The 4 Most Important Things to Know Before Paying Someone
By VICKY BROWN
Payroll? What do you mean I have to do payroll – I don’t have time for all that. Just tell me the most important things I need to know.
Hi entrepreneurs, I’m Vicky Brown. And you’re in the right place if you want to engage your team, boost your business, and grow your leadership muscle.
So many times, especially if you are running a smaller company – the entrepreneur, founder or CEO is tasked with taking care of payroll. And while I know there are a lot of online systems that say – just plug in the amount you want to pay the person and you won’t have to do anything else. That’s not quite the case.
There are still vital bits of information you need to make sure payroll is running smoothly, and you aren’t going to get dinged because of some compliance thing you knew nothing about.
So here are 4 of the most important things you need to know when you’re paying someone – specifically in California.
First, be sure you’re paying the right amount. Know I know you’re probably thinking – what’s so hard about that. You decide how much you’re going to offer, offer it, and if they accept that’s what you pay them.
But there are things to think about before you formulate the offer. Is the job eligible for overtime or not (meaning are they non-exempt or exempt).
The reason you need to figure this out first, is because it’s going to put some parameters around your salary levels. You see, if the person is non exempt, then you have to at least pay them the minimum hourly wage. And it may be more complicated to determine what the minimum wage is than you think.
For example, beginning this month (January of 2024) the California minimum wage is now $16.00 per hour. But if your business is located in the city of Los Angeles, then the minimum wage is actually higher than that – it’s $16.78. And if you happen to be in an unincorporated city in Los Angeles county, well then your minimum wage is $16.90.
And while the state’s minimum wage will hold until January of next year (2025) both LA County and LA City minimum wages increase mid year, in July of 2024.
So see, figuring out what the minimum wage is take a bit of sleuthing.
Oh, and it’s not just a minimum for non exempt employees, exempt employees could have a minimum amount they have to be paid as well. For instance, in California exempt employees have to be paid at least twice the weekly minimum wage at the State level. So, since California’s minimum wage is $16 per hour, the exempt level minimum wage would be $16 times 2, times 40, which equals $1,280. And whenever the state minimum wage goes up, the minimum wage for exempt employees goes up as well.
Here’s a pro tip – this is a state law, so it only applies to the state’s minimum wage, not the minimum wage at a county or city level.
When are you going to pay them? Meaning how often. And no, you can’t just wing this. Aside from it being a really important item for the team member, there are laws that dictate when someone has to be paid.
For instance, if the person is non-exempt (meaning eligible for overtime), well then they have to be paid, at minimum, two times each month. Now, you have the option of going with bi-weekly (meaning every other week) or semi monthly (meaning 2 times a month). And no, actually they aren’t the same thing.
A bi-weekly payroll is for the same amount of time each time (2 weeks), and happens 26 times a year. While a semi monthly payroll won’t cover the same amount of time each pay period, because there are a different number of days in any given month. Also, semi monthly payrolls happen 24 times a year.
So you need to get this all sorted before you set up the payroll process. Oh, one more thing – earlier I mentioned that non-exempt employees have to be paid at least two time each month – well exempt employees can be paid once a month if you wish. But there a strict guidelines as to what period that monthly paycheck has to cover. And yes, you can have two different payroll schedules; one for exempt and one for non-exempt employees.
“… Now the other thing to think about with bonuses is the tax implication. The IRS considers a bonus as supplemental wages, so specific tax rules apply. Now, as an employer, you have two options for calculating how much tax to withhold on bonus payments. You can use the percentage method …or you can use the aggregate method.“
Are you going to give bonuses? If so, be sure you have a solid bonus program written down somewhere. Oh you don’t need to give it to your team members, that is, unless it’s tied to performance – after all, anyone would want to know how and if their performance might impact a bonus payment. But if it’s just a general bonus (and you aren’t going to give your team written documentation of the calculations etc.); then at least have a record you can stand on if you get questions around fairness.
I know it might seem like overkill – but better to have your ducks in all in a row than to be caught flat footed if or when a question comes up.
Now the other thing to think about with bonuses is the tax implication. The IRS considers a bonus as supplemental wages, so specific tax rules apply. Now, as an employer, you have two options for calculating how much tax to withhold on bonus payments. You can use the percentage method – generally that means you will withhold at a flat rate of 22% – 37% depending on how much the bonus is (and by the way, that rate can change from year to year, so always check with the IRS website). Or you can use the aggregate method.
With the aggregate method, the bonus amount is simply added to the regular wages, and the whole check is taxed as though it’s a regular paycheck. Be careful though – because that can easily bump the employee into a much higher tax bracket for that check. The payroll system thinks every check for the year will be that high, so it calculates the withholding taxes accordingly.
You’ve actually probably experienced this before yourself – you get a bonus in your check and can’t believe how little you actually receive because so much is taken out in taxes. Well, that can easily happen with the aggregate method.
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Now the other, little known pitfall with bonuses, is bonuses for non-exempt employees. You see, as far as the IRS is concerned, a bonus is a wage, and the overtime rate is based on the employee’s base wage. So, with a bonus, it actually changes what the base wage is – and therefore, changes the amount you should use to calculate overtime.
Those of us in HR actually call it the bonus recalculation. If you give a non-discretionary bonuses, you have to look at the period the bonus covers, and recalculate any overtime that has been paid based on the new base rate (which would include the bonus amount).
Now, I could dive deeper into the specific calculations and what is and isn’t considered a discretionary bonuses – but that would take a good deal of time, and you might as well hear it directly from the horse’s mouth as it were. So take a look in the description for a link directly the IRS Fact Sheet that explains this in detail
And finally, if you are going to pay commissions, there are some rules and regs you need to know. First, commissions are subject to the same tax rules as bonuses. If they are considered supplemental then they will be flat taxes, and if they are processed as aggregate then they will be taxed at the regular rate.
But the other important thing to know about commissions is that (at least in California) you have to have a written commission agreement outlining things like when the commission is earned, what the rate is, when it will be paid, how and why it might be reduced, what happens if the sale is paid after the person has left the company etc.
Now, actually it’s a good idea to have all this in writing anyway, even if your state doesn’t require it – because it goes a long way toward avoiding confusion and misunderstanding.