Payroll costs are all the expenses involved in labor compensation and employers’ tax, administration, and other obligations. Here’s the scoop.

Payroll costs are all the costs that an organization needs to pay to compensate its employees for their labor. These costs include, but go beyond, wages and salaries. Also included in payroll costs are employee benefits, paid time off, bonuses, commissions, the employer-paid portion of payroll taxes, and the cost of administering the payroll process.
For many businesses, the cost of payroll is one of the largest, if not the largest, category of expenses. This is especially true for service businesses. In general, payroll costs for a midsize company can account for up to 70% of the total costs of the business.¹
This article will break down payroll costs and expenses to help provide insight into all the components of labor costs. This knowledge will help employers and Human Resources professionals manage their payroll costs, increase efficiencies, and make informed personnel decisions.
Types of payroll expenses
There’s a range of types of payroll expenses for employers to understand, consider, and manage. These costs typically include total employee compensation, the employer’s portion of payroll taxes, administrative expenses, and more. Payroll costs can be categorized as direct or indirect.
Direct costs are payments or benefits provided directly to employees or contractors. Indirect costs include taxes and the expenses involved in payroll administration.
Direct payroll costs
Direct payroll costs are payments or benefits provided directly to employees. These include:
Wages for hourly workers
Hourly wages are calculated as a worker’s hourly rate multiplied by the number of regular (not overtime) hours worked. Overtime for covered, nonexempt employees must be paid as mandated by federal and state laws and the Fair Labor Standards Act (FLSA). Depending on the state and the number of hours worked, this may be 1.5 or 2 times the worker’s hourly rate.
Salaries
Salaried workers earn a fixed income for each pay period. Typically they are exempt from overtime requirements. Some salaried employees, however, may be nonexempt and entitled to earn overtime pay as well.
Employee benefits
If employees pay part of the costs of any of their benefits, when you calculate your company’s payroll costs, include only the portion that the employer contributes. Employee benefits may include:
- Health, dental, vision, life, and disability insurance.
- Paid time off, including vacations and sick days.
- Retirement plans, including 401(k), savings, and pension.
- Health insurance for after retirement.
Bonuses
Recurring or one-time bonuses paid to workers are also part of your payroll expenses.
Indirect payroll costs
Employers incur additional expenses for other responsibilities.
Payroll taxes
Employers have to pay certain taxes based on their employees’ gross pay:
- Medicare and Social Security taxes which, together, are called FICA taxes. The employer’s portion of FICA is currently 6.75% of the worker’s wages or salary.
- Federal and state unemployment taxes. The federal unemployment tax rate is currently 6% of each employee’s first $7,000 of gross income per year. But the total amount you will pay for unemployment taxes varies by state.
Employers only have to pay FICA and unemployment taxes for their employees, not for independent contractors.
Administrative costs
Whether you do your payroll processing in-house or you use a third-party payroll provider, administrative costs can be significant. Some of the steps involved in processing payroll by any given payroll solution include:
- Calculating gross pay for each employee.
- Calculating net pay by deducting federal and state income tax, the employee’s portion of FICA, and the employee’s contribution to health insurance premiums, retirement plans, and other benefits.
- Depositing tax withholdings.
- Accurately completing payroll tax forms; sending W-2s to employees and 1099s to contractors.
- Posting journal entries for accrued payroll, accrued payroll in cash, and income taxes withheld.
- Delivering pay to employees, whether by paper checks or by direct deposit.
Labor and payroll records must be maintained as required by the FLSA and other official regulations. All of these steps must be done correctly to avoid penalties. Payroll outsourcing or payroll processing software are good options to help ensure accuracy and reduce administrative burden on in-house staff. If you do use a payroll services company, be sure to include its fees in your total payroll cost. If you use payroll software, include the purchase or subscription costs along with costs for training your employees to use it.
Payroll services companies generally charge a base fee plus an additional cost per employee. For small businesses, payroll providers’ base fees typically range from about $30 to $150 or more, and the fee per employee per pay period from about $2 to $15. Additional services will generate additional cost.
Strategies for managing payroll costs
Payroll costs are significant overall and are often a company’s top expense. Employers and HR professionals should manage these costs carefully. The initial step is to become informed about what your total payroll costs are. Then you can look for ways to make your payroll spending more efficient. These may include:
- Managing staffing requirements to reduce the need for employees to work overtime.
- Determining if it would be more cost-effective to handle payroll administration in-house or by outsourcing payroll to a payroll company.
- If planning to use an outside provider, shopping around to find the one who offers the best price for the services and quality your company needs. For some businesses, this may mean switching payroll companies after reevaluating their current service.
- Improving employee morale to reduce the expenses caused by employee turnover.
Understanding your overall payroll costs is key to being able to identify areas that could be streamlined or otherwise improved. For additional tips, tools, and resources to help further your pursuit of HR and business success, count on Workest daily.
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