4.3 Payroll & Pay Practices

4.3 Payroll Fundamentals & Deductions

Payroll turns compensation decisions into compliant paychecks. The core formula is the gross-to-net flow:

Gross pay − pre-tax deductions − taxes − post-tax deductions = net (take-home) pay.

• Gross pay: all earnings before deductions — wages, overtime, bonuses, commissions, shift differentials.
• Net pay: what the employee actually receives.

Types of deductions

Deductions fall into mandatory (required by law or court) and voluntary (employee-authorized) categories.

Pre-tax deductions (traditional 401(k), HSA, Section 125 premiums) reduce taxable wages, lowering income and sometimes FICA tax. Post-tax deductions (Roth contributions, garnishments, union dues, charitable gifts) come out after taxes.

Wage garnishments

A garnishment is a legal order to withhold part of an employee's pay to satisfy a debt (child support, taxes, defaulted loans, court judgments). The Consumer Credit Protection Act (CCPA) limits how much can be taken from disposable earnings (gross minus legally required deductions):

• Ordinary debts: the lesser of 25% of disposable earnings or the amount above 30× the federal minimum wage weekly.
• Child/spousal support: up to 50–65% depending on whether the worker supports another family and is in arrears.

Trap: the CCPA also prohibits firing an employee because their wages are garnished for one debt — a frequently tested protection.

Pay Frequency, Overtime Calculation & Compliance

Pay frequency

Employers choose a pay frequency, often constrained by state law. Knowing the number of pay periods is essential for converting annual salary to a paycheck.

Trap: biweekly (26) and semimonthly (24) are NOT the same — biweekly pays every two weeks and produces 26 (occasionally 27) checks, while semimonthly pays on fixed dates such as the 15th and last day, producing 24.

Calculating overtime the right way

FLSA overtime is 1.5x the regular rate over 40 hours, but the regular rate is not always the base hourly wage. It must include nondiscretionary bonuses, shift differentials, and most incentive pay — it excludes discretionary bonuses, gifts, and reimbursements.

Worked example: an employee works 45 hours at $20/hour and earns a $100 nondiscretionary production bonus that week.

1. Straight-time earnings = 45 × $20 = $900, plus $100 bonus = $1,000 total.
2. Regular rate = $1,000 ÷ 45 hours = $22.22/hour.
3. Overtime premium owed = 0.5 × $22.22 × 5 OT hours = $55.56 (the straight-time portion is already in the $1,000).
4. Total due = $1,000 + $55.56 = $1,055.56.

A simpler base-only check: 40 × $20 + 5 × ($20 × 1.5) = $800 + $150 = $950 — but ignoring the bonus would underpay and violate the FLSA.

Pay-related compliance and recordkeeping

• Wage payment laws (state) dictate timing of final paychecks, permissible deductions, and pay statements.
• The FLSA requires keeping payroll records for at least 3 years and timecards/wage-computation records for 2 years.
• Misclassifying employees as independent contractors or as exempt is a top enforcement target; the IRS and DOL use control and economic-reality tests.
• Form W-4 sets withholding; Form W-2 reports annual wages/taxes to employees by January 31; Form 941 reports quarterly payroll taxes.

Scenario: a nonexempt worker is paid semimonthly but the workweek spans two pay periods. Overtime must still be computed by the fixed workweek, not the pay period — averaging hours across a pay period to avoid overtime violates the FLSA.

Employer payroll tax responsibilities

Beyond withholding the employee's share, the employer owes its own payroll taxes that never come out of the worker's check:

• Matching FICA: 6.2% Social Security (to the $184,500 wage base) + 1.45% Medicare. The employer does NOT match the 0.9% Additional Medicare surtax.
• FUTA (federal unemployment): paid entirely by the employer; the base rate is 6.0% on the first $7,000 of each employee's wages, usually reduced to an effective 0.6% after the state credit.
• SUTA (state unemployment): employer-paid at an experience-rated rate — employers with more unemployment claims pay higher rates.

Trap: unemployment taxes (FUTA/SUTA) are employer-only in most states; do not list them as employee deductions.

Common payroll errors and controls

Strong payroll controls include segregation of duties (the person who enters new hires should not also approve pay runs), regular reconciliation of hours to time records, and direct-deposit/pay-card authorization on file. Pay statements must generally show gross pay, each deduction, and net pay so employees can verify accuracy.

Final synthesis: the payroll professional's compliance triangle is (1) pay the correct gross including all FLSA-required premiums, (2) withhold and remit the correct taxes and garnishments within legal limits, and (3) keep accurate records for the required retention periods. Errors in any corner expose the employer to DOL, IRS, and state enforcement.