Whenever I travel to a new country where I don’t speak the language, I try to learn a few words and phrases to help me get by. I can’t overstate how useful “Help,” “I’m lost,” and “Where’s the bathroom” can be when traveling.
Payroll might not be a foreign country, but new small business owners should nonetheless familiarize themselves with these standard payroll terms and abbreviations.
Here are the top-line payroll terms you’ll hear as a small business owner.
Gross pay, also called gross wages, is the total amount an employee earns before payroll deductions. It’s the amount an employee sees on an offer of employment.
For example, say you hire Julie and say you’ll pay her a $50,000 salary. Her gross pay is $50,000 annually.
Net pay is the amount an employee takes home after taxes and other payroll deductions. An employee’s net pay for the year is the sum of his or her paychecks for that period.
Labor burden refers to the cost of having employees. It comprises the employer’s portion of Federal Insurance Contributions Act (FICA) taxes, unemployment taxes, and workers’ compensation.
Paychecks, also called payroll checks, are checks issued to employees for working. The amount of a paycheck is the employee’s net pay, or gross pay minus payroll deductions.
Payroll is the process of compensating employees. Businesses can run payroll manually or outsource the task to payroll software or an accounting firm.
An essential part of the process is holding a portion of each employee’s earnings and making tax payments on their behalf. In addition, employers are responsible for employer taxes, paid using business funds separate from employee compensation.
Pay periods refer to how frequently a business runs payroll. The Fair Labor Standards Act (FLSA) requires employers to pay employees regularly. Your pay-period options are weekly, biweekly, semimonthly, or monthly.
Pay stubs accompany payroll checks. They show how the paycheck was calculated by breaking down the number of hours worked, pay rates, and payroll deductions subtracted from gross pay.
Most pay stubs also give employees an update on how many vacation and sick days they’ve accrued and used during the year.
You can’t talk about payroll without talking about taxes. Here’s what you need to know.
Income tax withholding
Income tax withholding refers to the money an employer keeps, or withholds, from an employee’s paycheck to remit for paying federal or state income taxes. Employees fill out Form W-4 and a state withholding certificate to direct their employers how much to withhold for income tax payments.
Unlike payroll taxes, employers never contribute to paying their employees’ federal or state income taxes.
Federal Insurance Contributions Act (FICA) taxes
Federal Insurance Contributions Act (FICA) taxes comprise Social Security and Medicare taxes. They’re payroll taxes that both employees and employers pay based on eligible employee compensation.
The FICA tax rate is 15.3%, split evenly between employees and employers, with 12.4% going toward Social Security tax and the remaining 2.9% for Medicare. The Social Security tax applies to the first $142,800 of eligible compensation in 2021. The Medicare tax doesn’t have a limit, though higher-earning employees must contribute an additional 0.9%.
Federal Unemployment Tax Act (FUTA) tax
The Federal Unemployment Tax Act (FUTA) tax is a payroll tax that only employers pay. It taxes the first $7,000 of each employee’s eligible compensation for the year at a 6% rate. The FUTA tax funds the administration of state unemployment programs.
But most businesses don’t pay the full 6%. Most businesses qualify for a 5.4% FUTA credit reduction after paying their state unemployment taxes, bringing the FUTA tax rate down to 0.6%.
The exception is employers in credit reduction states. The U.S. Department of Labor for businesses in states that are late on repaying federal advances to fund their state unemployment program. For the past few years, the Virgin Islands has been the only state or territory designated as a credit reduction state.
Payroll deductions are all the taxes, benefits, and other payments taken out of an employee’s paycheck. It’s the difference between an employee’s gross pay and net pay.
Payroll Deductions = Gross Pay - Net Pay
Payroll taxes are taxes levied on employers, employees, or both based on employee earnings. Most payroll taxes are calculated as a percentage of employee earnings. Each payroll tax comes with its own set of rules, exceptions, and limitations.
Governments at all levels can impose payroll taxes to fund public programs like unemployment.
Payroll tax forms
Payroll tax forms are documents created to collect and report information related to employee compensation.
The most common payroll tax forms are:
- Form W-4: To collect an employee’s federal tax withholding information
- Form W-2: To report employee compensation to the Social Security Administration, states, and employees
- Form 940: To report a company’s FUTA tax
- Form 941: To report a company’s FICA taxes and federal income tax withholding
State Unemployment Tax Act (SUTA) taxes
State Unemployment Tax Act (SUTA) taxes fund state-administered unemployment programs. SUTA is an employer-paid tax, except in Alaska, New Jersey, and Pennsylvania, where both employers and employees chip in.
A business’ SUTA rate depends on its industry, age, and history of former employees filing for unemployment. That’s in contrast to FUTA, which charges a uniform rate for every employee at every business. A company’s SUTA rate can change once a year.
Unemployment programs offer temporary compensation to people who have lost their jobs through no fault of their own. The program helps tide them over until they find new work.
Taxable wages are the earnings from which an employer must withhold taxes. The definition of taxable wages depends on the tax you’re talking about. For example, taxable wages for federal income tax withholding isn’t the same as taxable wages for FICA taxes.
Not all wages are taxable; for example, an employer’s contribution to an employee’s health insurance premiums is not taxable.
Tip credits set the minimum wage for tipped workers. Just like states have their minimum wages, they also set their corresponding tip credits.
For example, the New Jersey minimum wage is $12 per hour in 2021. Their maximum tip credit is $7.87 per hour, meaning employers of tipped workers must pay their employees at least $4.13 per hour ($12 - $7.87). If a New Jersey server doesn’t make enough in base pay and tips to earn $12 per hour each shift, the employer must contribute the difference.
Let’s talk about the different types of employee pay.
Compensation is an overarching term that encompasses all the types of payments an employee earns.
Examples of compensation include:
- Hourly wages
- Fringe benefits
Exempt and non-exempt
Exempt and non-exempt are classifications that refer to whether an employee position is subject to Fair Labor Standards Act (FLSA) rules and regulations, including overtime pay and the minimum wage.
Non-exempt employees must be paid the minimum wage and are entitled to overtime pay for every hour worked above the standard workweek. Exempt employees are not subject to the FLSA rules.
Fringe benefits, also called imputed income, are the perks that businesses offer aside from regular wages. Some fringe benefits are taxable, and others aren’t.
Fringe benefits include:
- Subsidized health insurance plans
- 401(k) retirement plans
- Commuting benefits
- Gym memberships
Wage garnishment is a legal process that requires employers to withhold a specified amount of money from an employee’s paycheck and remit it to a third party. Garnishment is a tool that courts use to get people to repay debts, whether they’re unpaid child support or credit card bills.
Independent contractor vs. employee
Independent contractors and employees are two categories of workers. Independent contractors are self-employed people or businesses hired to complete specific tasks and most often receive project-based compensation. Companies hire employees to perform services and are salaried or paid hourly.
Paid time off
Paid time off encompasses all the time an employee is not working while being compensated.
Examples of paid time off include:
- Sick time
- Paternal leave
- Jury duty
Shift differentials are additional compensation for irregular shifts. Businesses often entice employees to work the graveyard shift by paying a few dollars more per hour or a percentage increase on their regular hourly pay.
Say you own a storage facility with 24/7 security. There are three shifts: 8 a.m. to 4 p.m., 4 p.m. to midnight, and midnight to 8 a.m.
To encourage your workers to take the overnight shift, you might offer any takers an additional $5 per hour. That $5 is the overnight shift differential.
Variable pay, or incentive pay, is a far-reaching term for employee payments made to influence employee behavior or reward meeting specific goals. Employees earn variable pay after reaching a company milestone, like a sales target, or an employee-specific objective, like making a sale as a salesperson. You can use payroll analytics to help determine variable pay.
Types of variable pay are:
- Performance bonuses
- Profit-sharing plans
- Sales commissions
- Shift differentials
Accounting for payroll
Throw some of these terms around the next time you talk to your accountant about payroll.
Arrears payroll points to a delayed payroll process where the business only pays employees once the pay period has ended, not before.
Say a company pays its employees every Friday at 9 a.m. If the company pays in arrears, the paycheck will be for the workweek that ended seven days before. If the company does not pay in arrears, then the paychecks will be for the current workweek, even though it hasn’t yet ended.
Businesses with hourly employees often pay in arrears to give time for employees to submit timesheets.
Employee self-service (ESS)
Employee self-service (ESS) portals, provided by payroll software, are where employees can log in using an email address, username, or employee ID number (EEID) to access their digital pay stubs and tax forms. Employees may edit their addresses and submit updated income tax withholdings forms through the portal.
Payroll accruals happen at the end of every accounting period — monthly, quarterly, or yearly — to reflect wages owed to employees and other payroll liabilities. Businesses that follow the accrual basis of accounting record journal entries at the end of the accounting period for expenses they’ve incurred but not yet paid.
A timesheet documents the number of hours an employee worked within a pay period. Businesses may use paper timesheets, time clock software, or an ESS portal to track how much an employee worked.
Employees submit timesheets on a weekly or biweekly basis. Supervisors approve employee timesheets to ensure their accuracy.
That’s a start
Someone with a working knowledge of these 28 payroll terms will be able to speak intelligently about payroll. There’s a lot more to learn, though, so keep up with The Blueprint’s payroll content.