Can someone tell me how the service items work in timesheets/payroll? What is their purpose?

Timesheets are not strictly for Employees and Payroll. A vendor can be paid from a timesheet. The Service Item would be the item you have set up when the Vendor Bills you. For instance: you hire a painting contractor who bills by the hour. When you enter the Vendor Bill, you use the Painting item from your item list. If you use a Time tracking program (like TSheets) or create a Timesheet in QB for your painter, you would enter his daily hours using the Service Item (Painting) instead of a Payroll Item.

So you would use either payroll items or service items but not both together then?

They can be used together or separately.

An example of using together: Your business provides landscaping services - lawn care is one of the Services provided and you have set up Lawn Care in your Item List. 

Lawn Care is performed by your own employee who is paid hourly. On the employee timesheet, you would select Lawn Care as the Service Item and Hourly as the Payroll Item. The info is transferred to the paycheque.

Used Separately:

Lawn Care is performed by a subcontractor (Vendor) also paid by the hour. In this case, on the Vendor timesheet you would select Lawn Care as the Service Item. Because the Vendor is not an employee, NO payroll item would be used. The Vendor can now be paid using the Timesheet data.

Ok. Thank you. I've never known that we could use timesheets for vendors. I may have to explore that as we do hire mechanics that are paid by the hour.