For many folks who are unfamiliar with payroll or new to it, producing a paycheck seems as simple as just “pressing a button." However, the life of paycheck can be a long, winding, and difficult road – especially for non-exempt (better known as hourly) employees.
But if it's more complex than it seems on the surface, what does that process look like? How exactly are these paychecks produced? And how do you reduce the complexity and make the process repeatable? Here’s a high-level overview.
Step 0: Timecard is approved
Before a paycheck can even be created, your people and their managers need to send in all approved timecards to payroll. The timecard is mission critical to ensuring payroll can even start creating a paycheck for most employees. That's why payroll professionals cite late and missing timecards as their top two payroll roadblocks.
What this really highlights is the importance of a unified approach to time and pay. Your workforce management processes don't exist in a bubble; they also affect the payroll and HR strategies the wider organization relies on. Making sure your time rules automatically translate over to how your paychecks get calculated, especially for hourly employees who rely on the time they post to get paid correctly, is essential to success for modern payroll teams.
Step 1: Gross pay is calculated
Gross pay is the total amount of money an employee earns in a pay period. Basically, it’s the compensation you negotiated with your staffer during the hiring process, and it reflects their wages before any deductions or withholdings. It's the starting point for a paycheck, and calculating it correctly is indispensable if you want pay to be accurate for your employees.
For example, say an employee gets paid $20 per hour. If they work 40 hours per week, their gross pay for that week would be $800.
Gross pay can also include bonuses, imputed income, and any overtime, shift, or other premiums that can increase their hourly rate. Or an employee can work various roles throughout the week with different hourly rates – which would impact their gross pay (and how overtime is calculated).
Step 2: Pre-tax deductions are removed from gross pay
Once payroll calculates gross pay for the pay period, they then need to subtract voluntary pre-tax deductions (for instance, 401(k) contributions, health insurance, or flexible spending accounts). These deductions reduce gross pay, which means they also decrease the amount of tax withheld.
Getting these deductions right isn't just important for taxes, though. A lot of these deductions correspond to the benefits your organization provides for your people, meaning they have a big impact on employee engagement and trust if they're wrong.
Step 3: Tax calculations are made
Now that payroll has adjusted gross pay by removing pre-tax deductions, they can now calculate all federal, state, and local taxes that will be withheld from pay.
This step gets tricky because of how often tax rates change at the state and local level. And it can be particularly risky – because failing to calculate the right amount of tax to withheld can mean compliance fines for an organization, or worse a surprise tax bill for the employee when they file their taxes causing another negative impact to engagement and trust.
Having a modern payroll solution that's a seamless part of your wider HR technology ecosystem is a major help in mitigating the risks of the tax calculation process because it can automatically make withholdings based on employee records and the latest compliance regulations.
Step 4: Post-tax deductions are removed from pay
While some deductions were removed before tax was calculated and withheld, there are some other deductions that need to be removed after taxes are withheld. For example, disability insurance, charitable donations given through the workplace, and parking or public transportation passes.
Another important post-tax deduction is garnishments – or pay that is ordered by the court or the government to be withheld to pay a debt, levy, child support, medical support, etc. These can be tricky, as there are many regulations around how much money can be garnished from a paycheck and, for employees with multiple garnishments, in what order those can be taken from a paycheck. However, a modern solution can automate garnishment processing too in a similar way to the tax calculations we just talked about, ensuring that garnishments are applied to employee pay in compliance with all the different regulations.
Step 5: Net pay is calculated
After all deductions and taxes are removed from an employee's gross pay, payroll has successfully calculated the net pay for an employee’s paycheck. The net pay is the amount they’ll see in their paycheck and on their pay statement to reflect the hours they've worked minus the relevant deductions and withholdings.
This is the number your people will see first when they access summaries of their paychecks or look at direct deposit records, so making sure all the steps prior to this calculation go right will ensure the net pay numbers align with their expectations. Also, giving your people easy access to this number is important to reduce financial stress and improve well-being, so make sure pay summaries are available easily on any device.
Step 6: Payroll gets finalized
Although most of the important pieces of a paycheck have been calculated at this point, payroll’s job isn’t done quite yet. After calculating net pay, payroll needs to review their entire payroll cycle and check for discrepancies and errors to make sure all employees are being paid accurately and all taxes and deductions are being properly calculated and withheld. You can get this done quickly when you have a solution that puts all the pieces of the process in front of you – look for simple breakdowns of tasks like checklists and summary reports when you consider payroll technology options.
Step 7: Checks are printed and ACH deposits are made
Once payroll is finalized, the actual paycheck itself needs to be produced. This can happen one of two ways – through a printed check or a direct deposit – but both typically include an itemized pay statement that outlines pay earned and the deduction and taxes withheld for employees.
So payroll needs to product the printed check to deliver to employees or prepare the ACH files to make the direct deposits. While it sounds simple – this process often has tight deadlines driven by banks and financial institutions which can impact when an employee actually receives their pay, which means doing this efficiently is key.
Conclusion: Strong payroll processes smooth out all the steps
As you can see, there’s a lot more that goes into producing a paycheck than most people realize – but talented payroll professionals make it look simple. And beyond that, they make smart choices about the HR technology they select to support their organization and themselves effectively.
