These terms are the most important ones you will encounter as you begin to work on employee paychecks, which signifies the start of the payroll process. These paychecks are used for two main purposes: Even if you have an accountant to do your payroll accounting, or you use payroll software or a payroll service company, you’ll need to be comfortable working with the common terminology.
Payroll
Payroll is a general term, and it has several meanings. It can be:
The amount of money paid to all employees in a payday, as in, “We ran payroll this morning for tomorrow’s payday.“The financial records of a company relating to the payment of wages and salaries to employeesThe total record of earnings of employees for a year
Gross Pay
Gross pay is the total paid to an employee each pay period before any deductions for taxes or other purposes, and it is determined in different ways for salaried and hourly employees. For salaried employees, gross pay is stated as an annual amount. To determine gross pay for a pay period, the annual salary is divided by the number of pay periods in the year. For hourly employees, gross pay is the worker’s hourly rate times the number of hours worked in that pay period; overtime is included in gross pay, too. The IRS doesn’t discuss gross pay; it instead uses the term “gross income,” or “total income,” which is the income that must be reported on an employee’s annual wage tax report (Form W-2).
Net Pay
Net pay is the amount of pay an employee receives after all withholding and deductions from gross pay. In other words, net pay is the amount of the employee’s paycheck. The calculation for net pay begins with gross pay. Then amounts for federal and state income taxes are taken out, as well as FICA tax (Social Security and Medicare). Finally, discretionary deductions like health plan contributions and retirement plan amounts are taken out.
Pay Periods
A pay period is a recurring length of time over which employee pay is recorded and paid. Some common pay periods are:
Monthly (12 pay periods a year)Weekly (52 pay periods a year)Bi-weekly (every other week, 26 pay periods a year)Semi-monthly (twice a month, 24 pay periods a year).
The number of pay periods in a year is important in computing total pay for employees for a year.
Withholding and Deductions
Federal income taxFICA taxes (Social Security and Medicare)State income taxes
Deductions are other types of payments taken out of an employee’s paycheck. Most deductions don’t affect the amount of an employee’s taxable income, but some are considered pre-tax. Pre-tax deductions are subtracted from the person’s gross income to reduce their taxable income. Examples are retirement plan contributions and some health care costs. An employee’s federal income tax withholding is determined by using the information on a Form W-4 completed by the employee at hire, and for state income tax by a state W-4 or other tax form.
Wage Garnishment
In addition to withholding and deductions, there’s a third type of payment that some employees must make. Courts sometimes issue garnishment orders for debts like student loans, small claims judgments, child support, or other amounts the employee owes. If you receive a garnishment notice ordering your business to garnish wages, you must comply with the order. Typically, garnishment is on a per-paycheck basis, so you’ll have to add this to your list of deductions.
Salaried vs. Hourly Employees
The terms “salaried employee” and “hourly employee” relate specifically to how these employees are paid. Salaried employees are paid an annual salary, while hourly employees are paid an hourly rate times hours worked.
Overtime
Overtime is the additional amounts paid to hourly employees who work over 40 hours in a week, who work on weekends, or other additional amounts. Overtime must be paid at one-and-a-half times the person’s hourly pay rate for employees who work more than 40 hours in a workweek. Of course, you can pay overtime at higher rates. Overtime is calculated differently for hourly and salaried employees. Most salaried employees are exempt from overtime, but your business may be required to pay overtime to some lower-paid exempt employees.
Exempt and Non-Exempt Employees
Exempt means “exempt from overtime.” Exempt and non-exempt employees are categorized typically by the work they do. Most exempt employees work in professional, managerial, and executive positions sometimes called a “white-collar exemption.” But not all “white collar” professionals are exempt from overtime. To be exempt, they must be over a standard salary level of $684 a week ($35,568 a year for a full-year worker). In other words, if an exempt employee is paid less than $684 a week, you must pay them overtime. Other workers are considered non-exempt, meaning you must pay them overtime. A worker is considered non-exempt (eligible for overtime) unless an exemption can be proved by the employer. The concepts of salaried vs. hourly and who is and is not exempt from overtime are often confusing. This comparison might help sort out the confusion.
Tip income Benefits of using a company car Stock options Bonuses, awards, and gifts to employees (unless they are very small) Some commuting and transportation benefits Some educational benefits Other benefits, like meals, may or may not be taxable to employees, depending on the circumstances
Because these payments are taxable, you must separate them out when doing payroll accounting and clude them in the employee’s taxable wages for the year and report these wages on the employee’s W-2 form.
Can an employer fire an employee who has their wages garnished?
Federal law protects an employee from being fired because their wages have been garnished for one debt, and it limits how much can be deducted from an employee’s paycheck each week.
In some years, there are 27 periods for bi-weekly employees. How do I handle that?
You have several alternatives for paying the extra 27th pay period. The two important things to remember are don’t make it too complicated, and be sure to give employees notice if you are making any changes to their paychecks.
How long should I keep payroll records?
The U.S. Department of Labor requires employers to keep all payroll records for three years. This DOL Fact Sheet has more details. The IRS requires that all tax records, including those for payroll taxes, be kept for at least three years, and longer in some cases.
