Payroll Expenses: A Comprehensive Guide

Running a small business means wearing many hats. One minute you’re managing staff schedules, and the next, you’re trying to figure out why payroll taxes seem to eat up so much of your budget. If you’ve ever wondered, “What exactly are payroll expenses?” or “How do I calculate payroll tax expense without losing my mind?” you’re not alone.

Payroll isn’t just about cutting checks. It’s about understanding wages, taxes, benefits, and other costs that all add up to your total payroll expenses. If these terms feel overwhelming, you’re in the right place. In this guide, we’ll break down payroll expenses in simple terms, explain how to calculate them step-by-step, and share practical tips to keep your payroll costs under control.

What Are Payroll Expenses: An Overview

Payroll expenses include all the costs you pay to your employees for the work they perform. It’s not just their hourly rate or salary. Payroll expenses also include:

• Employer payroll taxes (like Social Security, Medicare, and unemployment taxes).
• Employee tax withholdings that you pass along to the government.
• Employer-paid benefits such as health insurance or 401(k) contributions.
• Paid time off, bonuses, or commissions.
• Any payroll service fees you pay to run payroll.

For most small businesses, payroll expenses are one of the largest recurring costs. Understanding exactly what’s included will help you stay compliant with tax regulations and keep your finances on track.

Payroll expenses vs. salary expenses

These terms are often confused, but they’re not the same thing. Salary expenses only include the wages or salaries you pay your employees. Payroll expenses, on the other hand, cover everything tied to compensating your team, including taxes, benefits, and any additional costs.

Think of it this way: salary expense is just one piece of the puzzle, while payroll expense is the entire picture.

Payroll expenses vs. cost of labor

Cost of labor is a broader term. It includes payroll expenses but also factors in additional costs like training, recruiting, and equipment needed for employees to do their jobs. If you own a construction company, for example, the cost of labor might include payroll expenses plus the cost of protective gear, tools, and certifications. Payroll expenses focus solely on the financial aspects of paying your employees.

Step-by-step guide to calculating payroll expenses

Calculating payroll expenses can feel overwhelming, especially when tax rules and benefits come into play. Here’s a simple process to break it down.

Gathering necessary information

Before you start calculating, gather all the data you need for the pay period. This includes:

• Employee names and pay rates.
• The number of hours worked for hourly employees.
• Salary amounts for salaried employees.
• W-4 forms (to determine tax withholdings).
• Any deductions, like health insurance or retirement contributions.

Keeping this information organized will make the process smoother and reduce the risk of errors.

Calculating gross pay

Gross pay is the starting point. For hourly employees, multiply the number of hours worked by their hourly rate, including any overtime. For salaried employees, divide their annual salary by the number of pay periods in the year.

Example: If an employee earns $50,000 annually and you pay bi-weekly (26 times a year), their gross pay for each paycheck is $1,923.08.

Accounting for deductions and taxes

Next, you’ll need to subtract deductions and calculate taxes. Deductions may include:

• Federal income tax (based on the employee’s W-4).
• State income tax (Maine has its own rates).
• FICA taxes (Social Security at 6.2% and Medicare at 1.45%).
• Employee contributions to benefits like health insurance or a 401(k).

Don’t forget your share of payroll taxes as the employer. For example, you must match the employee’s 7.65% FICA contributions, pay Federal Unemployment Tax, State Unemployment Tax, etc.

Finalizing net pay

Once you’ve deducted all taxes and benefits from the gross pay, you’ll have the employee’s net pay—the amount they actually take home. But your payroll expenses don’t stop there. Add your portion of payroll taxes, employer-paid benefits, and any payroll processing fees to get the total cost of payroll for that pay period.

Expert strategies for managing payroll costs

Payroll expenses can be one of the trickiest costs to manage. Here are some proven strategies to keep things efficient and cost-effective.

Leverage payroll software and automation

Using modern payroll software can save hours of manual calculations and reduce mistakes. Automation also ensures tax deposits and filings are handled on time, keeping you compliant and avoiding penalties.

Streamline payroll processes

Consider simplifying your pay schedule (e.g., moving from weekly to bi-weekly payroll) to cut down on processing costs. You can also use integrated time tracking tools to ensure accuracy when calculating hours.

Offer smart benefits

Benefits are a big part of payroll expenses. Focus on benefits that employees value most, like flexible schedules or financial wellness programs, rather than costly perks that don’t get much use. Competitive benefits can reduce turnover, saving money in the long run.

Monitor overtime

Keeping an eye on overtime hours can prevent payroll expenses from skyrocketing. Cross-training employees or improving scheduling can help spread workloads more evenly.

FAQs: Payroll Expenses

Is payroll tax expense an operating expense?

Yes, payroll tax expense is considered an operating expense because it’s part of your day-to-day costs for running a business. Payroll taxes, such as Social Security, Medicare, and unemployment taxes, are directly tied to your workforce. Since these taxes are a regular and ongoing part of compensating employees, they fall under operating expenses on your income statement.

What is the difference between salary expenses and payroll expenses?

Salary expense refers only to the wages or salaries you pay your employees for their time and work. Payroll expenses are broader. They include everything it costs to have employees on your team, such as:

• Employer payroll taxes like FICA, FUTA, and SUTA.
• Contributions to employee benefits like health insurance or retirement plans.
• Paid time off, bonuses, and overtime.
• Fees associated with payroll processing or software.

In other words, salary expense is just one part of payroll expenses. Payroll expenses give you a more complete picture of the total cost of having employees.

Is payroll a liability?

Yes, payroll can be a liability—at least for a short time. A liability is any amount you owe but haven’t paid yet. When you run payroll, you create temporary liabilities, such as:

• Wages earned by employees that haven’t been paid yet.
• Taxes withheld from employees’ paychecks that need to be sent to the IRS or the state.
• Employer taxes that need to be deposited.

Once these payments are made—once you’ve paid your employees and remitted the taxes—they move from liabilities to expenses on your books.

What are payroll expenses for employers?

For employers, payroll expenses include the total cost of paying employees beyond just their wages. This often covers:

• Gross wages: Salaries, hourly pay, overtime, and bonuses.
• Payroll taxes: Employer portions of Social Security and Medicare (FICA), Federal Unemployment Tax (FUTA), State Unemployment Tax (SUTA), and any local taxes like Maine PFML.
• Benefits: Employer contributions to health insurance, retirement plans, or other perks.
• Payroll service fees: Any costs tied to using payroll software or a third-party provider.

These costs add up, which is why tracking them closely is important for managing your budget.

How often should I review my payroll expenses?

It’s a good idea to review payroll expenses every pay period and conduct a deeper analysis at least once per quarter. Regular reviews help you spot errors, track overtime costs, and ensure compliance with tax requirements. For small businesses with tight budgets, this can also help identify opportunities to save money on benefits or scheduling.

What happens if I miscalculate payroll expenses?

Miscalculating payroll expenses can create a chain reaction of problems that hurt both your employees and your business. Even a small error—like forgetting to withhold the correct amount of taxes or miscalculating overtime—can lead to:

• Incorrect paychecks: Employees may be underpaid or overpaid, which can quickly damage trust and morale. Fixing these errors often requires extra time and money.
• Tax penalties: Underpayment or late payment of payroll taxes can trigger fines and interest from the IRS or state tax agencies. These penalties can add up fast.
• Compliance issues: Mistakes in payroll calculations can put you at risk of violating federal and state labor laws, like those covering minimum wage, overtime, and paid leave.

Because payroll is complex and changes frequently with tax laws, many small businesses choose to use payroll software or outsource payroll tasks to experts. These tools and services can automatically calculate withholdings, submit taxes, and generate reports—helping you avoid costly mistakes.

Do payroll expenses affect my business taxes?

Yes. Payroll expenses are generally tax-deductible as a business expense, which means they can lower your taxable income. This includes wages, employer-paid taxes, and benefits. However, you need to ensure proper documentation to claim these deductions.

Final Thoughts

Payroll expenses might seem complicated at first, but understanding the pieces that make up your total cost of paying employees will help you run your business with fewer surprises. From gross pay to employer taxes, benefits, and compliance requirements, each part plays a role in your bottom line.

At Paper Trails, we work with small business owners every day to simplify payroll and HR so they can focus on what they do best—running their business. If you’re ready to make payroll less stressful, reach out to learn how we can help.