The key part of processing payroll is calculating employees’ gross and net pay. Distinguishing between gross and net may not be all that hard—after all, gross pay is nothing more than the total amount earned by the employee before any deductions and net pay is the amount that actually ends up in the employee’s bank account—but there are many different payroll components to consider in the process.
Payroll components are all the different elements related to an employee’s pay that can come up in the payroll process, including the different pay elements as well as payroll deductions that are taken out of the employee’s gross pay to determine net earnings. Although pay elements and deductions can differ from country to country—for instance, there are specific payroll components in the U.S. and in the U.K.—the basic classification remains the same. But what are the different payroll components employers should be aware of?
Let’s start with the different pay elements employers must take into consideration when determining an employee’s gross pay.
The main component of an employee’s pay is his or her salary (or wages, depending on the remuneration model). We basically distinguish between basic salary and gross salary. Basic salary is the amount earned by an employee without considering any additional incentives such as bonuses or benefits and before making any deductions. Gross salary, on the other hand, includes the basic salary plus any bonuses, commissions, etc. (again before any deductions are made). Additional payments to the employee such as 13th and 14th salary also fall under this category.
Overtime is another important payroll component. Additional hours usually have to be compensated at higher rates, which means the amount owed for overtime must be calculated separately (unless, of course, the employee earns a fixed salary and is therefore not entitled to overtime pay). When doing so, employers must distinguish between different types of overtime, i.e. overtime on normal work days during daytime, overtime on normal work days during nighttime, and overtime on weekends and on holidays.
There are various different additional compensation elements which can be added to an employee’s base pay as an incentive. The most common ones are bonuses (e.g. sign-on bonus, annual bonus, or seniority bonus), allowances (e.g. meal allowances, wellness allowances, or home office allowances), commissions, and benefits in kind (BIK), also known as perks or fringe benefits (e.g. company car, gym membership, or private healthcare).
Pay for holidays, vacations, and other paid time off is yet another element to consider when calculating an employee’s gross pay. There are many different types of leave which must be accounted for in the payroll components. The most common ones being sick leave (either in form of employer-paid sick leave or statutory sickness benefits), annual leave, maternity leave, paternity leave, and parental leave.
When employees pay for business-related expenses with their own money, they are usually entitled to reimbursement. Which expenses are covered—and which aren’t—is outlined in the company’s expense policy. Typically covered expenses include transport, accommodation, hospitality, and professional training costs, among others. However, when reimbursing expenses through payroll, employers should make sure the reimbursement doesn't end up being taxable to the employee.
Employer-paid social security contributions don’t constitute a pay element as such—since the money isn’t paid to the employee—but they are an important payroll component nonetheless. The mandatory social contributions for employers vary from country to country and can include payments towards health insurance, pension insurance, accident insurance, unemployment insurance, disability insurance, long-term care insurance, and more.
There can also be voluntary contributions to additional insurance schemes such as life insurance or dental insurance, as well as payments to private pension funds. Employers also shouldn’t forget about accruals (e.g. severance or holiday pay accrual) or other payroll taxes such as skills development levies or insolvency fund payments.
Now that we know the different payroll components that make up an employee’s pay, it’s time to take a look at the different deductions employers must make from their employees’ gross earnings.
One deduction employers have to make in almost every country in the world (except in some rare cases such as Switzerland, where employers are not responsible for withholding income tax at source) is income tax. Depending on the country’s tax system, employers may not only have to consider federal income tax but also state income tax and municipal income tax.
Contributions to the social security system are the second-most important payroll deduction applicable to an employee’s gross pay. Depending on the local social insurance schemes, mandatory contributions may include pension insurance, unemployment insurance, health insurance, long-term care insurance, and more.
In addition to the mandatory deductions, employees can choose to contribute to voluntary insurance schemes and funds. These voluntary contributions can include private health insurance premiums, supplemental pension plans, life insurance premiums, disability insurance premiums, union fees, and more.
In addition to the common payroll deductions that apply to all employees, employers might have to make additional deductions depending on the employee’s personal situation. Examples for additional payroll deductions are wage garnishments (i.e. deductions in connection to credit or civil matters which are carried out by the employer following a court order), student loan repayments, and child support payments.
The Lano Academy is for informational purposes only and should not be construed as legal advice. Lano Software GmbH disclaims any liability for any actions you take or refrain from taking based on the content contained in this article.
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