What are Payroll Costs? Your Guide to Wages, Taxes, and Benefits

Payroll business owner

Payroll costs are usually your largest expense as a business owner. With the recent historic period of transformation in labor throughout the U.S., it’s important to know what goes into payroll costs to keep your business growing.

It’s important that you consult with a good third-party payroll service or an experienced accountant to set up and manage your payroll, while also staying updated on this aspect of your business yourself. Knowing how much your payroll truly costs can help you better price your products and services and better estimate how much revenue you need to generate to cover your operating costs.

Let’s take a deeper dive on what’s included in payroll expenses.

What is payroll?

Payroll is the wages you pay to your employees, not including independent contractors you contract with for services.

Payroll is made up of a group of expenses that are all related to compensating employees and include the following:

  • Actual pay that the employees earn
  • Taxes that you withhold from those employees
  • Payroll taxes that your company pays for having employees
  • Benefits that your company pays for your employees

Wages:

Wages are the actual money that you pay to your employees, literally a product of their salary for a period of time or their hourly rate times the number of hours they worked. This total will count for the actual wages expense that your company pays.

Employees that receive tips will need those tips reported on their paystubs as they are subject to the same withholdings and taxes as their salary. Generally, employees are entitled to their whole tip; however, with tips paid by credit card, an employer can withhold an amount equal to the fees paid for tips paid by credit cards.

Withholdings:

Many of the taxes you’ll pay related to an employee are withheld from the employee’s paycheck. So, if an employee has $1,000 in wages and $200 in withholdings, that doesn’t mean that your business pays $1,200 for that employee. It means that you’ll pay $1,000, with $200 of that $1,000 going toward taxes on behalf of the employee. The employee would then receive a paycheck for $800. The specific withholdings that every employer needs to make from their employee’s checks are:

  • Federal, state, and local income taxes: These are the employee’s payments for income taxes, based on the information they entered on their form W4 when you hired them.
  • Employee’s payroll taxes: This includes taxes for Social Security and Medicare. Which equals 7.65% of the employee’s wages.

Employer taxes:

Employer taxes are what your business needs to pay on top of the amounts you’ve withheld on behalf of your employees. As an employer, you’re required to match the amount of money that the employee paid toward Social Security and Medicare in their withholdings. You’ll withhold 7.65% of your employees’ wages, and then also contribute that same amount as part of your employer taxes.

Federal and state unemployment insurance are one of the required payroll taxes that you’ll pay directly to the government. This expense can range from 3-5% on top of the wages paid. New York has another small tax called “Re-employment insurance” which is usually factored into the payment made for various NYS employer taxes.

Benefits:

Benefits are the most diverse and wide-ranging in terms of payroll costs. Some benefits are required, some are just accruals that an employee can cash in on later, and some are put in place to attract the best talent. Let’s look at the differences between required and non-required benefits.

Required benefits:

  • Workers’ compensation insurance: Most states require that employers carry workers’ compensation insurance. Workers’ comp covers the cost of an employee getting injured on the job, and it’s the only required benefit that is regularly occurring.

  • Paid leave: Some states and localities, such as New York City, require certain types of leave to be accrued and paid for employees. This includes leave for an employee when they’re sick, or for the employee to take care of a sick family member. It also covers maternity leave and leave for an employee to support a family member who is on active military duty.

    On a pay period by pay period basis, this might not amount to actual cash coming out of your business’s accounts. But you need to accrue these types of leave in your payroll system so that when your employees need them these funds are available. In New York, employees are eligible for up to 10 weeks of paid leave, and New York City employees can earn more than 40 hours of paid sick leave per year.

  • Health insurance: Per the Affordable Care Act, health insurance is required to be paid for by all businesses with 50 or more employees. Businesses of this size need to either use a private HMO or purchase insurance on one of the state healthcare marketplaces.

    For businesses with fewer than 50 employees, health insurance is still deductible but not required.

Non-required benefits:

Benefits that your business chooses to provide beyond those that are required might include retirement plans, health insurance, life insurance, gym memberships, childcare programs, and so much more. Most of these costs are deductible as an expense to your business if they’re provided to non-owner employees.

Profession Employer Organization (PEO) service:

The wage, tax, and benefit rules listed above are the most basic rules for your business, but the full scope of these laws can get very detailed and is constantly changing.

There has been a boom in technology companies entering the payroll processing and benefits administration space, otherwise referred to as PEO services. As a result, using an outsourced service to handle all payroll payments, withholdings, and recordkeeping is highly recommended as an easy, affordable, and safe way to handle an otherwise complicated job. Many of these service providers now also have deals with major insurance and retirement planning services to offer bulk pricing that would otherwise not be available to smaller companies.

Conclusion

By learning how to manage your payroll costs, you can better understand how to run your business for long-term success while increasing your financial stability. Also, you can take the points above to stay diligent about collecting taxes, staying up-to-date on important employee laws, maintaining important employee tax documents, and more. Overall, giving yourself a better picture of your largest expense has an infinite number of benefits for future growth and development.

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