How Does Payroll Work? A Step-by-Step Guide

Whether you're opening your first business or growing your team, payroll shouldn't be the thing keeping you up at night.

Let's be honest, most local business owners didn't start their restaurant, store, or service company because they love doing payroll. You're passionate about creating great customer experiences and building an amazing team. The paperwork? Not so much.

Good news: Payroll doesn't have to be complicated. This guide breaks down exactly how payroll works and shows you how to make it simpler with a payroll processing tool like Homebase.

Ready to take the stress out of payday? Let’s dive in. 

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What is payroll?

Payroll means getting your team paid accurately and on time. It’s tracking hours, calculating employee wages, handling taxes, and making sure everyone gets their correct take-home pay. Ensuring compliance with labor and tax laws is also an important part of payroll. 

Whether you’re running a restaurant, retail store, or service business, good payroll keeps your team happy and your business compliant.

How does payroll work?

Payroll works by following three main steps: collecting employee data and time worked, calculating total pay and deductions, and distributing payments. 

First, you'll track employee hours worked and verify their pay rates. Then, calculate gross pay and subtract taxes and other withholdings. Just note that calculating payroll taxes can vary based on business and local regulations. Finally, distribute the remaining net pay to employees through direct deposit or checks while filing necessary tax forms with government agencies.

Modern payroll software automates this process by:

• Syncing with time tracking to import hours automatically.
• Calculating taxes and deductions based on current rates.
• Processing direct deposits on schedule.
• Filing required tax forms.
• Maintaining compliance records.

Key components of payroll

Before you run your first payroll, you need five essential pieces working together. Get these components right, and payday becomes smoother for everyone. Skip any of them, and you risk errors that can cost time and money to fix.

Employee information

Start with the basics—you can’t run payroll without accurate employee data. You'll need W-4s for tax withholding, I-9s for work authorization, direct deposit forms, and pay rate documentation that lists the employee's wages.

Beyond the basics, track benefit selections, overtime eligibility, and any special pay arrangements like tips or commissions. Keep these records updated. When employees change their withholdings or benefits, these updates affect their take-home pay.

For example, if you hire a server who works different roles (server wages vs. prep cook wages), you'll need to document both pay rates and set clear rules for when each applies. Set this up correctly from the start to avoid paycheck corrections later.

Time tracking

For hourly employees, accurate time tracking drives accurate paychecks. Modern time clocks do more than just record clock-ins and clock-outs—they handle complex calculations for overtime, breaks, and multiple pay rates automatically.

When your time tracking connects directly to payroll, you eliminate manual data entry and reduce errors. Your system should handle:

• Regular hours and overtime by state law.
• Paid and unpaid breaks.
• Split shifts and multiple pay rates.
• Tip reporting.
• Holiday or premium pay rates.

Gross pay

Your employee's gross pay is the total amount earned before any deductions. For hourly workers, multiply hours by pay rate, adding any overtime, tips, or bonuses. For salaried staff, divide the annual salary by pay periods.

Consider these common additions to base pay:

• Shift differentials for evening or weekend work
• Performance bonuses or commissions
• Holiday premium pay
• Tips and service charges

Tax and voluntary deductions

Understanding deductions helps you explain paychecks to your team. Required deductions start with: 

• Federal income taxes
• Social Security (6.2% up to annual limit)
• Medicare (1.45% on wages up to $200,000, with an additional 0.9% tax on wages above this threshold)
• State and local taxes (vary by location,some cities even have their own income tax)

Voluntary deductions let employees customize their benefits. Health insurance premiums typically come out pre-tax, lowering taxable income. Retirement contributions like 401(k) plans work the same way. Other deductions might include life insurance, FSA/HSA contributions, or union dues.

The order of these deductions matters. Pre-tax deductions reduce taxable income before calculating income tax, while post-tax deductions come out of already-taxed pay. A good payroll system handles this sequencing automatically.

Net pay

This final number shows what actually hits your team's bank accounts. Direct deposit has become the standard, offering faster access to funds than paper checks. Some states require specific information on pay stubs, from year-to-date totals to remaining PTO balances.

Keep detailed records of each payment, including:

• Gross pay calculations.
• All deductions taken.
• Tax withholding records.
• Payment method and date.
• Year-to-date totals for earnings and deductions.

How to process payroll

Running payroll smoothly means following a clear system. Here's how to make sure everyone gets paid correctly and on time, every time.

Set up payroll.

Before your first payroll run, get your business properly registered and documented. Start with your Employer Identification Number (EIN)—think of it as your business’s Social Security number. You’ll need it for tax filings and banking.

Registration goes beyond federal requirements. Each state has its own tax agencies and registration process. Some cities require additional registrations, especially if they have local income tax. Set these up early to avoid last-minute scrambles.

Choose a pay schedule.

Your pay schedule, or pay period, affects both your team's financial planning and your cash flow. Weekly payroll gives employees faster access to their earnings but means more processing time for you. Biweekly payroll offers a good balance of administrative efficiency and employee satisfaction. 

Consider these factors when choosing your schedule:

• State law requirements
• Industry standards
• Cash flow timing
• Processing costs
• Employee preferences

Calculate and withhold taxes.

Tax calculations form the backbone of payroll processing. Start with federal income tax, using each employee's W-4 to determine withholding. Add Social Security and Medicare (together known as FICA taxes), which have fixed rates but income limits that change yearly.

State and local taxes add complexity. Each jurisdiction has its own:

• Tax rates and brackets.
• Filing deadlines.
• Deposit schedules.
• Special assessments.

Pay your employees.

Paying employees can be done through direct deposit, checks, or payroll cards. Direct deposit has become the standard, as it offers:

• Faster access to funds.
• Lower processing costs.
• Automatic transfer records.
• Less risk of lost checks.

For employees without bank accounts, consider payroll cards as an alternative. They work like debit cards but don't require a bank account. Some states require you to offer paper checks as an option. Know your local requirements!

File payroll taxes.

Tax filing follows a regular schedule, but timing varies by tax type and business size. Monthly or semi-weekly deposits cover your federal tax obligations throughout the quarter. Quarterly returns (Form 941) summarize these payments and report total wages.

State requirements vary widely. Create a tax calendar that includes:

• Federal deposit due dates.
• State tax deadlines.
• Quarterly filing requirements.
• Annual reconciliation dates.
• W-2 and 1099 deadlines.

The consequences of missed deadlines can be severe. Late payments often incur penalties and interest, so build reminders into your process.

Payroll compliance and record-keeping

Don't let compliance feel overwhelming. With the right system in place, staying on top of payroll laws becomes part of your regular routine.

Payroll laws

Running payroll means following both federal and state regulations. The Fair Labor Standards Act (FLSA) sets your baseline for minimum wage and overtime pay, ensuring nonexempt employees are compensated for hours worked beyond 40 in a workweek. But that’s just the start—state and local laws often add stricter requirements.

Know your obligations around:

• Minimum wage by location.
• Overtime calculations.
• Break and meal period rules.
• Final paycheck deadlines.
• Pay stub requirements.

Think of these laws as your payroll playbook. When you understand the rules, you can focus on growing your business instead of worrying about compliance.

Maintain payroll records.

Good record-keeping protects your business. Keep at least three years of records for:

• Employee information.
• Pay rates and job classifications.
• Hours worked and overtime.
• Deductions and tax payments.
• Time off and benefits.

Store these records securely but make them easy to access. You’ll need them for tax filings, audits, or employee questions about past pay.

Simplify payroll with payroll processing software.

Manually processing payroll can be overwhelming. Just think about the risks your business undertakes when you run payroll systems by hand:

• Calculation errors cost time and money
• Tax rates change constantly
• Manual filing increases audit risk
• Paper records get lost or damaged
• Employees wait longer for pay 

A 2023 Homebase survey reveals that on average, employers spend 63 hours each year running payroll and 76% of employers have made a payroll calculation error in the past. 

Stop spending hours on manual calculations. Choose a modern payroll processing tool that helps turn complicated tasks into simple clicks. Here’s how Homebase makes payroll actually work for your business:

• Say goodbye to manual work and let software handle the heavy lifting. Put payroll on autopilot or run it the next day—whatever works for our business. Auto-payroll even handles your team’s wages and pooled tips with zero clicks required.
• Keep compliance simple. Stop wondering if you’re doing payroll right. Homebase automatically calculates hours, breaks, and overtime based on your local laws. We also store time cards and payroll records for FLSA compliance.
• Scale without the stress. Homebase allows you to run payroll for multiple locations, process unlimited payroll runs for one monthly fee, and add new team members easily.

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FAQs

How does payroll payment work?

Think of payroll payment as the final step in getting your team paid. After calculating gross earnings and subtracting taxes and deductions, you'll distribute the remaining net pay to your team. Most businesses use direct deposit because it's fast and secure, but you can also offer paper checks or payroll cards for employees without bank accounts.

How many days before payday is payroll done?

Payroll processing usually starts 1–3 days before payday. This allows time for verifying employee hours, calculating paychecks, withholding taxes, and transferring funds, especially for direct deposit. Pro tip: Set a consistent schedule and stick to it. Your team counts on getting paid on time.

What is the process of doing payroll?

The payroll process includes:

• Collecting and verifying employee hours (or confirming salary amounts).
• Calculating gross pay and subtracting taxes, benefits, and other deductions.
• Processing and issuing payments to employees.
• Filing payroll taxes with the appropriate agencies.
• Keeping accurate payroll records for compliance and future reference.

Modern payroll software automates most of these steps, turning hours of work into a few simple clicks.

How do you do payroll?

You can process payroll manually, hire a payroll service, or use payroll software. Doing payroll yourself is when you’re in charge of everything—from tracking hours to filing taxes. While it puts you in complete control and saves money upfront, you'll need to dedicate significant time to learning tax laws and staying on top of calculations.

Instead, you could consider outsourcing payroll to a professional, or use a payroll service provider like Homebase. Software is the most efficient option, as it automates calculations, tax filing, and direct deposits while reducing the risk of errors.

For more details on each method of running payroll, check out our blog post on how to do payroll.

How does payroll tax work?

​​Payroll taxes aren't just income tax, they include Social Security, Medicare, and unemployment taxes too. As an employer, you're responsible for:

• Withholding the correct amount from employee paychecks.
• Matching their Social Security and Medicare contributions.
• Paying your share of unemployment taxes.
• Filing tax forms on schedule.

Your payroll service should handle these calculations and filings automatically, keeping you compliant without the stress.

How does ADP payroll work?

ADP payroll is a professional service that automates payroll management, including calculating wages, withholding taxes, and filing compliance forms. It integrates with time tracking systems and provides features like direct deposit and benefits management, making it a popular choice for larger businesses.

How does payroll software work?

Payroll software takes the manual work out of paying your team. Good software will:

• Import hours directly from your time clock.
• Calculate earnings and deductions automatically.
• Process direct deposits.
• File your payroll taxes.
• Keep your records organized.

The best part? Everything happens in one system, just like with Homebase. When your scheduling, time tracking, and payroll work together, you eliminate double entry and reduce errors.

How does payroll work for a small business?

Small businesses face unique payroll challenges—you need a solution that's powerful but not complicated. Start with the basics:

• Track employee hours accurately
• Calculate pay and deductions correctly
• Pay your team on time
• Handle tax filings

Look for tools that scale with your business. Whether you have 5 employees or 50, your payroll system should grow with you without getting more complex.

How does biweekly payroll work?

Biweekly payroll means paying your team every two weeks, which works out to 26 pay periods per year. This schedule:

• Creates consistent paydays (same day every other week).
• Simplifies overtime calculations.
• Reduces processing time compared to weekly payroll.
• Helps employees budget with regular payments.

Remember: Some months will have three paydays instead of two. Plan your cash flow accordingly.

How does payroll processing work?

Payroll processing involves collecting employee data, calculating gross pay and deductions, issuing net pay, and complying with tax obligations. Modern payroll processing turns complex calculations into simple steps:

1. Your team clocks in and out.
2. Their hours flow to payroll automatically.
3. The system calculates gross pay and deductions.
4. You review and approve.
5. Everyone gets paid on time.

How does a payroll service work?

A payroll service handles the entire payroll process for you, from tracking hours to issuing payments and filing taxes. Think of a payroll service as your payroll department without the overhead. A good service will:

• Set up your tax accounts.
• Process your payroll runs.
• Handle tax payments and filings.
• Keep you compliant with changing laws.
• Provide support when you need it.

Look for a service that understands your industry. Restaurant payroll works differently than retail payroll. Your provider should know the difference.

Why do you need a payroll system for your small business?

Running payroll manually creates too many risks, from calculation errors to missed tax deadlines. A good payroll system:

• Saves hours of work each week.
• Ensures accurate tax calculations.
• Keeps you compliant with labor laws.
• Maintains organized records.
• Gives employees easy access to their pay info.

The right system pays for itself in time saved and mistakes avoided. Plus, your team gets the reliable, professional payroll experience they deserve.