What is small business payroll?
Payroll is the business operation of paying your employees. It distributes money via cash, check, direct deposit or peer-to-peer payment apps such as Venmo or Zelle. Payroll also involves recording and tracking these payments and paying business taxes on your employees.
Setting up a well-functioning payroll system ensures that employees are paid on time and that your business follows all local, state and federal regulations and laws. In most businesses, an appointed person or team handles payroll for all employees.
Responsibilities for the person who does payroll for a small business include:
- Knowing how to process payments and following all payroll procedures.
- Being the knowledgeable contact person for employees who have questions about payroll.
- Ensuring payments are made on time.
In many businesses, payroll personnel also handle small business bookkeeping tasks such as tracking financial records and transaction and tax payments.
Most small business owners choose to set up payroll for their small business themselves at first. Over time, as the company grows, they may move the responsibility to another team member or outside bookkeeper or accountant.
How to do payroll for small business in 5 steps
For one employee or 50, handling payroll is an essential business task. Take these steps to make it work.
1. Get an employer identification number (EIN) and register as an employer
An EIN is a numeric identifier that the IRS uses to track your tax payments; it’s like your business’s social security number. You can apply for an EIN free on the IRS’s website.
You’ll also need to register with government agencies that collect tax information. Every state has a different process and requirements, so check with your state’s Department of Revenue or Labor.
2. Register with the Electronic Federal Tax Payment System (EFTPS)
To pay your payroll taxes, you’ll need to register with the EFTPS.
This free online service, run by the Department of Treasury, allows you to pay your federal payroll taxes and federal unemployment taxes.
If you’re going to use software that includes a payroll service, the software could automatically send your tax payment for you.
3. Understand the legal requirements of an employer
Before you hire someone, it’s best to know your legal responsibilities as an employer. This includes paying your employees on time, withholding and paying taxes, and more. If you don’t do this correctly, the penalties can be severe.
For example, as a small business, it is critical to make sure all of your business insurance policies are up-to-date and relevant.
Here are a few payroll-related laws you’ll want to familiarize yourself with:
- General payroll requirements (pay stub information, payment frequency, final paychecks etc.)
- Minimum wage laws
- Work hours, breaks and overtime regulations
- Tax withholdings
- Workers’ compensation insurance requirements
Check with your state or local Department of Revenue or Labor for the regulations you need to know
4. Set up payroll services or software
Online payroll services and software for small businesses, such as Quicken or Gusto, can help you stay organized and ensure you’re compliant with all requirements.
What should you look for when choosing the best payroll service for your business? A wide range of features with an intuitive, easy-to-use interface. Helpful software tools can help with tasks like:
- Calculate benefits to limit errors
- Comply with federal standards
- Payroll distribution
- Connect with mobile apps
Prices for software range from tens to hundreds of dollars a month, according to your needs.
5. Collect necessary paperwork from employees
All new employees must fill out IRS documents before they start work. These forms include:
- W-4 form: This indicates how much tax to withhold for each employee.
- I-9 form: This form shows that an employee is eligible to work in the United States.
- Local and state forms: These vary depending on local regulations and requirements.
How to do payroll yourself
Once you’ve set up payroll for your small business, here’s how you pay your employees:
1. Establish a payment method
Decide how you want to pay your employees. Small business payroll is often transferred via direct deposit into an employee’s bank account. If you’ve not already set up a business bank account, you should. This can make tracking expenses, taxes and payments much easier.
2. Figure out a payroll schedule
Know when you’re going to pay. Typically, there are four types of pay schedules, all with advantages and disadvantages:
- Monthly pay periods — 12 paychecks per year
- Semimonthly pay periods — 24 paychecks per year (often the 1st and 15th days)
- Biweekly pay periods — 26 paychecks per year (often every other Friday)
- Weekly pay periods — 52 paychecks per year
Check to see if there are any state laws about your payroll schedule; it may help you decide what’s best for your business.
3. Calculate each employee’s gross salary and withhold income tax
If your employees are paid hourly, it’s important to have an effective time-tracking system. You can use a spreadsheet, payroll software, timesheets, time cards or apps.
To figure out gross pay, multiply the number of hours they’ve worked in a pay period by their hourly rate.
So, say you have biweekly pay periods. You hire Sara at $20/hour, and she works 83 hours in a pay period.
- 80 hours x $20/hour = $1,600
- 3 overtime hours x $30/hour (time and a half) = $90
- Gross salary = $1,690
Gross salary includes bonuses, sick time, vacation time, overtime pay, commissions and tips, so don’t forget to include these pay rates.
You will need to deduct all necessary taxes from the gross salary, including federal income tax, state, local and FICA (Social Security tax and Medicare taxes). You should also deduct health insurance, workers’ comp contributions and anything else standard in your company.
To determine allowances, withholdings and deductions, look at the employee’s W-4 or 1099 forms. You can also use the IRS tax withholding estimator to help you figure out how much to take out.
Once you’ve calculated the deductions, allowances and taxes, subtract them from your employee’s gross pay. What you have left is their net pay or salary. An employee’s net pay is what you transfer to them via direct deposit or check.
4. Pay your employees and update your records
Good payroll record-keeping is essential. You want to have your books in order if there’s a pay discrepancy and come tax time when you need to have this employee information on hand.
Some states have strict pay stub regulations, so keeping accurate records of hours worked, withholdings and wages is critical. Even if your state doesn’t have pay stub requirements, the Fair Labor Standards Act (FLSA) requires employers to maintain records about payments to nonexempt employees.
If you pay your employees electronically via accounting software, many of the calculations and deductions are generated automatically and attached to employee records. If you opt for paper checks, keep track of check numbers and mailing receipts if you use postal mail.
5. Pay payroll taxes and file tax forms
You may think that your small company’s payroll ends after your employees receive their paychecks. Unfortunately, this isn’t the case.
Once you’ve paid your employees, you need to transfer the relevant funds to the appropriate places. You’ll need to transfer funds (for all of your employees together) for:
- Federal tax deposits: Pay your Federal and FICA taxes (Social Security and Medicare) to the IRS via your EFTPS login. To determine which deposit schedule to follow and when deposits are due, check the IRS’ employment tax due dates page.
- State and local tax deposits: Your state may require you to collect and pay state income tax and unemployment tax.
- FUTA tax: Also known as Federal Unemployment Tax Act, these taxes are paid quarterly.
One last step: File your quarterly and yearly tax forms that show the amounts you’ve withdrawn from your employees and documentation of what you’ve transferred to the IRS.
Check the IRS for requirements and exemptions for these tax filings.
