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The moment you make the decision to hire your first employee(s), it’s time to learn how to properly handle your payroll. Payroll is a vital component of any business, large or small. Your payroll record will list all of your employees, including a record of their individual wages and salaries, deductions, bonuses, withholdings and paid time off.
Payroll can also be defined as the process of paying your employees for the work they did for your organization. There are many federal, state and local laws that govern how you handle your payroll.
Like everything else, payroll comes with its own jargon. And if you are running payroll for your small- or medium-sized business — in-house or outsourced — here are some common payroll terminologies you must familiarize yourself with to avoid making any potentially expensive mistakes.
Gross Earnings: Gross pay is an employee’s total compensation before any taxes or deductions are taken.
Net Earnings: Net pay is what is left of an employee’s compensation after all deductions are subtracted from the gross earnings. It is also called take-home pay.
Payroll Deduction: This is the money you withhold from an employee’s earnings to pay for such benefits as insurance premiums and other expenses like garnishments, taxes, child support and so on.
Pay Period: A recurring length of time over which employees’ hours (worked) are recorded and wages are paid. The pay period establishes the number of paychecks your employees receive every year. They might be monthly, weekly, biweekly or some other time period.
Employee: Employees are workers who are formally hired to fulfill specific positions within an organization. They are paid a wage and may get benefits, especially if they work at least 40 hours every week — taxes are also typically withheld from their earnings.
W-2 Form: This is a government document that summarizes an employee’s earnings in addition to the taxes and withholdings for the year. Employers are required to file a W-2 form with the Social Security Administration (SSA) for each employee and issue a copy to each employee by January 31 of the following year. However, they don’t have to issue this form for 1099 contractors — these workers receive a 1099-MISC report.
Independent Contractor: Independent contractors are hired to perform specific projects or jobs. They’re not employees, and hence, aren’t protected by federal labor laws or the federal government’s minimum wage requirement. Employers don’t pay payroll taxes on their earnings; instead, they usually send contractors a 1099-MISC form.
1099-MISC Form: This is a government tax form that business owners use to report payments made to independent contractors. Employers are required to complete a Form 1099-MISC when they pay $10 or more in gross royalties, or $600 or more in rents or compensation.
Minimum Wage: According to the Department of Labor, the minimum wage is the lowest amount per hour that business owners are legally allowed to pay their employees. In addition to the federal minimum wage law, certain states and some cities have their own minimum wage laws. In this case, employers are required to pay the higher of the two wages. The federal minimum wage provisions are contained in the Fair Labor Standards Act (FLSA).
Fair Labor Standards Act: The FLSA is a federal act that consists of a number of laws that are meant to ensure that employees are paid fairly and generally treated well by employers. The federal minimum wage and overtime rules fall under this act, in addition to child labor laws and recordkeeping rules.
Employer Identification Number (EIN): In simple words, the EIN is like a Social Security number for businesses. It’s a unique nine-digit number that’s assigned to employers who submit an IRS EIN application. This unique number helps identify businesses as they open business bank accounts, file taxes or apply for business loans. It’s a basic requirement for any business processing payroll.
Garnishments: These are court-ordered deductions that allow business owners to withhold a certain amount from an employee’s paycheck to pay an outstanding debt, and remit it to a court or other agency. Garnishments are most common for employees who have failed to repay child support payments, student loans or other such debts.
401(k): The 401(k) plan is an employer-sponsored retirement plan. Employees can have money deducted from their salaries on a post- and/or pre-tax basis. Some employers choose to match the amount employees save up to a certain percentage.
Employee contributions to 401(k) plans are typically exempt from federal income tax withholding, and may be exempt from state income tax withholding, depending on the state. However, these are not exempt from Federal Insurance Contribution Act (FICA) withholding.
Federal Insurance Contribution Act: The FICA is a federal law that establishes payroll tax funds to Medicare and Social Security. Both business owners and employees pay the FICA tax. Business owners pay their own contributions, whereas the employees have FICA taxes withheld from their salaries.
CPP: Certified Payroll Professional, or CPP, is a designation assigned to those professionals who successfully complete the certified payroll professional examination.
This is, in no way, an exhaustive list of terms that are related to payroll. But these will give you a head start in understanding payroll better.