What Are The Components Of A Payroll Software? 3 Key Elements You Should Know

What are the components of a payroll software? As a business grows, hiring employees becomes essential to be able to assign roles and responsibilities to those who are qualified and experienced. The owners and managers, as employers, have certain responsibilities in compensating their employees. This may take up a firm’s largest business expense, thus, stressing the importance of getting it right.

Handling payroll is complicated. Calculating an employee’s gross pay is already complex with the numerous factors to consider, including the number of hours worked, payroll income taxes to be deducted, and benefits to be taken out from the paycheck. This must be accomplished accurately to avoid paying fines as experienced by 33% of small businesses that completed incorrect payrolls due to lack of knowledge.

In addition, there are more payroll operations to handle such as filing payroll taxes, ensuring compliance, and sending out the paychecks, among others. A technology that can streamline and automate this process is a payroll software. It reduces cycle times and lessens manual errors. To understand the system and its function, it’s essential to know what are the components of a payroll software. If you feel you need to expand your basic knowledge on these types of solutions you can also check out our what is payroll management software guide to give you some extra info.

In most cases, the payroll system is a part of a larger suite of accounting and HR solutions and a module within an ERP (enterprise resource planning) package. It may also be purchased as a service from a human resource technology vendor. It serves a major aspect of employee and business management and administers its own vital functions. Here are three of its major components.

1. Employee Payment

A key component of a payroll management solution is streamlining the process of paying employees. Using the software, you can input necessary information to let the system accurately calculate the employee’s gross compensation. This is the starting point of determining payrolls which refers to the amount that employers use to calculate the wages and salaries of hourly and salaried employees, respectively, based on the amount agreed upon by the employee and employer.

Tracking working hours is crucial as this determines the employee’s paycheck for the applicable pay period. Most software has a time-tracking HQ where employees can clock-in and clock-out in real time. This lets you easily view their complete work hours. Some systems also have an anti-fraud detection to make sure you are only paying the real amount of work given by an employee.

This is essential for hourly employees whose earnings are regulated based on their hourly rate times number of hours worked. Meanwhile, salaried employees who are compensated based on their annual salary are also covered by the payroll management software. Time off requests, vacation leaves, sick leaves, and overtimes will be taken into account as well.

When sending out payments, it also simplifies the process using various methods. One of the go-to methods is using direct deposit as it is convenient and time-saving for both parties to send the paychecks directly to the employee’s bank account. After setting it up once, you can immediately pay full-time and part-time salaried employees, US-based vendors and contractors, and hourly employees. One-off payments, such as bonuses, may also be processed separately anytime. For a comprehensive list of solutions that offer such features check out our top 20 payroll software solutions guide.

Employee payment and tracking components 

  • Real-time clock in and clock out view
  • Automatic proration of new hires
  • Payroll timeline
  • Intuitive payroll run
  • Direct deposit
  • Digital paystub email
  • Employee access
  • Electronic approval

2. Payroll Tax Payment

As an employer, managing payrolls doesn’t end at sending payments to employees. There are taxes to be taken care of, both mandatory and voluntary ones. Withholding payroll taxes from the employee’s gross pay is required by law for employers. In compliance with government regulations, it must be deducted prior to issuing the paycheck. When asking what are the elements of a payroll software, payroll tax payments are among the fundamental components.

Mandatory payroll taxes

  1. Federal income tax. Each employee pays this no matter where their location is in the country. This represents the money owed to the U.S. Federal government. The amount to be withheld differs on various factors like the amount an employee earns and the number of allowances they claimed on their W-4 (a form that must be completed by the employee when hired and before receiving their first paycheck.)
  2. State taxes. Some states have no state income tax (Alaska, Nevada, Florida, South Dakota, Wyoming, Washington, and Texas) while others impose it. The tax rate percentage is based on factors such as deductions, filing status, and income level of the employee. If your business location requires filing state income taxes, you are responsible for collecting and submitting it to your state department of revenue. The process of calculating, deducting, paying, and reporting is generally the same as federal income tax.
  3. Local income tax. The same as state income tax, the local income tax is only applicable in some areas.  This is imposed by cities, school districts, counties, and local governments. There are 14 states that charge local income tax. These are:
    • Alabama
    • Maryland
    • Michigan
    • Colorado
    • New York
    • Delaware
    • Oregon
    • Indiana
    • Kentucky
    • Missouri
    • Ohio
    • West Virginia
    • Pennsylvania
    • New Jersey

Social Security and Medicare

Additionally, there are also Social Security and Medicare taxes for all employees working in the United States. FICA (Federal Insurance Contributions Act) taxes require mandatory payroll deductions for the two. The total FICA tax is 15.3% of the employee’s gross compensation where the employer and employee contribute half or 7.65% each. Here’s a breakdown of the 7.65%:

  1. Social security. This takes up 6.2% for OASDI (Old Age, Survivors, and Disability program). The percentage is up to the employee’s annual maximum wages. This portion is capped each year at a set amount. You must not deduct the employee’s gross pay more than the Social Security maximum for the year. If you withhold more than the Security System maximum, it must be refunded to the employee.
  2. Medicare. Its portion is 1.45% of all employee earnings and it’s not capped. This social insurance program is applicable to all wages. Higher paid employees have an additional Medicare tax (0.09%) that’s withheld when their earnings reach more than $200,000 in a year.

Miscellaneous Benefits

Depending on the company, there are also benefits like health/dental/vision insurance, retirement plan, life insurance and disability insurance that are paid by the employer and the employee if they agree to elect themselves to the benefit contributions. Manually doing these is complicated and time-consuming. However, the software automates the calculation to promptly implement the applicable deductions to an employee’s paycheck.

Payroll tax payment components

  • Automated taxes
  • Integrated pre-tax benefits
  • Federal R&D Tax Credit
  • Payroll report
  • Tax calculator
  • Multiple states payroll run

3. Tax Filing Compliance

What are the components of a payroll software? Another critical component of payroll management covered by a payroll software is tax filing. After taking the taxes, the employer must go to IRS and state to deliver the tax payments, make a report on the taxes paid, and then file the payroll tax reports.

The software payroll ensures compliance with your business by administering the withholding, reporting, and remitting of your payroll taxes. On behalf of your company, it uses e-file, e-sign, and e-fax technologies for a paperless and hassle-free filing of federal, state, and local payroll tax forms. It also ensures staying up-to-date with changing employment regulations in the US. They file and issue W-2s and 1099s available in all 50 states and even send them to your employees and contractors after. Here are some of the forms they cover:

  1. Form W-2. An annual report of an employee’s withheld taxes and compensation (including wage, tips, and overtime).
  2. Form 1099. An annual payment report for independent contractors or unincorporated business.
  3. Form 940. An annual report for payments, tax liabilities, and wages under FUTA (Federal Unemployment Tax Act).
  4. Form 941. A quarterly report of Social Security and Medicare tax, tax withheld from employees, total tax deposits, and federal wages.
  5. Form 8974. A quarterly report along with Form 941 for those who claim the Federal R&D Tax Credit.

Tax filing compliance components 

  • Automated payroll tax forms
  • Employer payroll tax filings (Form 940 and 941)
  • Employment Practices Liability Insurance (EPLI)
  • Workers’ compensation
  • ACA compliance
  • Wage garnishments
  • COBRA management
Daniel Epstein

By Daniel Epstein

Daniel Epstein is a senior financial research analyst at FinancesOnline and the architect behind our Fintech and ERP content division. His main areas of expertise are blockchain technologies, cryptocurrencies, and the use of biometrics in fintech solutions. His work has been frequently quoted by such publications as Forbes, USA Today, Entrepreneur, and LA Times. With more than 1,800 solutions scrutinized in the last 5 years spent on our team he always prioritized offering readers an unbiased perspective on modern financial technologies.

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