Description of a Payroll System

Solomon Poretsky, Demand Media / AZ Central writes: Your company's payroll system is the arrangement it uses to compensate your employees and fulfill the company's obligations to withhold taxes and other expenses and forward them to the appropriate government agency or company. A payroll system can be as simple as a checkbook and a ledger, or it can be integrated in your company's accounting software. You can do your payroll in-house or use a third-party service that handles calculations, reports and payments for you.

Wages and Salaries

The first responsibility of a payroll system is to properly calculate each employee's wages or salary. For a salaried employee, the system calculates pay by dividing the annual rate of pay by the number of pay periods. Payroll systems use time clock data to figure out exactly how long an employee who is paid an hourly wage worked during the pay period and then multiplies it by an hourly rate. The system also calculates overtime pay based on both federal law and your state's labor laws.

Tax Withholding

Payroll systems handle tax withholding. At a minimum, your company has to withhold federal income taxes, Federal Insurance Contributions Act payments for Medicare and Social Security, and federal unemployment taxes. You may also need to withhold state and local income tax and other charges. After withholding the money from the employee's paycheck, the system stores the withheld money and pays it to the appropriate government agency. It also tracks the employer's portion of payroll taxes.

Other Subtractions and Costs

If you offer employee benefits, your payroll system handles taking out money for them. These include insurance, retirement plan contributions, and flexible or health savings accounts. Payroll systems also handle both taking out and forwarding wage garnishments for unpaid child support, judgments, and Internal Revenue Service and state tax levies.

Reporting

In addition to handling money, the payroll system contains a large store of data that your company can use to meet its reporting requirements. Every paycheck carries a stub that contains information on gross pay and withheld amounts. Your company uses the payroll system's data to issue yearly W-2 reports to your employees. It gives you the data you need to fill out your employment tax returns for the IRS and for the state, as well as to fill out any insurance or employer's compensation coverage paperwork.

Issuing Payments

Finally, a payroll system involves cutting paychecks. The most basic systems use handwritten checks to pay employees out of the company's account. Systems that are more elaborate maintain a string of separate accounts so that the company keeps employee pay separate from other corporate expenses. In addition to issuing paychecks, payroll systems can issue direct deposits or put money on debit cards for employees who don't have checking accounts.

Payroll Providers

Doing payroll is a complicated process that requires the management of multiple accounts, constantly changing withholding requirements, and meeting many different payment and reporting schedules. For this reason, some businesses choose to use third-party payroll companies like Intuit Payroll, ADP or Paychex. These companies handle all the behind the scenes work for you and charge a monthly or per-employee fee for doing it. If you choose to use one of these services, consult with an attorney to see if your company can be held liable for any errors that the service makes.