What is a payroll system? A beginner’s guide for 2025

Staying on top of your business payroll allows everyone on your team to get paid the correct amount on time. However, the payroll process can be repetitive, mundane, and time-consuming. The payroll process can also get complicated for companies with many employees. Let’s explore what a payroll system is, how payroll works, and how your business can benefit from a payroll process.

What is a payroll system?

Why are payroll systems important?

How does a payroll system work?

Pros and cons of a payroll system

How to choose a payroll system: 6 features to consider

Next steps for streamlining your payroll process

What is a payroll system?

A payroll system is a software application businesses used to manage and automate the process of paying employees. It calculates employee paychecks, salaries and taxes, tracks hours worked, and issues payments through direct deposit or check.

Most companies will need to set up a payroll system at some point—even if you only have one employee. And while it may not be the most glamorous part of running a business, it’s still essential.

Why are payroll systems important?

Companies can better manage payroll with a system in place. The last thing you want as an employer is for your team to have problems with their paychecks. Employees expect to receive the amount they earn and won't be happy with a late payment or a light paycheck.

Payroll systems are important for several reasons, including:

• Saves time: An employee payroll system can help you streamline the payroll process. Manually adding figures, entering data, and calculating taxes can be extremely time-consuming. A payroll system allows you to spend less time on payroll and more time running your business. Based on an Intuit survey in February 2023, respondents save an average of 2.56 hours per pay period and 3.93 hours per week using Quickbooks payroll software.
• Boosts employee satisfaction: Your employees want to receive the wages they’re due on payday. As an employer, even making a single mistake with a paycheck can be damaging. If a paycheck arrives in an employee’s bank account late, this can prevent them from paying bills and hurt their trust in the company. A paycheck system helps to ensure employees get the correct amount on time.
• Complies with bookkeeping requirements: A payroll system automatically generates detailed reports, including pay stubs, tax documents (such as W-2s and 1099s), and year-end summaries. These records help your business stay compliant with the Fair Labor Standards Act (FSLA) and IRS regulations while making it easier to reconcile payroll expenses with financial statements. If you don’t maintain accurate payroll records, you could face penalties, fines, and legal issues.
• Withholds taxes and calculates wages: Payroll taxes can get complicated fast. A payroll system automatically withholds federal, state, and local taxes, plus Social Security, Medicare, and unemployment taxes. It also calculates overtime, bonuses, and deductions for benefits like health insurance or retirement plans. Without automation, it’s easy to miscalculate, which could lead to IRS fines or unhappy employees questioning their paychecks.

As long as you have at least one employee, a payroll system is necessary. But who handles it? That depends on the size of your business.

For small businesses, payroll usually falls on the owner or a trusted team member with the help of basic software. As companies grow, payroll responsibilities typically shift to the finance or HR department. Larger companies might have a dedicated payroll team or even outsource the entire process to a payroll provider.

How a payroll system helps employees

A good payroll system also benefits employees in multiple ways, including:

• Timely, accurate payments: No one wants to deal with a late or incorrect paycheck. Automated payroll systems help make sure employees get paid accurately and on schedule. That’s especially important considering nearly half (49.15%) of workers say they’d struggle to pay their bills if their paycheck was delayed by just a week, according to the 2024 Getting Paid in America survey by Payroll.org.
• Transparency in pay and benefits: Many payroll systems come with employee self-service portals, so your workers can check their pay stubs, tax deductions, and benefits anytime. According to the survey, 84% of employees have access to an online payroll portal, making it easier to track earnings and deductions without constantly reaching out to HR. 
• Taxes are automatically withheld: No one wants a tax nightmare at the end of the year. A payroll system makes sure the right amount is withheld for taxes, Social Security, and benefits so employees don’t have to stress about it. In fact, nearly 60% of workers feel confident that their paycheck withholdings are accurate each payday.
• Supports direct deposit: Nearly 92% of respondents reported receiving their wages via direct deposit, making it the most popular and convenient payment method. A good payroll system makes sure everything runs smoothly, so employees don’t have to deal with lost checks, delays, or extra trips to the bank.

How does a payroll system work?

Running payroll is the process of paying employees for their work. Every pay period, an employer calculates and distributes employees’ wages. The employer is responsible for accurately adding up the hours an employee worked and calculating their gross wages.

Employers must also deduct local and federal taxes, Social Security, unemployment insurance, and more. Then the company must disburse paychecks to employees on payday. As you can imagine, this process can get messy quickly.

One reason payroll can be complex is that employees are paid in different ways, depending on their role and industry. The four main types of pay structures are:

• Hourly: Employees get paid for the exact hours they work. This is common in jobs like retail, restaurants, and customer service, where hours can vary from week to week.
• Salary: Employees earn a set annual amount, usually broken into regular paychecks (weekly, biweekly, or monthly). You’ll see this most in office jobs, management positions, and corporate roles.
• Commission: Pay is based on performance, usually tied to sales. This structure is common in industries like real estate, recruiting, and sales, where earnings depend on deals closed or targets met.
• Piece rate: Instead of hourly or salary pay, employees earn money per task or unit completed. This is common for factory workers assembling products, freelance writers paid per article, or gig workers completing specific jobs.

For time and convenience, most business owners find ways to avoid running payroll themselves. They set up an in-house payroll system or outsource payroll to a different company. 

Types of payroll systems

There are four key types of payroll systems:

Each payroll system has its own advantages and challenges, so choosing the right one depends on your business size, budget, and payroll complexity.

The phases of payroll

When it comes to knowing how to process payroll, there are several key steps you need to follow to ensure you pay your employees accurately and on time, as well as stay compliant with tax laws. Here’s a breakdown of the phases of payroll:

Pros and cons of a payroll system

Payroll software and systems offer unique advantages over other payroll solutions. Here are several benefits of these particular payroll services:

• Saves money: Pricing is one of the most important considerations for many small business owners. Hiring in-house payroll managers or an accountant can be expensive. You’ll have to pay for salaries, benefits, PTO, etc. However, with a payroll provider, you typically pay a flat monthly fee, making it a cost-effective option in the long run.
• Minimizes errors: Some businesses rely on Excel spreadsheets for payroll, which can work for small teams, but as payroll gets more complex, so does the risk of errors. These mistakes can result in employee dissatisfaction or tax noncompliance. Payroll software can complete complex calculations quickly, saving you time and minimizing the chance of human error. Many payroll companies even offer penalty protection in case you incur a tax penalty.
• Access anywhere: Almost every payroll provider has a website or mobile app, so you can access payroll data no matter where you are. Many also offer employee self-service portals that allow your workers to track their hours and view HR data on the go.
• Secure data: Payroll involves highly sensitive information, including Social Security numbers, bank account details, and tax records. A good payroll system adds an extra layer of protection by encrypting data, restricting access, and keeping businesses compliant with privacy laws like General Data Protection Regulation (GDPR). That means less risk of fraud, data breaches, or costly fines, as well as more peace of mind for you and your employees.

Pains of a payroll system (and how to avoid them)

Despite the benefits of a payroll system, it does come with certain pain points you’ll want to consider:

• Inaccurate calculations: Your paycheck system is only as good as the inputs you enter. If you enter the wrong information, the systems' calculations will be wrong. To avoid this, double-check your entries.
• Compliance: While an employee payroll system can help keep you on the right track, it’s important to ensure you’re paying the right payroll tax rates and on the right payment schedule. You can improve this step by setting reminders and automating as much of the process as possible. Don’t forget to stay up-to-date on any legal or tax regulation changes.
• Growth limitations: If you have a growing business, you may outgrow your initial or current payroll system. You can avoid switching systems by starting with infrastructure that can expand as your workforce does
• Different pay rates: Handling various pay structures (e.g., hourly, salaried, commission-based, and piece-rate) can complicate payroll quickly. For instance, industries like construction typically employ a mix of full-time, part-time, and contract workers, and they each have distinct pay rates and compliance requirements. That’s why it’s important to use a flexible payroll system that can handle multiple pay types, tax rates, and classifications automatically. 

A little research and due diligence can help you avoid these pain points. Choose a system that will help you today but can also scale to meet your future needs.

How to choose a payroll system: 6 features to consider

The right payroll system can make life a lot easier. It saves time, prevents mistakes, and keeps your business on the right side of tax laws. Here are some key features to look for:

Automation

Automation is a great way to streamline your payroll—making it easier to manage. Automated payroll systems can cover payment processing, tax calculations, and report generation tasks.

When you use payroll software, you can automate most aspects of the payroll process. In this case, you’ll just have to do some initial setup, then you can run online payroll in a matter of clicks each pay period.

Automated payroll systems tend to be more secure and accurate than manual systems. They come with encryption technology and built-in calculators to prevent breaches and errors.

Tax compliance

One of the most difficult parts of processing payroll is accounting for tax withholdings. Each pay period, you deduct payroll taxes, federal and local taxes, Social Security, Medicare, and state unemployment taxes.

Failing to account for employment tax deductions can land your company in trouble with the IRS. A solid employee payroll system will make any necessary tax deductions or garnishments so that your company stays compliant.

Time tracking

Time tracking can be a game-changer for businesses—both big and small. A time tracking system ensures employee hours are accurate. It also helps boost productivity and saves time.

When you have a payroll system with time tracking, you can embrace a variety of tools, like mobile apps and punch-in clocks. You can ensure there’s a time-tracking system for everyone.

Beyond time tracking for payroll, such features can also help monitor employee performance, boosting efficiency.

Attendance tracking

Beyond tracking work hours, attendance tracking can help your business manage PTO, sick leave, and vacation days. Instead of keeping track with spreadsheets, a payroll system with attendance tracking makes it easy to see who’s working, who’s off, and how much leave employees have left.

Some systems even sync with scheduling software, so you can spot patterns in absenteeism and adjust staffing as needed.

Payroll reporting

A good payroll system also provides detailed payroll reports that help businesses track expenses and maintain compliance. These reports can break down total payroll costs, tax withholdings, overtime expenses, and employee deductions. Many payroll systems generate reports automatically, so it makes it easier for you to analyze payroll trends, budget for labor costs, and stay audit-ready.

Business size and industry

The best payroll solution for your business also depends on the size of your team and the industry you’re in.

Small businesses may prefer a simple, cost-effective payroll system that handles basic pay processing and tax filing.

Mid-sized and large businesses often need more advanced payroll features, like customizable reporting, benefits management, and multi-location payroll processing.

Industries with different pay structures—like construction, retail, or commission-based businesses—should look for payroll systems that support various pay types (hourly, salary, commission, and piece-rate).

At the end of the day, the best payroll system is one that fits your business, grows with you, and makes payroll as painless as possible.

Next steps for streamlining your payroll process

If you run a small business—or any business—setting up a payroll system is essential. A payroll system makes it easy to accurately compensate your team on time. And these days, more and more companies are beginning to automate the payroll process.

With payroll software like QuickBooks, you save time and minimize errors at an affordable price. You can set up auto payroll to run each pay period—and get automatic payroll tax filing and free direct deposit services.