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How Payroll Systems Work


Payroll Services
Payroll systems produce checks for a company's employees, who will receive payslips like this one.
Payroll systems produce checks for a company's employees, who will receive payslips like this one.
­iStockphoto/­MJHollinshead

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A payroll service is an outside company that special­izes in every aspect of the payroll process. The first such service in the United States, Automated Payrolls, was founded in 1949 and relied on primitive technology like electro-mechanical calculators and something called the Comptometer bookkeeping machine [source: Reynolds]. Automated Payrolls grew to become Automated Data Processing (ADP), one of the largest business outsourcing services in the world.

A basic payroll service will collect wage and hour information from the employer and use that information to calculate gross wages, subtract all pertinent withholdings and deductions, print checks, make direct deposits and prepare all employment tax filings. The service will also mail out W-2 and 1099 forms and resolve any inquiries from the IRS or other government agency.

Some payroll services offer more comprehensive help. They can take over some of the responsibilities typically handled internally by human resources, like administrating a company's retirement accounts and benefits programs. They can file new employee forms with the state and help comply with any court-ordered wage garnishment programs. Some payroll services even offer a free phone help line for any questions related to human resources or payroll.

The Internet has made payroll services even more convenient. In the past, an employer had to call the payroll service with information about wages and hours for the upcoming paychecks. Now the employer is provided with a Web-based payroll account that he can update 24/7. All he has to do is log on to the system, punch in the hours for the pay period and the data is updated in real time. Payroll services keep record of all payroll information and make all of this data available online through reports, payment histories and other features.

The cost of payroll services depends on several factors, namely the number of employees, the number of pay periods every month, and the level of comprehensive service of the services required. If a company with 10 employees pays its workers twice a month, it can expect to pay around $50 each pay period, or $100 a month, for basic payroll services. The same company can pay up to $200 a month for upgraded services like online reporting, direct deposit and phone help. In general, costs are calculated per employee and per check [source: ADP].

The biggest advantage of a payroll service is that takes all payroll responsibilities away from the business owner, allowing him to focus on other aspects of running the business. The downside is that a payroll service can get expensive, especially as a company adds more and more employees.

A good compromise between expensive payroll services and time-consuming manual bookkeeping is payroll software, which we'll talk more about in the next section.