To make sure that they comply with Internal Revenue Service (IRS) regulations and state and local government laws, companies must include crucial employee and company information in their payroll systems. Setting up and running the different components that comprise a payroll system requires due diligence and adequate knowledge of tax legislation. As a result, it is common for companies to hire an external consultant, bookkeeper or payroll service to deposit tax payments, process W-2s, manage retirement and insurance plans and perform other payroll-related duties.
During the new hire process, companies must collect information such as medical insurance and W-4 forms to determine what should be deducted from an employee’s paycheck. These forms also provide employers with crucial information, such as the employee’s Social Security number and their withholding amount for federal and state tax purposes. The system must also track and process changes made to the employee’s tax exemption status, pensions, insurance plans or retirement funds.
As part of the new hire process, payroll systems include a component that designates which employees are full time, part time and contractors. Classifying workers in a payroll system is important since the government levies high penalties on companies that categorize employees incorrectly.
Without knowledge of the number of hours an employee has worked, employers cannot determine what to pay an employee. While some workers are paid a salary, others are compensated hourly or designated as nonexempt employees. Payroll systems include timesheet information or areas where hourly and nonexempt employee hours are recorded and reviewed for accuracy. Information can be collected through a computerized time clock, punch card stamp clock or paper timesheet.
Although the IRS provides companies with tax tables to calculate employee tax withholdings, vendors and payroll computer systems can also supply this information. Employers must consider year-to-date annual earnings, wage levels and tax allowances when summarizing applicable taxes. In addition, payroll systems must calculate deductions made through pension plans, 401(k)s, insurance plans, union dues and garnishments. The payroll department also monitors loans and other deductions that have cap amounts and ceases paycheck deductions when the total amount has been repaid.
The payroll register summarizes employee earnings and deduction information in a journal entry that is inserted into the general ledger for accounting and general research purposes. Payroll registers are also used to create tax reports. These documents are prepared by payroll staff or generated using payroll computer systems.
Occasionally, companies issue manual paychecks to employees between pay periods because of termination or a payroll error. Payroll systems must account for the check amount in the payroll register for tax and reporting purposes. This ensures that the employer’s tax withholding amount is reconciled with employee deductions.