Payroll processing

Payroll Processing

Purpose

Every employee and contractor must be paid correctly and on time, with all tax withholdings, benefits deductions, and compliance filings handled accurately. This skill calculates gross-to-net pay, applies federal/state/local tax tables, handles benefits deductions, and prepares the payroll register for review. Without it, payroll errors lead to compliance penalties, employee dissatisfaction, and cash flow surprises.

When to Use

• "Run payroll for this period"
• "Review payroll before processing"
• "Calculate net pay for these employees"
• "Process contractor payments"
• "File payroll taxes"
• "Update benefit deductions"

Inputs Required

1. Employee roster — name, salary/hourly rate, pay frequency, tax withholding elections (W-4), benefit elections, state of employment.
2. Pay period data — hours worked (hourly), PTO taken, commissions/bonuses earned, expense reimbursements.
3. Prior payroll register — last period's numbers for sanity check.
4. Tax rate tables — federal, state, local for each employee location.
5. Benefits elections — health, dental, vision, 401(k) deferrals, HSA/FSA.

Quick Reference

Calculation	Formula / Rule	Why It Matters
Gross Pay (Salaried)	Annual salary / Pay periods per year	Base for all deductions
Gross Pay (Hourly)	Hours worked × Rate (OT at 1.5× over 40 hrs)	Accurate for variable-hour employees
Federal Income Tax Withholding	IRS Pub 15-T tables based on W-4 and taxable wages	Largest single withholding; errors trigger penalties
FICA (Social Security + Medicare)	SS: 6.2% up to wage base / MC: 1.45% (0.9% additional over $200k)	Mandatory employer + employee portions
Benefits Deductions	Pre-tax: 401(k), medical, HSA / Post-tax: Roth 401(k), life insurance	Correct treatment prevents tax filing errors
Net Pay	Gross − Taxes − Deductions + Reimbursements	What employees actually receive
Total Employer Cost	Gross pay × 1.25–1.4× (incl. employer taxes, benefits, workers comp)	True cost of headcount for planning

Procedure

1. Gross Pay Calculation

• Salaried: annual salary / pay periods. Prorate for mid-period hires/terminations.
• Hourly: hours worked × rate. Overtime at 1.5× for > 40 hours.
• Commissions: apply the commission plan. Validate against deals closed.
• Bonuses: apply the bonus formula. Confirm eligibility and approval.
• Contractors: flat amount per invoice, NO tax withholding.

2. Tax Withholding

• Federal income tax: IRS Pub 15-T tables based on W-4 elections, pay frequency, taxable income.
• Social Security: 6.2% up to the annual wage base.
• Medicare: 1.45% + 0.9% additional above $200k.
• State income tax: per-state tables.
• Local taxes: where applicable (NYC, SF, etc.).

3. Benefits Deductions

• Pre-tax: 401(k), medical/dental/vision premiums, HSA, FSA, commuter.
• Post-tax: life insurance, disability, Roth 401(k).
• Employer contributions listed separately.

4. Net Pay = Gross − Taxes − Deductions + Reimbursements

5. Payroll Register Review

Generate a payroll register:

Employee	Gross	Federal WH	FICA	State WH	Benefits (Pre)	Benefits (Post)	Net Pay	Employer Taxes & Benefits
...	...	...	...	...	...	...	...	...

• Flag any net-pay anomalies: change > 20% from prior period, zero net pay (garnishment/error), negative net pay.
• Verify total employer-side taxes and benefits: FICA match (~7.65%), FUTA, SUTA, 401(k) match, health insurance contribution.

6. Payment & Filing

• Present the payroll register for human approval.
• After approval, prepare the journal entry: debit salaries/benefits/taxes expense, credit cash/bank, credit tax liabilities.
• Filing calendar hand-off to tax-compliance-management for: 941 (quarterly), 940 (annual), state quarterly filings, W-2/W-3 (annual), 1099-NEC (annual).

Output Format

Payroll Summary:

• Total gross payroll
• Total net pay to employees
• Total employer taxes
• Period-over-period change (headcount and dollars)
• Runway impact

Done Criteria

The skill is complete when:

1. Gross pay is calculated correctly for all employees and contractors (salaried, hourly, commission, bonus)
2. Tax withholdings are applied using current federal, state, and local tables
3. Benefits deductions (pre-tax and post-tax) are applied correctly
4. Net pay is calculated and anomalies are flagged
5. Employer-side taxes and benefits costs are calculated and documented
6. The payroll register is presented for human approval (not auto-disbursed)
7. Journal entry is prepared for hand-off to ledger-management

Pitfalls

• Misclassifying employees as contractors (1099 vs W-2): If they work full-time, on your schedule, with your equipment → they're likely an employee. Misclassification carries heavy penalties
• Using outdated tax tables: Tax withholding tables change annually. Always use the current year's IRS Pub 15-T and current state tables
• Forgetting multi-state withholding: Withholding by state based on physical work location, not company HQ. Remote employees trigger nexus in their state
• Ignoring bonus supplemental rate: Federal supplemental rate is flat 22% for bonuses under $1M. Using regular withholding tables over-withholds
• Skipping period-over-period comparison: Not comparing the register to the prior period. A sudden 20% swing in net pay for an employee is usually an error worth catching before disbursement
• Auto-disbursing without human approval: Processing payroll directly to the bank without a review step. Payroll errors are expensive and embarrassing — always present for review first

Verification

Is each employee's gross pay calculated correctly based on their pay type (salaried, hourly, commission)? Are tax rates verified against current tables for each employee's work location? Are pre-tax and post-tax deductions applied to the correct income basis? Is the payroll register compared to the prior period for anomaly detection? Is the register presented for human approval before any disbursement?

Example

Example 1: Standard Payroll Run

User: "Run payroll for the bi-weekly period ending April 18 — we have 12 employees and 3 contractors"

→ You load the employee roster, pull W-4 elections and state info, collect timesheets for hourly employees and commission data for sales, calculate gross pay ($124,500 total), apply federal/state tax withholding ($31,200), apply benefits deductions ($8,900 pre-tax, $2,100 post-tax), compute net pay ($82,300), calculate employer-side taxes and benefits ($18,675), flag one employee with a 35% net pay increase (bonus included — confirmed), and present the full payroll register for human approval with a total cash outflow of $100,975 (net pay + employer taxes).

Example 2: Contractor Payment Run

User: "Process May contractor payments — 5 contractors totaling $28,000"

→ You verify each contractor's invoice against their agreement, confirm no tax withholding applies (all 1099-NEC eligible), run a quick worker classification check (all are genuinely independent — separate schedule, own tools, multiple clients), present the payment summary for approval, and note the 1099-NEC tracking requirement for year-end filing.