As an entrepreneur, you know that your employees are the backbone of your operation.

Having the right processes and policies in place can make all the difference when it comes to finding and hiring the right employees – those who can set your business up for success and allow you to focus on the overall strategy and direction of the company.

One of those key processes to consider is how you will compensate your employees. While it seems like a basic and simple concept in theory, it is not always so straightforward in practice. Having an organized, prepared, and efficient payroll process is a crucial step for retaining a happy and productive staff and staying legally compliant.

Business owners must make numerous – but important – decisions before their employees start tackling their assigned responsibilities. Fortunately, a methodical approach and ample preparation can help you integrate the payroll process seamlessly into your business.

Schedules, Wages and Payment Methods

Much more goes into payroll than issuing a paycheck. There are several steps and a variety of factors to consider. One of the first steps is to select your payment schedule, based on what you think will work best for your operation. Examples of pay schedules include:

  • Weekly pay – Employees get paid at the end of every week.
  • Bi-weekly pay – Payrolls are processed, and employees receive compensation every two weeks.
  • Semi-monthly – Pay schedule is twice per month on set dates by the employer.
  • Monthly – Employees are paid once per month.

There are benefits to each pay schedule, but there are inherent challenges to consider when landing on the right structure for your operation. For example, a bi-weekly or weekly pay schedule may be your employees’ preference since they would be paid more frequently than monthly. This can help with your staff’s personal budgeting and bill payments. However, bi-weekly or weekly payments could also result in varying tax and other deductions, since some months may have more paydays than others. Those figures can be calculated easily with a set semi-monthly or monthly pay date. Whichever route you choose, it is best to streamline your payroll process by sticking with one method for the entire staff rather than accommodating individual preference.

Employers also need to think about how they would categorize each member of their staff with the following designations in mind:

  • Full-time – Works the full work week as set by the employer, which is usually 40 or more hours a week, and is eligible for company benefits.
  • Part-time – Works less than 40 hours a week, usually paid hourly, and may not be eligible for company benefits.
  • Temporary – Works on a temporary basis, as needed by the employer, and usually is not eligible for benefits. They could be hired to work on a special project or might be filling in for an employee taking time away for an extended period.
  • Contractor – An independent worker, one who usually runs their own business, who is not an employee but hired on a contract basis for a certain project.

Once you settle on these items, you’ll need to decide what type of wages to pay your staff. There are three main types of wages, which include:

  • Hourly – This is a rate that is paid to your employee per hour of work completed. This is usually paid to part-time employees but can be applied to full-time staff members as well. This type of pay can lend flexibility. For example, if revenue decreases unexpectedly, a business owner can temporarily cut employee hours as needed to offset those losses. However, the constantly changing costs per pay period can become tedious amidst the other countless responsibilities you may have. Business owners should also take into consideration what type of work is assigned to a particular employee. Usually, labor-intensive jobs in the construction, hospitality, restaurant, or retail industry are paid hourly.
  • Salaried – Employees who receive this type of pay are compensated based on a set salary, divided across pay periods in a fixed amount before taxes and other deductions. Hiring salaried employees can make your payroll process easier by minimizing changes in pay, thus giving consistency to your cash flow. Employees would receive steady pay and are more likely to receive full benefits under this structure, making them more inclined to come work for you. However, the U.S. Department of Labor mandates that salaried employees make at least $684 per week. This means a salaried employee would have to be paid more than a full-time hourly employee earning minimum wage, raising your costs.
  • Commission-based – This is usually based on the volume of sales that are closed specifically by an employee during the pay period, and may only work in certain industries. Typically, an employee will be compensated for a certain percentage of their sales – which is commonly measured in terms of overall profit. Some businesses choose a hybrid approach and provide employees a base salary in addition to their commission incentives. Commission-based pay can be cost effective if an employee does not bring in enough revenue. At the same time, a motivated and skilled employee can drive revenue with a commission incentive. This wage structure can also help a business owner easily evaluate employee performance. On the other hand, because of the potential fluctuation in pay - and a desire for a more stable paycheck - employees may be dissuaded from working at a company that offers commission-based compensation.

Finally, business owners need to consider how employees will receive their pay. This can be based on an individual employee’s preference, or a business owner could choose to take a blanket approach for all employees. One of the most preferred methods of payment for many businesses and employees alike is direct deposit, which allows an employer to deposit paychecks directly into an employee’s bank account. This would give employees immediate and convenient access to their pay on payday and could eliminate the risk of lost paychecks. However, you can also choose to pay employees with a physical check or debit card if that is your and/or your staff’s preferred method.

Classifying Your Employees

This is a crucial step in determining how to pay your employees and plan their work. The way business owners classify their employees will have a direct impact on an employee’s paycheck. Employers must classify employees as exempt or non-exempt. These terms stem from a federal law called the Fair Labor Standards Act (FLSA),[1] which includes minimum wage and overtime protections.

For example, an exempt employee, typically referring to someone who is paid on a salary basis, wouldn’t be eligible for overtime pay under the Fair Labor Standards Act (FSLA) if they were to work more than 40 hours a week. They are “exempt” from the protections provided by the FLSA. A non-exempt employee is commonly paid hourly, must be paid the minimum wage, and is eligible for overtime if they work past 40 hours in a week.

It’s important to note that while it is the employer’s responsibility for how they classify their staff, there are rules they need to follow from the IRS to avoid misclassification.[2] Business owners should consult with their tax or legal advisor for guidance on proper employee classification.

Taxes and Witholdings

Once you’ve figured out how to pay employees in terms of wage type and schedule, you will need to consider deductions such as federal, state, and local taxes, as well as state disability insurance and wage garnishment. As an employer, you’ll need to provide employees the right paperwork to calculate the correct tax withholdings per pay period. Be prepared to have employees fill out a W-4 form, as well as any other applicable state or local withholding forms, upon hiring. The Internal Revenue Service (IRS) offers their Understanding Employment Taxes page[3] for more information on specific taxes and forms needed. When you’re preparing to process your payroll, these are the forms you should reference to correctly calculate an employee’s pay.

In addition, if you are offering your employees a benefits package, you’ll have to make those deductions as well. Examples of employee benefits can include but are not limited to health and life insurance, retirement plans, and leave benefits. There are government mandated benefits to remember as well, including social security taxes, workers’ compensation, and unemployment insurance.

As an employer, you’ll also have to report employment taxes to the IRS and corresponding agencies and pay employer contributions and premiums from other benefits that your small business may offer.

Figuring out and setting up taxes and withholdings may seem like an intimidating process. However, there are payroll systems available that can help you with this part of the process. For example, PNC has a diverse suite of options for small business owners, from do-it-yourself products to fully managed processing by third party providers ADP and PayChex.

Running Your Payroll

At this point, you have checked the following items off your list:

  • Decided on pay schedule
  • Determined which employees are hourly, salary or commission based
  • Sorted through how your employees prefer to get paid and what best fits for your operations
  • Classified your staff
  • Considered withholdings and gathered the appropriate paperwork needed from employees
  • Set up a payroll processing system, which may include a payroll processing offering from your financial institution

Now it’s time to run your payroll and ensure you’re paying your employees correctly, complying with federal, state and local laws, and protecting your business.

Most payroll processing systems will do the bulk of the work for you; however, if you choose to run payroll manually, remember the following calculations to consider:

  • Gross pay: This is calculated by multiplying hourly rate by hours worked for hourly employees or dividing an employee’s salary by the number of pay periods in a year.
  • Taxes and withholdings: Refer to the paperwork you collected from each employee, such as selected benefits and W-4 forms, to submit the correct number of deductions for that staff member.
  • Take-home pay: This is gross pay minus the amount of taxes and withholdings you calculated in the previous step.

Things to remember

Untangling how to pay employees is a crucial component to a small business’ operations and success. While setting up the process and compensating your staff is a big milestone in your entrepreneurial journey, so is record-keeping, deadline tracking and awareness.

Keep the following things in mind, beyond setting up and running your payroll:

  • Document payroll: Remember to keep documents such as direct deposit slips, W4 and benefits forms, timecards, pay stubs, and any other documents that you may use that categorizes employees and determines their compensation. According to the IRS, employers need to keep tax records for at least four years.
  • Deadlines on taxes: Employment tax deposits with the IRS follow certain schedules, so it’s important to know which schedule applies to you and your business. See more information here.[4]
  • Payroll laws can change: State and federal tax laws can change. Business owners have enough on their plate, so it would be beneficial to implement payroll systems that can automatically update entrepreneurs of certain changes in their region. See more about this type of feature here.

Peeling back the layers of the payroll process takes time, but there are various resources that can help you make the right decisions for your operation and staff. Like all the phases of the small business journey, being as prepared as possible will make paying your employees go smoothly for both you and the team you’ve built. Teaming up with qualified legal, tax and finance professional can also make the process a lot easier.

For more information on payroll and other small business startup topics, visit PNC’s Starting Your Business page.