Common Payroll Terms
Payroll is the process of paying employees for work they performed for your business. Federal, state, and sometimes local laws govern how you do payroll (and to an extent, how much you pay and how often), meaning you can’t make up all the rules as you go. The process also consists of withholding money for taxes and other employee expenses, not to mention paying your business employment taxes.
A payroll deduction is money you withhold from an employee’s earnings to pay for benefits (like insurance premiums) and other expenses (like taxes, garnishments, and child support).
A pay period is the time frame of work for which you’re paying an employee. Common periods are Weekly, Bi-Weekly (every two weeks), Bi-Monthly (twice a month), and Monthly.
Employer Identification Number (EIN)
The 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 and is a requirement for any business processing payroll.
Gross pay is the amount of an employee’s paycheck before payroll 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 their annual salary divided by the number of pay periods in the year plus bonuses.
Net pay is the final amount you pay your employees for their work, after all deductions have been made.
Minimum wage is the lowest hourly pay rate you’re legally allowed to pay an employee. Per the 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.
Overtime pay is the additional hourly money you pay an employee in excess of their regular pay rate, usually for time worked over 40 hours in a seven-day period.
Per federal law, these hours are paid at time and a half, or 1.5 times the employee’s regular hourly pay rate.
A shift differential is a premium amount that you can pay employees who work outside of normal business hours. For some companies, this is the overnight shift and on weekends.
The additional pay is usually calculated as a percentage of the employee’s pay rate, like 30% extra, or a flat dollar amount, like an extra $3 per hour.
“Employee” sounds straightforward, but we do need to clarify, as you’ll see when we review the next term, independent contractor. Employees are workers that are formally hired 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; you must also pay and withhold taxes on employee earnings. In exchange, these employees must abide by company rules such as when and how to work.
Independent contractors are workers who are hired to perform a specific job or project. They’re not employees so they aren’t protected by federal labor laws or the federal government’s minimum wage requirement. In turn, employers don’t pay payroll taxes on their earnings; instead, they complete a Payroll Form 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.
Exempt is a classification employers typically assign to employees who are paid on a salary basis versus hourly (although in some circumstances, hourly workers can be exempt). Exempt employees are not entitled to overtime pay; however, an employer may choose to pay exempt employees extra compensation in addition to their fixed salary without jeopardizing the exempt status.
Classification assigned to employees covered by the Fair Labors Standard Act. A nonexempt employee must be paid the minimum wage and overtime pay for any time worked beyond 40 hours in a given week. Under FLSA rules, nonexempt employees are entitled to time and one-half of their regular pay rate for each hour of overtime.
Employees who regularly receive more than $30 monthly in tips for their work. Federal law allows employers to factor tips into their hourly pay rate.
As long as employee earnings are equal at least the federal and state (and local, if applicable) minimum wage rate, employers can pay $2.13 an hour.
Paid Time Off
Paid time off, or PTO, is time your employees don’t spend working but still earn a paycheck (at their regular pay rate). It consists of any paid leave, i.e., vacation or sick time and even jury duty and holidays. Federal law doesn’t have strict guidelines or requirements regarding PTO; you choose whether you want to offer paid vacation time or not. State laws may differ.
FICA taxes are Social Security and Medicare taxes that the federal government charges on each employee’s earnings. Employers must reduce employee paychecks by 7.65% (6.2% for Social Security + 1.45% for Medicare), and pay the money to the IRS; they also have to pay that same amount from their business funds.
Unemployment taxes are taxes employers pay out of their own money to fund their state and federal unemployment programs. The federal unemployment tax (FUTA) rate is 6% on the first $7,000 each employee earns, and the state unemployment tax (SUTA) rate varies depending on the state. 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.
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.
Fair Labor Standards Act
You’ll hear this thrown around quite a bit and also referred to as FLSA. It’s a federal act that consists of numerous laws meant to assure that employees are treated
well and paid fairly. The federal minimum wage and overtime rules fall under this act as well as record keeping rules and child labor laws.
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 Jan. 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.
Annual Form used to report and calculate Federal Unemployment Taxes.
Quarterly Form required to report and calculate Federal Payroll Taxes.
Payroll Journal (Register)
Record used to summarize all employee earnings and deductions for each pay period.
Employee Earnings Record
Record maintained for each employee that summarizes their earnings and deduction for each pay period.
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Payroll Terms Video