Payroll is the process by which an employer pays employees for their work. It involves calculating wages, withholding taxes and other deductions, and distributing net pay. For restaurants, retail stores, and service businesses with shift workers, payroll isn't just writing checks. It's a complex process with legal requirements, tax obligations, and serious penalties for mistakes.
Why Payroll Complexity Matters
Payroll errors aren't minor inconveniences. According to the IRS, employment tax issues are among the most common problems for small businesses, resulting in billions in penalties annually.
The stakes: Miscalculate overtime, you violate the FLSA. Miss a tax deposit deadline, you face IRS penalties. Pay employees late, you violate state wage laws. Payroll mistakes are expensive.
The Payroll Process: Step by Step
1. Track Hours Worked
For non-exempt employees, you must track all hours worked. This includes:
- Regular hours
- Overtime hours
- Break times if paid
Use time clocks, timesheets, or time tracking software. The Department of Labor requires accurate recordkeeping.
Your restaurant server works 42 hours this week. You need documentation showing those 42 hours, including when she clocked in and out each day.
2. Calculate Gross Pay
Hourly employees: Hours worked × hourly rate, plus overtime premium for hours over 40.
Example: 42 hours at $15/hour = (40 × $15) + (2 × $22.50) = $600 + $45 = $645 gross pay
Salaried employees: Fixed amount per pay period regardless of hours worked (if exempt).
Tips: For tipped employees, track tips separately. You may be able to use tip credit against minimum wage in some states.
3. Calculate Deductions
Mandatory deductions:
- Federal income tax (based on W-4)
- Social Security tax (6.2% of wages up to annual limit)
- Medicare tax (1.45% of all wages)
- State income tax (if applicable)
- Local taxes (if applicable)
Voluntary deductions:
- Health insurance premiums
- Retirement contributions
- Garnishments (court-ordered)
The IRS provides detailed guidance on tax withholding calculations in Publication 15.
4. Calculate Net Pay
Gross pay minus all deductions equals net pay (take-home pay). This is what employees receive.
Example: $645 gross - $120 taxes - $30 benefits = $495 net pay
5. Distribute Payment
Pay employees via:
- Direct deposit (most common)
- Paper checks
- Payroll cards
Payment must occur on the scheduled pay date. State laws typically require regular, predictable pay schedules.
6. Provide Pay Stubs
Give employees pay stubs showing:
- Gross pay
- All deductions
- Net pay
- Year-to-date totals
Some states mandate specific pay stub information.
7. File and Remit Taxes
Deposit withheld taxes according to IRS schedules (monthly or semi-weekly depending on your tax liability). File quarterly Form 941 reporting wages and taxes.
Pay Periods: How Often to Pay
Weekly: 52 pay periods per year. Common in restaurants and hospitality.
Bi-weekly: Every two weeks, 26 pay periods per year. Most common frequency.
Semi-monthly: Twice per month (e.g., 15th and last day), 24 pay periods per year.
Monthly: 12 pay periods per year. Least common.
State laws may dictate minimum payment frequency. Most states require at least monthly, some require more frequent payment for hourly workers. Check your state's requirements through the Department of Labor.
Employer Payroll Taxes
Beyond withholding employee taxes, you pay employer taxes:
Social Security: 6.2% of wages (matching employee contribution)
Medicare: 1.45% of wages (matching employee contribution)
Federal unemployment (FUTA): 6% on first $7,000 of wages per employee (reduced by state unemployment tax credits)
State unemployment (SUTA): Varies by state and employer experience rating
These are employer costs on top of employee wages.
Common Payroll Mistakes
Misclassifying employees: Treating non-exempt employees as exempt to avoid overtime. This is illegal and triggers back wages and penalties.
Calculating overtime incorrectly: Overtime is time-and-a-half for hours over 40 per workweek, not over 8 per day (unless state law requires). Comp time is illegal for most private sector employees.
Missing tax deadlines: Late deposits trigger automatic penalties. The IRS doesn't care why you're late.
Not tracking all hours: Failing to pay for time worked, including off-the-clock work, violates wage laws.
Ignoring state laws: Some states require meal break premiums, daily overtime, or split shift premiums. Federal law is the minimum, not the maximum.
Poor recordkeeping: You must keep payroll records for at least three years under FLSA.
Payroll Compliance Requirements
Federal Requirements
Form W-2: Provide to employees by January 31 showing annual wages and withholdings.
Form 941: File quarterly reporting wages, tips, and taxes.
Form 940: File annually reporting FUTA tax.
Form W-3: File annually with Social Security Administration transmitting W-2s.
State Requirements
States often require additional forms and filings:
- State unemployment tax reports
- State income tax withholding reports
- New hire reporting
- State-specific wage reports
The Society for Human Resource Management provides state-by-state guidance.
Payroll Technology
Manual payroll is error-prone and time-consuming. Calculating taxes, tracking deductions, and filing reports manually creates mistakes.
Payroll software benefits:
- Automatically calculates gross pay, taxes, and deductions
- Tracks overtime and ensures FLSA compliance
- Files tax forms electronically
- Generates pay stubs automatically
- Maintains required records
- Processes direct deposit
- Integrates with time tracking systems
Full-service payroll providers (ADP, Paychex, Gusto) handle everything including tax deposits and filings. Basic software (QuickBooks, Xero) requires you to manage deposits and filings.
For businesses with 10+ employees, payroll software or a service provider isn't optional. The risk of errors is too high.
Paying Final Wages
When employees leave (voluntary or involuntary), final wage timing varies by state:
Immediate: Some states require final pay immediately upon termination.
Next payday: Some states allow paying on the next regular payday.
Within 72 hours: Some states give a few days for voluntary resignations.
Final pay must include:
- All hours worked through last day
- Accrued vacation/PTO if state law requires payout
- Any earned commissions or bonuses
- No deductions beyond legally allowed amounts
California law is particularly strict, requiring immediate final pay upon termination.
The Bottom Line
Payroll is calculating wages, withholding taxes, and paying employees accurately and on time. It involves federal and state tax obligations, strict deadlines, and significant penalties for mistakes.
Track hours carefully, calculate pay correctly, withhold proper amounts, pay on schedule, file required reports, and keep detailed records. For most businesses beyond a few employees, payroll software or a service provider is essential.
Getting payroll wrong costs money in penalties, back wages, and legal fees. Getting it right is simply the cost of doing business.
