Payroll Terms and Key Concepts

If you've been performing your own payroll calculations, you know how difficult it can be to keep up with new legislation, changes in the tax code, and other elements that necessitate adjustments in employee pay amounts.  The following is a very basic list of some of the most common terms related to payroll services.  One of the reasons most businesses decide to use a payroll outsourcing company is because there is just so much information involved!  For a more complete list or more detailed descriptions of programs you need to know about, see the IRS website or the State Tax Board site for your state. 

Accounting Period: A period of time that is covered in an income statement.  Accounting periods are usually quarterly and annually.

Advance Earned Income Credit: If employees are eligible for this credit, it can be “advanced” to them in the form of less withholding of federal income tax.  Some payroll processing services offer this as an option or feature.  Ask a tax professional for more information about this option.

Archer Medical Savings Account: A pre-tax account where either an employee or employer (not both) can deposit funds for use at a later date.

Cafeteria Plan: Any plan where pre-tax benefits are taken out of employee pay.  Internal Revenue Code §125 outlines the various different types of qualified plans.

Circular E Employers Tax Guide: A guide published annually that outlines employer tax responsibilities. 

Compensation: Payment for services rendered.

Constructive Receipt: When wages are made available.  For example, direct deposit offers constructive receipt earlier than a paper check would.

Deferred Compensation: Any deferral of wage payment to a future date, such as a pension plan or employee savings account.

Defined Benefit Plan: A plan that defines employee benefits based on a pre-designed formula (usually computed based on salary and length of service), where only the employer makes contributions to the account.

Direct Deposit: The process of depositing employee pay amounts directly into the employee bank account.  Funds are made available faster and there is no waste associated with printing a paper check.

EIN (Employer Identification Number): The IRS and state “code” for an employer, how an employer is identified for tax purposes.

EFPTS (Electronic Federal Tax Payment System): A system that allows an employer to pay employment taxes, send withholding amounts, and deposit to qualified government savings plans electronically. 

Exempt: In payroll context, an employee is “exempt” from having tax amounts withheld if he or she meets certain qualifications.

FICA: The tax acronym for the “social security tax” withheld from employee paychecks. 

Withholding Amount: The amount withheld from employee wages for the payment of employment and other taxes. 

Gross Pay: Total amount received from employer before any deductions are made.

Independent Contractor: A non-employee that performs services for a business.  Independent contractors are paid differently than employees. 

IRA (Individual Retirement Account): An account that allows an employee to deposit funds for retirement and incur tax advantages.  Some employers “match” pre tax contributions of employees or offer incentives for using retirement accounts.

Payroll Register: A report that specifies pay amounts, taxes withheld, and other payments made in association with payroll services.

Percentage Method: Method for calculating how much tax to withhold from employee pay.

Tax Levy: A withholding of employee wages for payment of unpaid employee taxes. 

W-2: A statement of earnings, withheld amounts, and other payments made on behalf of an employee that is distributed at the end of the tax year. 

W-4: A form an employee fills out when hired that determines withholding amount and exemption status.

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