How to Set Up the Ideal Payroll Process?

Every company needs to manage the payment of wages to its employees. This process is known as payroll processing and typically involves the gathering of information on employees, such as their punctuality, benefits and deductions. While the process might seem pretty easy and straightforward, there are many underlying factors that need to be taken under consideration in order to make sure processing is executed smoothly. 

To streamline the process, most companies prefer to use payroll software or a third-party payroll processing service. If you’ve been wondering about payroll process and what goes into setting up an ideal payroll process, then you’ve come to the right place. Read on to find out more about the process and how payrolls work. 

Setting Up a Business Entity

Before setting up a payroll for a company, you are going to require a business tax ID and will also require a business license. The business entity will consist of a business name, taxpayer identification number (TIN) or employer identification number (EIN). You are also going to need a local business license and the necessary paperwork. 

Classifying Your Workforce

To clarify employee payment rules, the federal government has classified different types of workers. This also goes for what to pay, how much to deduct and when. For instance, most employees are considered to be direct hires, which means that they work for you, and not themselves, and that you supervise their work. 

Employees are the most common types of workers that fall under either W-2 (direct hires) or 1099 (contract hires). Employees that are direct hires get a W-2 form at year end and are paid net wages. On the other hand, contract employees receive a 1099-Misc form at year end and are paid gross wages, because they are considered to be self-employed, with the company being their client.

It is important for businesses to classify their workers correctly as failing to do so could lead to costly repercussions for the employer. Moreover, the US government also has strict rules that have been laid out for which kind of workers and what type of work is considered to be “contractual” work and what is not. For instance, employees have a fixed number of working hours that cannot be changed, while contract workers have control over their working hours and method. 

Payroll Processing for W-2 Employees

A direct hire employee works for a business, and employers are required under federal law to pay direct hire employees their gross wages after taking out taxes and making local, state and federal deductions, such as social security payments or unemployment insurance. After making the necessary deductions, the employer will be left with the net pay, which will have to be paid by each pay period. The employee’s taxes are paid by the employer, and the W-2 form is used to document the tax payment to the government. 

Payroll Processing for 1099 Contractors

An employee on contract will perform work for a company, but they are self-employed and therefore, will receive the 1099 form at year end. That’s because they pay their taxes on their own and the company they provide services to is not required to pay their taxes. When hiring a contract employee, a company needs to calculate their pay and provide them with a gross wage, leaving the tax paying part out of the agreement. 

Determining the Payment Process

There are multiple ways in which employers can make salary payments to their employees. Under state and federal laws, the lowest pay rate that’s allowed is called a minimum wage. But, there’s no upper limit on how much an employer can pay their employee. As a rule of thumb, new business owners normally pay their employees at an hourly rate, but the following are a few ways in which employers can compensate their workers;

  • Paying an hourly wage
  • Paying an annual salary
  • Paying for work by the project 
  • Paying commissions

Paying Hourly Wage

Employees can get paid hourly if the work schedule varies. For instance, if an employee works just 15 hours and the following week works for 30 hours, then its best to pay that employee an hourly rate. Normally, hourly workers are considered as non-exempt, which means in legal terms, they have to be paid for overtime as well. Companies need to do their research to find out the difference between exempt and non-exempt employees. Overtime is paid to employees who work more than 40 hours a week and at 1.5 times their regular pay rate. That being said, some states in the US like California require the overtime to be calculated on hours that are worked in a day. 


Employees are paid a salary which is a fixed amount that’s paid to them on a weekly basis. Regardless of how many hours they work in a day, they are paid on a fixed annual amount. Typically, there is no hour-to-hour tracking when it comes to the payroll of an employee. For instance, those employees who work part-time can be paid a salary for 15 to 20 hours per week, while full time employees will only receive a salary for 30 to 40 hours per week. The hours that an employee has to work during a week are determined by the employer and agreed to by the employee at the time of hiring. 

The main difference between an exempt employee being paid a salary and an employee who is non-exempt from an hourly rate is that those who are paid a salary can work for more hours if they choose to, but will not be paid overtime for working those extra hours. Salaried employees are normally considered to be exempt from overtime, unless stated otherwise in the employee agreement.  

By the Piece

Alternatively, some employees are also paid by the piece, although this is not common practice. For instance, an employee who repairs electronic items might be paid by the piece, as in, according to how many devices they have fixed during the day. Since the Fair Labor Standards Act (FLSA) requires that all earnings that are received should not fall below the recommended minimum wage limit, choosing the ‘pay-by-the-piece’ model of employee compensation can be risky. 


The commissions-only or salary-plus-commission model is another type of salary system that’s mostly used when hiring sales staff. For instance, the sales staff of an electronics shop usually get compensated based on the number of appliances they have sold. Although, a small base salary is also paid to the employee, apart from the weekly commission. 

Determining the Payroll Cycle

The US Department of Labor and the FLSA provide the guidelines for frequency of payments that are to be made to employees. But, oftentimes, state laws determine the payroll rules which also include the ‘what’ and ‘when’ of the payroll process. Generally, employees are required to be paid on a regular pay cycle which falls between 7 to 30 days of when they started work. There are also some employers in the US who prefer to provide a payroll twice a month, while governmental organizations usually pay their employee’s salary on a monthly basis. 

Weekly Payroll – Generating the payroll for employees every week is widely considered to be the best for businesses in the US, especially for part-time and entry-level workers. This helps ensure that the hourly workers who are living paycheck to paycheck are able to receive their earnings on time to pay their bills and other expenses. Companies that pay their employees weekly have to run 52 payrolls in a year. Weekly payroll makes it easier for companies to determine whether their employees have worked overtime or not, and pay accordingly. That said, some payroll providers charge per payroll run, which can make it a costly practice for some businesses. 

Bi-weekly Payroll – A bi-weekly payroll is a good alternative for those companies that find weekly payroll costly. Paying employees every other week is another common method of distributing earnings among employees. This process also reduces the number of payroll runs that are needed by a business. This usually means that the payroll processes half as many cycles as a weekly payroll. This usually amounts to 26 cycles per year instead of 52. But, this option also requires employers to budget their payroll process. This option is more common in businesses that hire professionals and administrative staff that is remunerated with a salary and exempt from overtime. However, if overtime calculations need to be made, it has to be done based on the weekly start and end dates to make sure it’s done correctly. 

Bimonthly Payroll – Bimonthly payrolls are only run 24 times in a calendar year. This means employees are paid twice each month, which commonly falls on the 1st and 16th of each month. Some employers pay depending on the number of work hours of each pay period, while others divide the employee’s annual salary by 24 and pay them the same amount regardless of how many hours they have worked. This helps stabilize the payroll expenses and avoids confusion. The bimonthly payroll model is used by companies who hire professional staff who are then paid a salary and work under an exempt status.

Monthly Payroll – A monthly payroll is a more straightforward payroll cycle where employees can expect their salaries at the end of one month or beginning of the next month. It is the easiest form of making salary payments for businesses that have an all-salaried exempt workforce. That being said, it is not the preferred option for many employees who have to wait till the whole month’s end to get paid. This is also the reason why some US states do not allow companies to pay their employees on a monthly basis. That being said, monthly payroll is the most commonly used method of payroll, which is common in government and educational institutions. 

It is important to note that employees have the right to receive their wages in a timely manner, regardless of which type of payroll is followed by a company. According to federal law, this means all employees need to be paid no later than the end of the next pay period. In case of employee termination, some states require the employer to pay their employee right away, while others practice more relaxed terms. The final paycheck of the terminated employee does not need to be handed to them right away and employers are given a reasonable amount of time to mail the paycheck to the terminated employee. The amount of that paycheck needs to be the net value that is accrued by the employee, which means, the amount the employer owes minus the amount the employee may owe. The full amount that the employer is owned includes the accrued vacation time or any earned bonuses during that time. 

Employee Benefits

Employers also need to determine early on if they want to provide their employees any benefits, such as 410(k) or health insurance. That said, these benefits are not mandatory, but offering employees benefits is a great way to attract the best from the talent pool and also retain employees in a company. 

Tax Withholdings

A company is also required to withhold the employees share of federal and state income taxes from their payroll. To do this, employers need to calculate income taxes and forward payments to the appropriate government agency on a monthly basis. A company is also required to submit payroll tax reports on a regular basis and a quarterly report to the IRS. 

Running the Payroll

Once you’ve got the answers to all of these questions, you will have to decide how you want to run the payroll. The following are some examples of how you can run a payroll:

  • Payroll calculator
  • Payroll software
  • Hire payroll services
  • Hire a professional payroll organization

Business owners can read online reviews of all of these methods to find the perfect payroll option that suits their needs. Before starting a payroll, you will need to set up a bank account that will house the funds specifically used for the payroll process. It is necessary for these funds to be kept separate from your personal funds.