’s a proactive approach that reduces errors by catching discrepancies in real-time — like incorrect pay rates or hours worked — before the payroll is processed.

    By allowing employees to verify their payroll details, Beti helps ensure a more accurate and reliable payroll process.

    Transparency between organization and employee

    Beti also enhances transparency by giving employees direct access to payroll information. This allows them to see and verify things like hours worked, pay rates and deductions and do it before payroll is finalized. Beti is designed to create an environment of transparent dialogue about payroll processing, one where employees can actively engage and raise concerns or questions regarding their compensation.

    This level of visibility fosters trust and accountability, as employees can see for themselves how their pay is calculated and ensure their information is accurate, building their confidence in the payroll process.

    Data protection

    With robust security measures and compliance with regulatory standards, Paycom makes sure sensitive payroll and personal employee information is secure and protected against unauthorized access. The single software uses encryption, secure authentication methods and regular security audits to safeguard data integrity and privacy, protecting your business from data breaches and ensuring that your payroll complies with data protection requirements.

    Payroll processing: FAQ

    Who in my organization should be processing payroll?

    Payroll is typically handled by HR or finance departments, which are trained in:

    • payroll laws
    • tax requirements
    • software

    In smaller businesses, office managers or business owners often handle payroll. Regardless of your organization’s size, accuracy and compliance are essential.

    What size team requires payroll software?

    Payroll software can benefit businesses of all sizes by ensuring accuracy, efficiency and compliance with state and federal regulations. Even small businesses with few employees can benefit from it.

    What happens if I make a mistake when processing payroll?

    Payroll errors can spur big consequences, from employee dissatisfaction to legal and financial repercussions. That’s why promptly correcting the error and communicating transparently with affected employees are crucial. Rectifying filings and payments with tax authorities is also necessary to avoid penalties and interest.

    Is it safe to put my employee’s data into payroll processing software?

    Payroll processing software is safe if it follows high security and data protection standards. Reputable vendors use encryption, secure data storage and understand privacy law compliance, so be sure to choose a provider with a strong security track record and stay informed about data protection regulations for added safety.

    How do companies issue paychecks?

    Issuing paychecks involves calculating gross pay, deducting taxes and determining net pay, a process made more efficient and reliable through payroll software. Accurate calculations and compliance with tax laws are crucial to avoid discrepancies and legal issues. Then paychecks can be issued either as physical checks or direct deposit.

    How do companies maintain payroll compliance?

    Payroll compliance requires keeping up with federal, state and local tax laws and labor regulations. It also involves timely and accurate reporting of payroll taxes, proper worker classification, adherence to minimum wage laws and accurate calculation of overtime pay. Using payroll software that updates automatically can improve this process significantly, along with regular training for payroll staff on any changes in legislation.

    How long does it take to process payroll?

    Payroll processing times vary based on organization size, complexity, and manual or automated processing. Small businesses might take a few hours per pay period, while larger ones could potentially take days. The right payroll software automates all the necessary calculations, tax withholdings and filings, significantly reducing processing time.

    What are the types of payroll processing?

    Payroll processing can be managed in-house, outsourced to a provider or done through a hybrid approach. In-house processing requires payroll software and knowledge of applicable tax laws, whereas outsourcing to a provider can relieve administrative burdens for a higher premium. A hybrid approach, naturally, combines both methods. The choice depends on your business’s size, complexity and resources.

    Explore Paycom’s resources to learn more about payroll, HR technology and more.

    DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.