Many small businesses start as a “one-person show,” but as you continue to grow and develop, you will inevitably hire your first employee. While this is an exciting step in any business, it can come with several legitimate concerns — one of these is payroll.
Every business owner asks themselves, "Should I outsource payroll or do it in-house?" For some, getting one more task off their plate is immeasurable, and they’ll gladly hire an accountant or bookkeeper to help. On the other hand, some entrepreneurs watching every penny may prefer the “do-it-yourself” method to save money.
Either way, having an effective payroll system for small businesses is critical. In this post, we will discuss how to do your own payroll. If you decide to do payroll on your own, it is important to consult a professional to make sure that you are following local, state and federal laws.
What is payroll?
Payroll is the process of paying your employees. It typically involves distributing money via cash, checks, direct deposit and even P2P payment apps. It’s also recording these payments and paying taxes for employees.
Payroll may even relate to a specific department within the company. When people say they’re “doing payroll” or need to “run payroll,” they usually mean processing payments or calculating payroll taxes.
Setting up a well-functioning payroll system ensures that you pay employees on time and follow all regulations and laws. We recommend that a specific person handles payroll for all employees.
This can be you, the business owner, or another employee that you trust within your business. Responsibilities for this person include:
- Knowing how to do payroll and following the payroll process
- Being a contact person for other employees regarding payroll
- Ensuring payments are made on time
This person will also handle small business bookkeeping in many cases. They need to keep accurate payroll records and tax payment information.
Most small business owners choose to set up payroll for their small business themselves at first. Over time, as the company grows, they will often move the responsibility to another team member.
How to set up payroll for small business in 5 steps
There are several steps to ensuring that your payroll is set up correctly and effectively for your small business. It doesn’t matter if you are doing payroll for one employee or 50; these steps are essential.
1. Get an employer identification number (EIN) and register as an employer
You may have already gotten an EIN when you first started your business. If so, you can move to the next step.
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)
Back in the day, you’d need to do a lot of paperwork to pay your payroll taxes. Now, you can do them from your laptop in your pajamas if you 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, you might be able to skip this step too. The software will send your tax payment for you. We’ll talk about this more in a bit.
3. Understand your legal requirements
Before you hire someone, it's best to know your legal responsibilities as an employer, right? This includes paying your employees on time, withholding and paying the appropriate 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. Did you know that having workers’ compensation insurance is required in most states?
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’ comp insurance requirements
Check with your state or local Department of Revenue or Labor for what your requirements are so you don't’ find yourself accidentally breaking laws.
4. Setup payroll software
These days there are many online payroll services for small businesses available such as Quicken or Gusto. While you can calculate payroll with a spreadsheet, using payroll software can help you stay organized and ensure you are taking care of all requirements.
What should you look for when choosing the best online payroll service for your business? The best payroll solutions for small businesses balance a wide range of features with an intuitive, easy-to-use user interface.
Most software will calculate benefits for you to limit the chances of mistakes, comply with federal standards, payroll distribution, mobile apps and more. Prices for software range from several to hundreds of dollars a month, according to your needs.
5. Collect necessary paperwork from employees
All new employees must fill out certain documents required by the IRS. It’s important to have employees handle this paperwork before they begin working.
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: Depending on local regulations and requirements
New hires should also fill out relevant details for payment (i.e., bank account for direct deposit, etc.).
How to process payroll for employees manually
Once you’ve set up the payroll system for your small business, it’s time to pay those employees. We'll outline the basic manual payroll steps for you here
1. Establishing a payment method
First, you’ll have to decide how you want to pay your employee’s paychecks. Small business payroll is often transferred via direct deposit into the employee’s bank account. If you haven’t already set up a business bank account, this can make tracking expenses, taxes and payments much easier.
2. Figure out a payroll schedule
Aside from how you’re going to pay, when you’re going to pay is important. Typically, there are four types of pay schedules, all with advantages and disadvantages:
- Monthly pay periods (paychecks per year): 12
- Semimonthly pay periods: 24 (often the 1st and 15th days)
- Biweekly pay periods: 26 (usually every other Friday)
- Weekly pay periods: 52
Also, look up 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 the allowances, withholdings and deductions, you need to 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 recordkeeping 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 any 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 the EFTPS login you set up earlier. 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: you need to file your quarterly and yearly tax forms, showing the amounts you’ve withdrawn from your employees and documentation of the amount you’ve transferred to the IRS.
- File IRS form 941: The employer's quarterly federal tax return is due on the last day of the month at the end of a quarter. (April 30, July 31, October 31, and January 31)
- File IRS form 940: The employer’s annual federal unemployment (FUTA) tax return is due on January 21 and covers the previous tax year.
Check the IRS for requirements and exemptions for these tax filings. You may not need to do these in specific circumstances, such as having household employees or paying less than $1,500 in employee wages during the year.
Should you do your own payroll?
While some small businesses decide to outsource the work, it is certainly possible to keep it in-house and save some of your hard-earned money. After all, you don’t necessarily have to do your own payroll manually as described in this post — there are affordable payroll software options that can take care of the heavy-lifting once set up.
Growing your company can be exciting and overwhelming. There are multiple challenges that small businesses have to deal with when expanding. Payroll can seem overwhelming and time-consuming at first, but there are many payroll providers for small businesses, making the process easier.
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