Payroll reconciliation is the key to maintaining accurate records of employee wages, withholdings, and other key pieces of tax information. Like many finance-related tasks, it’s a tedious yet crucial part of running a small business. In this post, we’re going to lessen the burden for you by breaking the process down into six simple steps.
What is payroll reconciliation?
If you own or manage a small business, then you probably understand what payroll is and how to manage it each pay period. But what exactly is payroll reconciliation?
In finance, reconciliation is the process of making sure two records of the same event are accurate and match each other. In the context of payroll, this means you’re ensuring that your ledger matches what you pay out to employees -- the books need to reflect both what the employee actually receives plus everything you deduct from each employee’s paycheck.
Put off payroll reconciliation, and you’ll have a ton of piled up work waiting for you when it comes time to submit your periodic tax deposits and tax forms. Get it wrong, and you risk hefty fines. Read on to learn how to manage payroll reconciliation throughout the year and avoid those negative outcomes.
How to reconcile payroll in 6 easy steps
Payroll reconciliation may seem like a mammoth task with lots of moving parts, but the good news is that you can (and should) make it more manageable by spreading the work out. You’ll start the process each pay period before wages are paid out and then perform further reconciliation at different times throughout the year. Below, we’ve broken the steps down over a simple timeline. Keep in mind that while these are the high-level tasks you need to accomplish for payroll reconciliation, there are additional rules to consider and potential variations for your process. We recommend consulting with a professional to get advice specific to your business.
At the end of each payroll period
Step 1: Make sure your payroll register accurately reflects wages and hours
You need to reconcile payroll each pay period before checks actually go out, as it’s much harder to correct any mistakes once people have gotten paid. The first step is to make sure everyone is getting paid the right amount.
At a high level, there are three documents you need to make sure are in alignment:
Your payroll register: This is the document you’ll use to run payroll. It should show employees’ total hours, pay, and deductions for the pay period.
Your time and attendance data: This refers to the records you’re keeping in real time throughout the pay period of the hours each employee has worked.
Employee pay rates: This is your record of each employee’s hourly pay rate. If you use a payroll or accounting software, every position in your company should have an entry you can pull this from. If not, you need to maintain these records manually.
You need to make sure that each employee’s total pay on the payroll register equals their pay rate multiplied by the number of hours worked. If you have more than, say, 20 employees, it may not be realistic to check each employee individually. In that case, we would recommend double checking records for new employees or for anyone who recently received a raise, as that’s where mistakes are most likely to occur. Beyond that, you can also spot check different employees each pay period to confirm wages are correct in a manageable way.
The amount of time and effort required for this step depends greatly on the tools you use to track time and attendance. If you use paper timesheets or a punch card time clock, you’ll need to confirm time and attendance manually, which can be an hours-long process. If you use a more advanced workforce management software that automatically tracks and records employee hours, you’ll be able to get this step done much faster.
Step 2: Confirm you’ve deducted the right amount from each employee’s paycheck
The next step is to verify that you’ve deducted the correct amount from every paycheck. These deductions can include, among others:
Federal and state income taxes
Social security payments
Retirement benefits (e.g. 401k deductions)
Workers’ compensation insurance
You can refer back to each employee’s W-4 form to double check their exemptions, which you can then compare to the IRS withholding tables to determine how much you should withhold for federal income taxes. You should also check your state’s withholding tables for state income taxes, which can be found on your state’s Department of Revenue website. Social security and Medicare withholdings are a static rate, so you only need to spot check them once in a while to make sure you’re calculating them correctly. Other deductions like health insurance, retirement benefits, workers’ compensation insurance rates, and wage garnishments should be in each employee’s profile in your accounting software, or in records you maintain yourself. We’re going to focus on federal income taxes for the remainder of this article, but it’s important you realize that there are plenty of other deductions, many of which vary by state.
Once you’ve reviewed those figures, make sure the deductions are reflected in each employee’s paycheck. The final payment amount for each check needs to equal their total pay minus the total of all those deductions. You also need to include an itemized summary of how much was deducted for each type of tax.
Step 3: Record everything in your general ledger
Finally, make sure you update your general ledger to reflect payroll reconciliation every pay period. Total wages paid out should be entered as a debit, while each deduction should be entered as a credit.
If you use a software like Quickbooks Desktop that maintains your books in addition to running payroll, you can skip this step. But many providers don’t do that. Most of them, however, will give you the option to download the data you need from each payroll period so that you can quickly insert it into your ledger. If your provider doesn’t give you that option, you’ll need to enter the data manually.
When you make your monthly or semi-weekly payroll tax deposits
Step 4: Run your payroll tax reports before making your periodic tax payments
You’ll need to make periodic deposits toward your payroll taxes throughout the year, either every month or every two weeks. The exact schedule depends on the size of your business’ total tax liability. Generally speaking, you’re on a monthly schedule if you pay $50,000 or less in payroll taxes each year, and semi-weekly if you pay more than that. The IRS provides more information here. You should check with your state tax authority to learn what the deposit schedule is for your state, though most will require monthly deposits for the majority of businesses.
Regardless of the exact schedule, you’ll be thankful you did payroll reconciliation so dutifully each pay period come deposit time. Before you pay your taxes, look back at your ledger entries and add up all your employee deductions to confirm you’re paying the right amount.
When you file your quarterly tax returns
Step 5: Run your payroll tax reports before making your periodic tax payments
At the end of each quarter, you’ll file Form 941 to report to the IRS how much you withheld from your employees’ paychecks that quarter to cover income taxes, Social Security, and Medicare. Once again, you’ll need to go back to the ledger. Add up all your employee deductions for the previous quarter, make sure the sum matches what you paid in deposits over that time period, and write the total on the form.
At the end of the year
Step 6: Prepare and reconcile your W-2 forms
At the end of the year, you need to prepare a W-2 form for each employee showing them their total wages and deductions for that year. You then send your W-2s to the Social Security Administration, along with a W-3 form that aggregates wages and deductions for all your employees over the past year. Think of the W-3 as the sum of all the numbers in the W-2s.
As part of this process, you need to ensure each W-2 is correct by comparing it to the previous year’s payroll data. Once again, you’ll be glad you were diligent about payroll reconciliation throughout the year. Pull up your annual payroll register summarizing all the payroll reconciliation data from the previous year for each employee, and make sure the wage and deduction amounts match what’s on each W-2 and the W-3. You should double check your work by also comparing these documents to the totals on the forms associated with each of your monthly or semi-weekly deposits.
It’s a lot to keep straight. But, to summarize, wages and deductions should match on all of the following at the end of the year:
Your W-3 form
The sum of all your employee’s W-2 forms
The sum of your periodic tax deposit forms (monthly or semi-weekly depending on the size of your total tax liability)
The sum of your quarterly 941 forms
If any of those don’t match, you’ll have a big problem. But if you’re diligent about reconciling payroll with each pay period and tax deposit, the year-end process should be a breeze.
Consistency pays off
Payroll reconciliation is complex, and encompasses several different types of deductions we didn’t cover in-depth here, such as health insurance, retirement benefits, wage garnishments, and more. You should consider contacting a professional to understand what the process looks like for your specific business.
But if you take away one thing from this article, it should be this: Keeping up with payroll reconciliation throughout the year is the best way to ensure you’re paying the correct amount in taxes. Your diligence will save you untold amounts of time, money, and stress, so take the time now to get organized. As your business grows, you can save yourself even more time by investing in software products to automate many of these processes.