Learning payroll terminology helps prepare employers for the intricacies of running payroll. However, employees should understand these terms and how it affects them. The terms discussed are fraught with legal implications and mathematical calculations. By definition, payroll is the payment of the 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.
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 35 to 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.
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.
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.
- 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 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.
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 the Government. 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 working 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).
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.
This is a sample timesheet you can use to track employee work hours manually.
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.
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.
About the Author
Charlette Beasley is a staff writer at Fit Small Business who focuses on developing content on payroll, human resources, and labor law. She is also a freelance content marketing writer and writes for numerous industries, including banking and recruiting. Prior to joining Fit Small Business, Charlette was a Senior Accountant at a marketing company and ran her own small content strategy and writing business.