What is Payroll Processing? How to Process Payroll

Common frequently asked payroll questions and answers

Processing payroll means compensating employees for their work. In India, it involves calculating total wage earnings, withholding deductions, filing payroll taxes, and delivering payment. These steps can be accomplished manually, but an automated process is usually more accurate and efficient and may help you comply with various payroll regulations.

What is payroll processing?

How do you manually process payroll?

If you’re a small business with only a few employees and choose to process payroll manually, you will need to keep precise records of hours worked, wages paid, and worker classifications, among other details. You must also ensure your calculations are correct and remember to file all the necessary taxes and paperwork with government authorities on time. As you add more employees, the more challenging payroll becomes and any mistakes you make can result in costly tax penalties.

Payroll’s impact on cash flow

Even if you’re not paying someone else to do payroll for you, it’s still considered a business expense. This is because your employees’ wages and your share of payroll taxes cut into your profit margin. And if business slows down, you may be faced with the difficult decision of delaying payments or diverting money from other resources.

One way to limit payroll’s impact on your cash flow is to pay your people using direct deposit or digital pay options instead of paper cheques. Because you don’t know when someone will cash a cheque, it becomes more difficult to ensure you always have sufficient funds in your bank account. With direct deposit, you only need to cover the cost of payroll on certain days of the month, allowing you to better manage your finances. Plus, going digital cuts the expense of printing paper.

Payroll regulations

Certain aspects of payroll processing are regulated by the Income Tax Department and the Ministry of Labour and Employment in India. Some of the laws you must comply with include:

Minimum Wages Act

The Minimum Wages Act entitles workers to a minimum wage that varies by state and type of employment. You need an accurate means of tracking time and attendance so you can apply wages in accordance with the law.

The Payment of Wages Act

The Payment of Wages Act requires employers to pay wages to employees on time and without unauthorised deductions. Payroll records typically include hours worked each day, total hours worked during the workweek, the basis on which employee wages were paid, regular hourly pay rate, total overtime for the workweek, date of payment and the period covered, and total wages paid each period. These records must be kept for at least three years.

Employee Provident Fund (EPF)

The EPF requires that a portion of every employee’s earnings help pay for retirement benefits, also known as a pension. For each pay period, you must deduct 12% of an employee's salary for EPF and match this deduction, contributing another 12%.

Employee State Insurance (ESI)

Most employers must contribute to the ESI scheme that provides medical, sickness, and disability benefits to employees earning up to a certain wage limit. Employers need to deduct 0.75% of the employee's salary and contribute 3.25% themselves.

Payroll processing state-by-state and union rules and regulations

In addition to central regulations, you must abide by state payroll processing laws. The states of India are self-governing administrative divisions, each with its own state government. Every state has its own rules, some stricter than others, governing labour laws, payroll, and recordkeeping. So, if you’re conducting business across states and unions, your payroll compliance becomes that much more difficult.

A good way to stay compliant is to task an executive or someone from your legal department to compile a list of all the labour laws that apply to your organisation. Ask that they track changes to existing laws and document any new laws being proposed. Review these findings on at least a monthly basis so you can adequately adapt your operations and avoid penalties.

Apply for a PAN

A Permanent Account Number (PAN) is a ten-digit alphanumeric number issued by the Income Tax Department. Think of it as a numerical identifier for your business. You can apply for a PAN card free of charge online or by submitting Form 49A. Once approved, it can’t be cancelled and will stay linked with your organisation for as long as you stay in business. Some state and local governments may also require you to have a separate tax identification number.

Documents required for payroll

Before you begin processing payroll, you generally need to gather these documents, some of which may be required by government agencies:

Form 16

On their first day of work, new hires usually complete Form 16, which you will use to deduct the correct amount of income tax from their pay. Although not required, your employees should fill out a new form each year if their personal or financial situation changes.

The Form 16 is an essential document provided by the employer to the employee annually, after the end of the financial year. It includes all of the details of the salary paid to the employee, including allowances, deductions, and net income

Form 26Q

If you hire freelancers or independent contractors, you should ask them to provide their name, address, and PAN. Use the information to file Form 26Q, which shows how much you paid independent contractors. 26Q is to be submitted on a quarterly basis.

Form 11

Form 11 serves two purposes: to verify an employee’s basic Employees’ Provident Fund Scheme account (PF) details with a ‘self-declaration’ and to automatically transfer their PF details to a new account. They will continue to enjoy the benefits of the scheme but under a new member ID. Employees must fill out this form on their first day of work. Once they do, you have three business days to complete and sign Section 2. Employees also need to present identification documents, such as a passport or Aadhar card as part of the authorisation process.

Job application

Although candidates often supply a CV, job applications help you obtain consistent information about potential new hires. Most require a signature, verifying the accuracy of the details, which you can use to start preparing a payroll record for anyone you decide to hire.

Bank information

If you plan to offer direct deposit, you will need your new employees to provide you with the name of their bank and account details.

Medical insurance forms

You may have the best intentions and truly care about your employees’ health, but you can’t deduct health insurance withholdings from their pay without first obtaining written authorisation.

Retirement plan documents

Payroll deductions require an employee’s signature before you can withhold contributions to an EPF.

How to classify workers

In order to comply with payroll tax laws, you need to properly classify your workers as either employees or independent contractors. The general steps to do this are:

Assess the nature of the work being done.
A worker may be an independent contractor if you have the right to control or direct only the result of the work, not what will be done and how it will be done. If you control both what will be done and how it’s done, the worker is usually an employee.
Determine if payroll deductions apply.
Withhold income tax, Social Security tax, and Medicare tax only on wages paid to employees, not independent contractors. These types of workers pay self-employment tax on their income.
File Form 16 for employees.
Include all forms of compensation paid to employees, including wages and tips, as well as the taxes that were withheld.
File Form 26Q for independent contractors.
You generally must report payments of ₹30,000 or more to nonemployees. The completed form gets sent to both the Income Tax Department and the worker.

Pay particular attention to details when determining a worker’s status. Misclassifying a worker can result in penalties and you may be responsible for any unpaid wages, including overtime. If you need help determining the status of a worker, you can consult with a tax professional or legal advisor.

What is a typical payroll cycle?

The most common payroll cycle or pay period in India is monthly. See how it compares to other payroll frequencies:

Payroll Cycle	Paychecks Per Year
Biweekly	26
Weekly	52
Semimonthly	24
Monthly	12

Payroll schedule considerations

Payroll schedules are a matter of preference, but minimum standards may apply. Employees, especially those in low-wage jobs, usually prefer to be paid more often, but as your pay frequency goes up, so does your payroll processing costs. You’ll need to carefully weigh the expectations of your workforce and your budget and comply with all state laws.

Create a payroll policy

To ensure that your payroll is accurate, processed timely and in accordance with all regulations, you’ll need to establish guidelines with both your employees and your payroll department.

A typical payroll policy covers:

Workweek definitions

Clearly defined workweeks are necessary to comply with overtime rules, as well as state wage payment requirements. You can choose when your workweek starts and ends, but they typically must constitute seven consecutive 24-hour periods.

Time and attendance

Accurate payroll begins with precise timekeeping. Your employees should know how to log their hours – time clock, paper timesheets, etc. – the approval process, and disciplinary action for submitting false records.

Break periods

Under the Factories Act of 1948, employees should receive a rest break of at least 30 minutes after five hours of continuous work. Similar interpretations of these labour laws are stipulated in most state-specific Shops and Establishments Acts.

When offering rest periods, clearly define their length and let employees know if the break is paid or unpaid and if they need to clock their time.

Overtime

According to the Factories Act of 1948, if an employee works for nine hours in a single day or over 48 hours in a week, they are entitled to receive overtime pay, which is twice their usual wage

Explain who is eligible for overtime pay and how the rate is applied. If your state also has overtime regulations, you must follow the law that provides the most generous benefit to the employee.

Pay periods

Document how often you will pay your employees. Monthly is the most common. Also note which specific day of the week will serve as payday.

Mandatory payroll deductions

Make clear all the central and state taxes that will be deducted from your employees’ paychecks. Include information on the forms they need to complete to get their withholding amounts correct and how wage garnishments work.

Voluntary payroll deductions

If you offer your employees health insurance or retirement plans, explain the costs and how they can participate. Also provide information on paying for benefits on a pre or post-tax basis.

Wage structure

Be transparent about the different ways employees are compensated at your business, whether it’s hourly pay, salary, bonuses, commission or stock options. In addition, pay careful attention to state laws covering the payment of final wages to those who leave your organisation.

Payroll recordkeeping

Authorities require payroll records to be kept on file for certain periods of time. Document the recordkeeping laws that apply to you and how you will maintain confidentiality.

Designate a payroll processor

Those who excel as a payroll processor have a specific skill set. They tend to be detail-oriented, organised, analytical and technically inclined. Their success, however, requires the collective teamwork of employees, managers and the human resources department. For example, workers must submit accurate information and managers need to promptly approve timecards in order for payroll processors to manage payroll correctly and on time.

Track employee time and attendance

How your payroll administrator manages time and attendance – whether it’s a time clock, a mobile app or a pencil and paper – is entirely up to you. Keep in mind, however, that doing it manually opens the door to human error. You can help eliminate many of these mistakes, speed workflows and make the payroll manager’s job easier by using an automated time and attendance solution that integrates with payroll.

Calculate taxes

As an employer, you’re responsible for calculating and withholding money for central, state, and local taxes from every employee’s paycheck. The amount you withhold is determined by the forms submitted by your employees and current tax rates. In addition, the Indian government requires that you pay various taxes, such as the Employee Provident Fund (EPF) and Employee State Insurance (ESI), and match what your employees contribute.

Withhold additional payroll deductions

Employees can choose to have you withhold money from their paychecks to fund retirement plans and insurance premiums. Each of these requires a separate consent form. Sometimes, you must also withhold deductions for court-ordered garnishments, such as child support and alimony.

Pay statement compliance

Most states require you to provide a pay statement in either print or electronic format at the time wages are paid. Some laws allow employees to opt in or out of electronic statements and you may have to ensure they are able to easily view or print their pay information.

The goal of these regulations is transparency. The hourly rate, total hours worked, gross pay, net pay and deductions are usually required details. Avoid violations by contacting state labour departments for specific pay statement guidelines.

How to issue paychecks

You can purchase cheque stock from the bank that has your payroll account or a stationary supply store. When placing your order, make sure that the cheque stock is designed to prevent fraud, uses ink that can be interpreted by bank cheque readers and has all of the necessary information. Most will display your business name, the employee’s name and address, the cheque number and date, and the bank’s name and address. Once the cheques are printed, seal them in a double-window envelope so that the destination and return addresses are visible, apply the appropriate postage and put them in the mail. This process can be simplified by using a payroll service, which in some cases, includes cheque delivery.

Direct deposit vs. pay cards

Printed cheques were the tried and true method of compensation for many years, but thanks to technology, there are more efficient and less expensive ways to pay your employees. Two such methods in use today are direct deposit and pay cards.

Direct deposit electronically transfers money from your payroll bank account to the personal bank account of an employee. The transaction is instantaneous and most banks don’t charge for it. For these reasons, direct deposit has surpassed printed cheques as the preferred method of payment. However, employees must have a valid bank account and it can sometimes take up to two weeks to set up.

A more recent payment option that’s growing in use are prepaid debit cards or payroll cards. They’re ideal for workers who don’t have a bank account, but still want immediate access to their pay.

Whichever wage payment methods you choose to offer to your employees, be sure to review all state-specific requirements. Most allow electronic payment, but it generally cannot be the only option.

How can I improve my payroll process?

Long hours spent on administrative work and responding to letters from the Income Tax Department or court orders for wage garnishments are tell-tale signs that your payroll process could use some improvements. Here are some tips to streamline your operations:

Unify your pay periods
Paying different types of workers on different schedules (i.e. paying hourly employees weekly and salaried employees semimonthly) complicates payroll. Find a pay period that complies with state laws and works best across your entire workforce.
Invest in payroll software
The automated features available in payroll software eliminate repetitive tasks, like manual data entry. This reduces errors, saves time and improves compliance.
Integrate your payroll with other processes
Many types of payroll software can be seamlessly integrated with time clocks and accounting ledgers. When these operations are in sync, you may have more accurate payroll calculations.
Use digital timekeeping solutions
Paper timesheets often lead to mistakes. Time tracking software uses biometric identification to prevent fraud and automatically calculates the hours worked.
Keep current with regulatory requirements
Laws governing payroll and employment are constantly changing. Staying informed of the latest legislation will help you maintain compliance and avoid expensive penalties.
Work with a payroll service provider
Often, the surest way to improve your payroll process is to work with a provider who can handle all aspects of payroll on your behalf. You may have peace of mind knowing that your employees are paid on time and your taxes are prepared correctly.

Payroll processing FAQs

See what other employers are asking about payroll processing:

What is a payroll processor?

A payroll processor is someone who administers payroll. Employers can hire someone specifically for this purpose, but in most cases, the role is filled by an office manager, human resources director or even the owner. As a result, many payroll processors have responsibilities beyond simply running payroll. They’re often tasked with providing customer support and answering employee questions, analysing the payroll system, keeping up with regulatory issues, working with auditors, and troubleshooting technical errors.

How long does payroll take to process?

The method you choose to process payroll will determine how long it takes. Manual calculations can take hours to days, depending on how many employees you have and the laws that you must comply with. If you’re a large business that operates across state lines, processing payroll this way is usually unfeasible. A more efficient approach is to use payroll software, which can run payroll in minutes thanks to automation.

What is full-cycle payroll processing?

The amount of time in between each payday is known as a payroll cycle. It can be as short as a week or as long as a month. During this period, several repeatable steps take place:

Employees work and track their hours
Gross pay is calculated based on hourly wage
Taxes and other deductions are withheld from wages
Net pay is delivered to employees via cheque, direct deposit or pay card

What is end-to-end payroll processing?

End-to-end payroll processing integrates payroll with other aspects of workforce management, such as performance measurement, training, scheduling, benefits and compensation. By making this connection, you can improve communication, recordkeeping, analytics and efficiency throughout the employee life cycle.

Why is the payroll process important?

Payroll processing is important because paying employees late or filing taxes incorrectly may result in penalties and interest on back taxes. Payroll that’s unreliable can also hurt employee morale and tarnish your business reputation. When you consider these ramifications, it’s often best to dedicate the necessary resources, whether it’s time or money, to make sure you get payroll right

What is the payroll process?

To run payroll for the first time, employers generally must perform the following:

Apply for a Permanent Account Number (PAN)
Employers need to obtain a PAN for tax purposes.
Obtain state and local tax identification numbers, if applicable
This may include Goods and Services Tax Identification Number (GSTIN) if the business is registered under GST.
Gather employee tax documents
Collect necessary forms such as Form 16 (Certificate of TDS on Salary), Form 12BB (statement showing details of claims and deductions), and other relevant documentation.
Open a bank account specifically for paying employees and taxes
A dedicated bank account can help you manage payroll more efficiently.
Hire or designate a payroll manager
Assign a qualified individual to manage the payroll process.
Develop a payroll schedule
Establish a regular payroll schedule that specifies the frequency and dates payments are processed.
Create a company payroll policy
Develop and document a clear payroll policy that outlines all aspects of payroll processing.

What are the types of payroll processing?

When it comes to processing payroll, you have several options to choose from, depending on the size of your business and individual needs. The most common are:

Do it yourself (DIY)
Manually manage payroll tasks using spreadsheets.
Outsource payroll to an accountant
Hire a professional accountant to manage your payroll tasks.
Purchase payroll software
Invest in software that automates payroll calculations, tax deductions, and other payroll tasks.
Work with a managed payroll provider
Work with a payroll service provider like ADP who can handle all the burdensome work of payroll processing on your behalf.