Businesses cannot avoid payroll processing, no matter how big or small. This critical function, however, is usually complex, with companies having to consider different factors like base pay, benefits, tax contributions, and deductions. There are guides on calculating payroll to make this process easier for small businesses. However, understanding the key payroll terms and acronyms can help you understand what payroll means and ensure you are processing employee payroll accurately.
Top 25 Payroll Terms You Should Know Before Running Payroll
Understanding basic payroll terminology can help eliminate stress from payroll processing, helping you avoid any potential mistakes that can cost your business dearly. Here is a list of 25 standard payroll terms you need to know before starting your payroll operations:
1. Accrue
Referring to the accumulation or build-up of things over time, payroll accruals are the funds the employees are owed for the hours they have worked since the last payment. Additionally, accruals are also a key part of the majority of employee benefits packages. For example, employees may earn and accumulate personal time or paid vacation per pay period.
2. ACH (Automatic Clearing House)
The payroll acronym ACH stands for the automated clearing house, which is an electronic network employers use to process payroll transactions. This often includes direct deposits of employee payments.
3. Compensation
Compensation is an all-encompassing term that includes all the monetary and non-monetary benefits a company offers its employees. Some of the most common types of compensation include:
- Salary (or hourly wages)
- Performance bonuses
- Transportation benefits
- Stock options
- Insurance coverage
- Tips
4. Deductions
Employees can voluntarily choose to have set amounts taken from their pay to contribute towards things like health insurance premiums or retirement plan contributions. Deductions are such money employers take out of an employee’s paycheck. Depending on the nature of deductions, employers calculate them pre- or post-tax.
5. Disposable Income
Disposable income refers to an employee’s wages after the employer has taken all the necessary taxes and deductions from their paycheck. Authorities use this amount to determine the pay level subject to child support withholding or garnishment.
6. EFTPS (Electronic Federal Tax Payment System)
EFTPS, or the Electronic Federal Tax Payment System, is the US Department of Treasury’s free system to help you pay your federal taxes.
7. Employee
Employees are the individuals or workers that the company has formally hired to fill a specific role within the company. It is crucial to distinguish employees from independent contractors regarding payroll processing and calculations.
Employers offer a reasonable compensation package – including decent wages and several benefits – to employees, especially those working full-time (40 hours per week). In turn, employers must also deduct (from employee paychecks) and pay (to the government authorities) appropriate taxes on employee earnings. In return, employers expect the employees to adhere to company rules and policies.
8. Employer Identification Number (EIN)
Employer Identification Number (EIN) is a nine-digit unique number assigned to every employer that submits an IRS EIN application. It is one of the key pieces of identifying information for a business as they apply for business loans, open business bank accounts, or file taxes. It is comparable to a Social Security Number for a business and is mandatory for payroll processing.
9. Exempt Employees
Exempt employees are usually paid on a salary basis instead of an hourly wage. However, there are some circumstances where hourly workers can be exempt. Exempt employees are eligible for overtime payment if they work more than 40 hours a week.
10. Fair Labor Standards Act (FLSA)
Fair Labor Standards Act, or FLSA, is a collection of various federal laws that ensure fair treatment and pay for all employees. Some laws falling under FLSA include the federal minimum wage, overtime rules, child labor laws, and recordkeeping rules.
11. Federal Insurance Contribution Act (FICA) Taxes
The federal government charges Federal Insurance Contribution Act (FICA) taxes on every employee’s earnings, including Social Security and Medicare taxes. Employers need to take 7.65% of an employee’s paycheck – 6.2% for Social Security and 1.45% for Medicare) and pay that sum to the IRS. Employers also need to make the same contribution from the business funds.
Additionally, for any employee making more than $200,000 per year (or $250,000 for married couples filing taxes jointly), employers need to hold an additional 0.9% for Medicare tax. In the case of Social Security, the government caps the tax amount at $160,200 per year.
12. Fringe Benefits
Fringe benefits refer to the additional benefits an employer offers its employees outside the compensation package. Employers may offer these benefits or award them to high-performing (or senior) employees as incentives. Some fringe benefits may be taxable, while others are not.
Some common examples of fringe benefits include:
- Gym memberships
- Subsidies in health insurance plans
- Tuition assistance
- Commuting benefits
13. Federal Unemployment Tax Act (FUTA)
The Federal Unemployment Tax Act (FUTA) is a payroll tax the federal government requires employers to pay to help fund unemployment benefits. The employers must pay 6% of the first $7000 an employee earns under FUTA. However, most businesses pay state unemployment taxes to qualify for a 5.4% FUTA credit reduction, having to pay only 0.6% FUTA tax.
14. Garnishment
Garnishments refer to court orders that direct employers to withhold a fixed portion of an employee’s paycheck against an outstanding debt. The employers must send this money to the concerned parties per the garnishment notice.
A garnishment notice often includes an end date for stopping the collection. The employers must act quickly once they receive the notice, as courts can hold them liable for failure to respect it.
15. Gross Pay
Gross pay refers to the amount of an employee’s paycheck before all the deductions.
For an employee paid by the hour, it is their hourly rate times the number of hours worked – plus any bonuses, overtime, or additional pay.
For a salaried employee, gross pay remains the same each day – their annual salary divided by the number of pay periods per annum.
16. Independent Contractor
Independent contractors are skilled workers a company hires to perform a specific job or complete a specific project. However, federal labor laws or minimum wage requirements do not protect independent contractors. And in turn, employers do not need to pay any payroll taxes on their income; instead, they must complete form 1099-NEC for every contractor earning over $600.
And since they are not employees, employers cannot dictate the work conditions of an independent contractor or determine when or how they complete their work.
17. Minimum Wage
The Department of Labor (DOL) defines the minimum wage as the lowest hourly rate employers are legally allowed to pay their employees. The current federal minimum wage is $7.25 per hour; however, this can vary depending on the state.
Minors, interns, or tipped employees are some exceptions to the federal minimum wage. For example, the federal minimum wage for a tipped employee is $2.15 per hour, with an expectation that tips will make up the difference.
18. Net Pay
Net pay refers to the final amount an employee receives on their paycheck after all the deductions.
19. New Hire Reporting
New hire reporting is the process employers follow to report their newly hired employees to the state. Federal law dictates that employers report every new hire within 20 days of hiring. Some states can have stricter deadlines; for example, Alabama mandates new hire reporting within seven days.
Federal authorities store this information in the National Directory of New Hires, and child support or debt agencies can use this information to find the individuals that owe money. However, your business must register under your state’s New Hire Reporting Program before you can report your new employees.
20. Overtime (OT) Pay
Overtime pay is the additional hourly pay – other than their regular pay rates – employers offer as a benefit to their employees. Employees who have worked more than 40 hours a week are usually qualified to receive overtime pay.
Federal law dictates that any overtime pay has to be 1.5 times the regular hourly pay rate of the employee, with some states offering additional guidelines. For example, in California, employers need to pay double for all the hours worked over a 12-hour day and for all hours over an 8-hour day if the employee is on their seventh consecutive day of work.
21. Paid Time Off (PTO)
Paid time off (PTO) refers to the time employees are off work while being paid in full at their standard pay rate. This includes any paid leaves the employer may offer, including holidays, vacation, or sick days.
Federal law does not have any strict guidelines when it comes to paid time off. It is entirely up to the discretion of the employers if they want to offer paid time as a part of their compensation package. However, some state laws may differ. For example, California state law mandates employers to provide a minimum of 24 hours (or three days) of paid sick leave annually.
22. Pay Periods
The pay period is the time frame for which the company pays an employee. The pay period also dictates the pay schedule and the frequency your employees receive their paychecks. This can be weekly, bi-weekly, monthly, or yearly. You need to process payroll every pay period. Therefore, selecting the best pay period to suit your business is crucial, depending on factors like cash flow, payroll processing time, employee expectations, and payroll processing costs.
23. State Unemployment Tax Act (SUTA) Taxes
Individual states require employers to pay the State Unemployment Tax Act (SUTA) payroll tax to offer unemployment benefits.
Every state has different guidelines and SUTA tax wage base, dictating the cap on employee income that is eligible for tax. Moreover, every state establishes tax rates, which can vary from 0.5% to 7% depending on various factors. Most states offer a standard SUTA tax rate to new employers.
24. Shift Differential
A shift differential is a monetary incentive (or premium rate) for employees working outside standard business hours. For many businesses, this includes working overnight shifts or working on the weekends. The shift differential can be a percentage of the employee’s pay rate – for example, 25% extra – or a set dollar amount – for example, an extra $4 per hour.
25. W-2 Form
The tax document that records all earnings, taxes, and deductions of an employee is the W-2 Form. Employees must receive this document by Jan 31 following the reporting year.
Employers must also send a copy of the W-2 Form to the IRS and state tax agency as applicable. Employees can use this information to complete their tax returns.
Conclusion
The first step in taking complexities and confusion out of payroll processing is understanding the basic payroll terms and giving your team the confidence to process payroll successfully. Understanding and including payroll terms and acronyms in your vocabulary can help you understand the related concepts and regulations. This way, you can ensure not only accurate payroll calculations but regulatory compliance as well.
Frequently Asked Questions
Why is the pay schedule important?
The pay schedule is crucial as it ensures timely and predictable compensation for employees, maintains financial stability and helps streamline budgeting and cash flow management for both employees and the business.
