Many business owners dread the thought of doing payroll because it can be a complex and exacting challenge. You might want to do it yourself rather than hire a third party, however, if you have only a couple of employees. It's doable if you take some basic steps, understand what you're getting into, and pay attention to detail.
- Before you begin the payroll process, you'll need to register with federal, state, and local tax agencies.
- To do payroll, calculate the pay rate, then withhold taxes and other deductions to get a net pay amount for each employee.
- The final part of the payroll process is reporting and paying payroll taxes to all taxing agencies.
- To make the process easier, you may want to use online payroll software or a payroll service.
Steps in the Payroll Process
The payroll process includes three basic steps:
- Preparation: Prepare for payroll calculation and processing, and decide who will do all the payroll tasks before you begin to hire employees.
- Paying employees: Set up a system to calculate employees' pay, to write paychecks, and to distribute them.
- Post-payment: Set aside money for taxes, make tax payments, and send payroll reports to the Internal Revenue Service (IRS), the Social Security Administration (SSA), and state and local tax entities at the correct times after you've paid your employees.
Before You Hire and Pay Employees
You'll need to make some decisions on paying employees in order to write paychecks. How often will you pay? What about paid time off? Will you pay overtime?
Find out about all the federal, state, and local employment laws, because they affect the amount you pay employees and check with an employment attorney to make sure you are following all the laws.
Decide on an Accounting System
Collect Paperwork New Hires Must Sign
Each new employee must complete certain paperwork as part of the onboarding process. You must be certain that the new hire forms and applications are completed and filed. These include:
- An IRS W-4 Form to designate withholding
- An application form
- An I-9 Form to show eligibility to work in the United States
- State and local tax withholding election documents
Set Up Direct Deposit for Paychecks
Contact your bank to find out how their direct deposit system works. You'll also need to get authorization from each employee and information about their checking accounts, such as account numbers and routing numbers.
Set Up a Separate Payroll Account
Set up a separate bank account for writing paychecks or paying through employee direct deposit. You'll also need this account for depositing funds you collected from employees for federal and state income tax and for Social Security and Medicare taxes (referred to as FICA taxes) and other amounts.
A separate payroll account can help you keep track of these transactions without getting them mixed up with your general business bank account.
Get an Employer Identification Number
An employer identification number (EIN) is effectively a Social Security number for businesses for federal tax purposes. You'll need one if you're going to have employees. Contact the IRS and they'll assign one to you, or you can apply online.
Pay your employees according to the pay periods you've decided upon. This involves figuring out how much they're each owed, and subtracting withholding and other deductions from their pay.
- Calculate employee pay: Calculate the gross pay amount for each employee. This is the total amount you owe the employee based on hours worked and the hourly rate or the total for the pay period for salaried employees.
- Calculate withholding and deductions: You'll use the gross pay amount to calculate withholding for federal, state, and any local income taxes. Calculate the deduction for FICA taxes, as well as for deductions like health plans and retirement plan contributions. The IRS offers a helpful online tool to walk you through this step by step.
- Write paychecks: Write paychecks and distribute them to the employees, or send them by direct deposit.
- Get totals for payroll tax deposits: Get totals for all employees for gross pay, federal, state, and local withholding, FICA taxes, and any other deductions. You'll need these amounts for your payroll tax deposits and reports.
These steps apply specifically to employees. You don't have to withhold taxes for individuals who work for you as independent contractors. The Equal Employment Opportunity Commission (EEOC) provides a comprehensive guide for who's an employee and who's an independent contractor, and it explains all the rules.
After You've Paid Employees
You must make certain payroll tax deposits to the IRS and state and local agencies for amounts you have taken out of employee paychecks:
- The amounts you withheld from employee pay for federal and state income taxes
- The amounts you deducted from employee pay for Social Security and Medicare
- The amounts you owe as an employer for Social Security and Medicare
You can make your payroll tax deposit payments using the IRS's electronic federal tax payment system (EFTPS).
Other Payroll Tax Deposits
You must make payments for federal unemployment tax on a regular basis in addition to federal withholding and Social Security/Medicare deduction payments. You must also make payroll tax deposits to your state, and possibly your locality, in addition to federal payroll tax deposits.
Payroll Tax Reporting
Businesses are required to submit certain payroll tax reports on a regular basis:
- Quarterly reports to the IRS on Form 941 showing the amount of your payroll tax liability and the amounts you've paid on this liability during the previous quarter
- Annual unemployment tax reports to the IRS on Form 940 showing the amount of your unemployment tax liability and the amounts you have paid on this liability
- Reports to state and local taxing agencies
Create a Payroll Register
Create and maintain a payroll register to keep track of all payroll information for each employee. Most online accounting systems these as part of their package of reports. You'll need this information for year-end payroll totals and reports.
Create a Yearly Tax Calendar
Creating and maintaining a month-by-month payroll tax calendar, either on your accounting/payroll software or manually, will help you keep track of all those payroll tax dates during the year. Add in your state's payroll tax dates for a complete calendar.
Getting Help With Payroll
Even if you decide to do payroll and payroll tax processing yourself, you'll need to have a licensed tax professional to oversee the process. Payroll processing is complex and taxes and laws are always changing, and each tax year is different in some way.
Frequently Asked Questions (FAQs)
How long do you have to keep payroll records?
You must follow federal and state requirements for keeping payroll records. Federal agencies have different requirements for length of time and what records to keep.
The IRS, for example, requires that all payroll forms and pay and benefit information must be kept for four years. The Department of Labor (DOL) requires employers to keep records on employee pay rate, hours worked, and overtime worked for at least three years.
For state recordkeeping requirements, see the website of the workforce agency for your state.
How do you do payroll for 1099 employees?
IRS Form 1099-NEC is is used to report payments to non-employees, including independent contractors, freelancers, and others who provide services to your business. You must file this report if you paid someone more than $600 a year, for federal income tax purposes. There is usually no withholding to report, unless the person is subject to backup withholding.
How much does it cost to have someone do your payroll?
You might want to use a payroll service instead of doing payroll yourself. Online services charge on a monthly basis, with a base price and an additional amount per employee. You may also pay a higher price if you want more tech support or additional services.
Another option is an offline service through a payroll company. They give more personal service, which is also based on the number of employees. Fees usually include processing the payroll, collecting the taxes due, and preparing reports for taxing agencies,