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The notion that payroll is hard to learn can sometimes lead business owners to make questionable decisions about how to staff their businesses (and think they’re unable to handle payroll processing). After all, why would you do something hard like payroll when it seems there are ways to make payroll “optional.”? Paying your workers accurately is a high-stakes business function. It requires good recordkeeping and organizational skills, and it really is a must to have basic knowledge of tax and labor requirements at both the state and federal levels.
All this seems to reinforce the notion that payroll is hard. In reality, payroll is not hard. It is complex, though, and you need certain skills to manage payroll effectively. Let’s take a look at some of the intricacies of payroll, with an eye on increasing your confidence when taking care of this business function.
What makes payroll hard to learn?
Once upon a time, business owners had to spend hours with complicated federal and state tax tables and an adding machine (or a spreadsheet) to accurately calculate payroll. Then, they had to write checks and create pay stubs showing current earnings and year-to-date earnings to give to their employees on payday. That’s it right? Not so fast! After that step, the business owner had to write checks to the tax authorities and make sure those checks were postmarked on time to avoid penalties.
That was when payroll was hard. But we’re now out of the “payroll is hard” era.
Today, payroll software removes much of the difficulty from payroll. You can simply enter some information about your employee and their tax status — and in many cases, there’s employee self-service tools so they can do this themselves — and the software takes care of the calculations and pay stubs and — often — the tax payments.
So, then, what’s the big deal about payroll? Even though payroll is no longer hard, it is still complex. And even though there’s many tools available to make the payroll function easier to administer, as a business owner, you still need to have basic skills and knowledge to make sure payroll for your employees is handled correctly.
Let’s get familiar with some of these fundamentals.
Skills and knowledge required to handle payroll yourself
Business owners handling payroll for their businesses need to have a basic working knowledge of certain labor and tax requirements. Even business owners outsourcing payroll to a bookkeeper, accountant, or payroll processing company should have this knowledge. Why is this so? At the end of the day, the responsibility to get payroll right lies with the business owner.
“I didn’t know” or “my bookkeeper/accountant/payroll processing company handles that for me” will not absolve a business owner from fines, interest, and possibly even legal action if payroll is mismanaged.
Let’s take a look at some of the things business owners need to know about payroll.
Payroll basics
Payroll straddles the line between accounting and human resources, meaning a business owner needs to know the basics of both functions. Specific to the management of payroll, a business owner must know the following.
Recordkeeping requirements
If you employ hourly workers or salaried workers who do not fall under the Department of Labor’s “exempt from overtime” classification, you must track the hours worked and retain those records. This recordkeeping ensures you not only pay your employees correctly, it also ensures you can defend your business against any claims an employee might make about labor violations.
The Department of Labor requires business owners to keep all records used to calculate payroll for at least two years, and all payroll records for at least three years. These records include timesheets, work schedules, wage rate tables, and records of deductions.
And that’s just at the federal level. State recordkeeping requirements could be different, and if you work with employees covered by collective bargaining agreements, those requirements could be different as well. Whenever recordkeeping requirements differ, you must keep records for the longest retention period.
Once the required timeframe has elapsed, it’s important to destroy the records. Yes, there is a temptation to retain old records “just in case,” but if your business ever undergoes an audit, the auditor has the right to examine all records available. Destroying records that are no longer needed can protect your business from an overzealous auditor.
Tax requirements
Mismanaging payroll tax requirements — whether accidentally or intentionally — can sink your business. Federal and state tax authorities have been known to grant forgiveness for one accidental tax indiscretion, but they are less likely to forgive suspected intentional mismanagement.
Payroll taxes are broadly broken into three categories:
Income tax withholding. These are the taxes an employer withholds from their employees’ paychecks to cover the employee’s federal, state, and (sometimes) local tax liabilities on the income they earn.
Unemployment insurance (UI) taxes. Unemployment insurance is one of the trickiest taxes to understand.At the federal level, unemployment insurance is covered by the Federal Unemployment Tax Act (FUTA). As of the time of this writing, an employer is required to pay 6% of the first $7,000 of an employee’s wages to cover the FUTA tax. This rate can generally be reduced to 0.6% if the employer makes the required payments under the State Unemployment Tax Act (SUTA) for their state.
The SUTA rate varies from employer to employer based on a number of factors, including length of time in business and experience rate (the number of unemployment claims an employer has.) FUTA is an employer expense, meaning these taxes are not withheld from employee paychecks. SUTA is also an employer expense in most states (Alaska, New Jersey, and Pennsylvania are the exceptions where a portion of SUTA is withheld from employee paychecks.) However, in some cases additional unemployment or disability insurance taxes are required by law, and in those cases a portion of the tax might be withheld from employee paychecks.
FICA taxes. Everyone who has ever been an employee is familiar with FICA taxes. Unlike withholding taxes, Federal Insurance Contribution Act taxes – or Social Security and Medicare taxes – are withheld regardless of how little an employee earns.FICA taxes are “matched” by the employer, meaning that half of the tax is withheld from employee paychecks, and half is paid by the employer.
Now, before you throw your hands up in exasperation and decide to just pay all your employees as independent contractors (more on that later), keep in mind that reputable payroll processing companies — including payroll software providers — have these requirements and rates on hand and will administer the appropriate deductions and payments for you. You only need to be aware that the requirements exist.
Labor requirements
We touched on this briefly under recordkeeping, and we’ll keep this section short and sweet as well. There are labor laws and requirements at the federal and state levels. If you work with union employees — those covered by collective bargaining agreements — there are requirements there as well.
If payroll is going to become more of a puzzle that needs to be solved, it’s here. But I would argue that understanding labor law requirements is more of a Human Resources (HR) function than a payroll function. Broadly speaking, you only need to be aware of regulations requiring payment for overtime worked (usually defined as more than 40 hours in a workweek, but sometimes defined as more than eight hours in a workday) to manage payroll.
Small business payroll concerns…and a solution?
Small business owners are not only concerned about payroll being a heavy lift, but they could also have some reservations about how much they’ll need to invest in getting it right.
In my experience, here’s what typically is involved when making the investment.
- The time required to administer the payroll function
- Platforms or tools
- Payroll taxes
There is one seemingly simple solution that eliminates all three of these issues, and that is hiring independent contractors instead of employees.
Independent contractors aren’t subject to payroll tax withholding or matching, saving business owners the effort required to withhold taxes and submit them on time, as well as the expense of matching FICA taxes and paying into SUTA and FUTA funds. There are no recordkeeping requirements associated with paying independent contractors aside from retaining invoices from them to back up tax deductions. And the only expense associated with using independent contractors is the amount required to pay them for their work.
So, why would any business owner choose to manage payroll when the seemingly simple solution of using independent contractors exists?
As is the case with many things in business, this “solution” isn’t as simple as it seems. The Department of Labor has strict rules about who can be considered an independent contractor and who must be classified as an employee. In many cases, these rules will classify workers as employees rather than independent contractors. Trying to circumvent these rules to save effort and expense related to payroll will only cause more effort and expense down the road.
Bottom line: Yes, business owners should carefully weigh the cost — both in time and expense — of doing payroll prior to hiring their first employee, but they should not make the mistake of classifying workers as independent contractors in order to avoid this cost.
What is the biggest challenge of payroll?
Although we’ve spent a good deal of time discussing the basic knowledge needed to manage payroll, you don’t have to have a degree in human resources or accounting to manage payroll for your business. In fact, the biggest challenge of payroll isn’t related to accounting or labor laws at all.
The biggest challenge of payroll is organization.
When you manage payroll for your business, you must keep track of:
Payroll schedules, including lead times for direct deposit. Throw in bank holidays and weekends, and you might feel like you’re always doing payroll.
Tax deposit deadlines. These deadlines shift as your tax liability changes. You might start out as a monthly depositor and have to deposit payroll taxes by the 15th of the following month, but it doesn’t take long at all to become a semiweekly depositor. And semiweekly depositors have to deposit payroll taxes on either a Wednesday or a Friday, depending on what day of the week payroll falls.
Benefits payments. If you provide health insurance, retirement, or other benefits to your workers, you must stay on top of your benefits payments. Few things will get an employee’s blood boiling more than learning their benefits have been canceled because you haven’t paid the bills.
Recordkeeping. We covered this above.
If organization isn’t your strong suit, you might want to consider outsourcing payroll to a company that will not only manage all of this for you, but that will also proactively send out communications letting you know about important changes to schedules, deadlines, and recordkeeping requirements.
If, however, you are relatively well-organized, simply plugging schedules and deadlines into your calendar will help you stay on top of your payroll management.
Learning and training for DIY payroll processing
By now, you’ve probably determined whether or not you can manage payroll yourself or if you need to outsource it to a payroll processing company, accountant, or bookkeeper. If you’re ready to take the reins, you’re probably wondering what you need to learn or what sort of training you need before you get started.
Here are some guidelines you can follow:
- Get help. Contact your state department of labor and state department of revenue to learn what regulations you need to follow to keep your payroll compliant. Many states have convenient checklists for new employers on their websites, but – if you find anything in those checklists confusing – call their assistance helplines. Make a note of who you speak with, the date of the conversation, and the guidance offered, and retain that with your permanent records just in case anything gets questioned in the future.Do the same for the federal level.If you aren’t excited about contacting government agencies, you can also get guidance from the American Payroll Association. The APA also provides training if you want to become a true payroll expert or put a member of your team on the path to getting this level of expertise.
- Do some research. On payroll software, that is. You want a software provider with a good track record of accuracy, support, and ease of use. Read online reviews, talk to other business owners in your industry, and watch training videos on the software you are considering to make sure you choose the software that will work best for you.A word of caution: The cheapest option isn’t always the best one. Invest in the most robust software you can afford. It will more than pay for itself in terms of time saved and the peace of mind it offers.
- Get (more) help. Once you have the basic payroll knowledge you need and have chosen a platform that makes sense for your business, talk to your accountant about setting up the software accurately. Yes, your provider will probably offer setup assistance, but it’s still a good idea to get your accountant’s input to avoid any accidental misunderstandings, especially if you have employees in multiple states.
Learning payroll should be on your to-do list
In and of itself, payroll isn’t hard to learn and DIY payroll software makes managing payroll easy for most businesses. However, payroll is an essential business function, and you don’t want to mistake “not difficult” with “unimportant.”
Most business owners making their first hire can manage payroll themselves. And this can hold true for your second through tenth hires, too. But as your business grows, and as tax and labor regulations change, managing payroll only increases in complexity. Only manage payroll yourself for as long as it remains simple and takes no more than 30 minutes of your time each payroll period. After that point, it will benefit your business to outsource your payroll.
Take a tour to see how easy payroll can be.
Billie Anne Grigg has been a bookkeeper since before the turn of the century (this one, despite what her knees seem to think). She is a Mastery Level Certified Profit First Professional and the Lead Technical Guide (coach) for the Profit First Professionals organization. She also frequently contributes to various small business and accounting industry publications.