Many business owners consult with an accountant, bookkeeper or tax professional on how to set up their payroll process. Some people choose payroll software to help them manage their small business payroll and payroll tax.
The bottom line: Whether you plan to run payroll yourself, hire a financial expert or use a payroll service, you may need help understanding what federal, state and local laws apply. You should also be aware of deadlines and the expensive penalties, interest and fines that come with mistakes.
How Payroll Processing Works: An Overview
When you hire employees, you must pay them for their work and withhold the related small business payroll taxes each pay period.
Running payroll is complex. It requires collecting important tax forms and tracking employee hours, including overtime, vacation time, and sick time. You need to calculate employee pay and distribute paychecks. You are also responsible for calculating, filing, and paying employee and employer taxes.
We’ll walk you through the main steps here. Or you can choose a payroll service for small business like SurePayroll® By Paychex to help you automate this important task.
7 Steps to Run Payroll
Step 1: Prepare to Process Payroll
It’s easier to set up payroll once you’ve made key decisions and have the necessary information and paperwork on hand.
Gather business information
- Get or find your Federal Employer Identification Number (EIN) from the IRS.
- Register with your state and local government and get IDs, if required.
- Check into workers’ compensation insurance, which is mandatory in most states.
- Report new hires to state and federal agencies by the required deadline.
Decisions, decisions, decisions
- Select a bank and open an account.
- Decide what payment options you can offer such as direct deposit, paper check or pay card.
- Set your frequency and pay period end dates, such as weekly, biweekly, semimonthly or monthly. You may be able to set different pay schedules for different employees. Make sure to consider applicable state laws.
- Decide what benefits you will offer and how much you will need to deduct from each employee’s paycheck for those contributions.
- Consider implementing a time-tracking system.
Collect employee information
- Identify which employees are covered by or exempt from overtime and minimum wage protections under federal, state and local laws.
- Ensure employees complete Form W-4 and any other forms your state or local government may need.
- Get employee banking information, including account and routing number, for direct deposit.
Gross Pay vs. Net Pay and Other Key Terms
- Gross Pay: The income an employee earns before taxes, benefits and other payroll deductions.
- Payroll Taxes: The taxes deducted from employee paychecks can include federal income tax withholding, state income tax withholding and local income tax withholding. This includes Social Security (also called Old Age, Survivors and Disability Insurance or OASDI) and Medicare. Employers may also handle paying FUTA (Federal Unemployment Tax Act) and SUI (State Unemployment Insurance).
- Payroll Deductions: Employees can have voluntary and involuntary amounts deducted from their paychecks for benefits like 401(k) retirement plans and health insurance. This may also include wage garnishment for items like child support and alimony. Reviews state laws for permissible deductions.
- Net Pay: Wages less all deductions and taxes.
Step 2: Choose Your Payroll System
Small business owners can choose from several options. The most popular small business payroll solutions are:
- Manage it manually.
- Hire a bookkeeper, CPA or accountant to handle it on your behalf.
- Work with a payroll service to help you automate it.
Managing payroll yourself may seem like a tempting way to save money.
Be aware—it can consume hours of your time. You must handle employee withholdings, IRS forms and payments, and manage deadlines. There are many federal, state and local laws and regulations to follow.
And your mistakes could cost you in penalties, fines and interest from errors and missed deadlines.
You can ease this administrative burden and take advantage of payroll expertise when you outsource payroll.
SurePayroll simplifies the complexities of payroll for small business. With SurePayroll, you can run payroll and calculate taxes in a few easy steps, from wherever you are. Then get right back to your business, customers and employees.
Step 3: Calculate Employee Pay
The exact steps you’ll take to run payroll for employees will depend on factors such as industry regulations, and state and local laws. Generally, you will start by calculating each employee’s gross pay.
Gross pay is the income an employee earns before payroll tax and other deductions.
Make sure to pay employees at the appropriate overtime rate and include commission and bonuses when calculating gross wages.
Below is a very simplified overview of the complex calculations of hourly and salary pay. Use our free online payroll calculator for a more accurate estimate.
Hourly
To calculate gross pay for an hourly employee without overtime, multiply their hourly rate by the total hours they worked during the pay period.
If you pay your hourly employees every two weeks, the calculation might look like this:
$18/hour x 80 hours = $1,440 gross pay for one pay period
Salary
To find the gross pay for a salaried exempt employee, first figure out the annual salary. Then, determine the number of pay periods in the year. Finally, divide the annual salary by the number of pay periods.
If you pay your salaried employees every two weeks–or 26 pay periods a year–the calculation might look like this:
$45,000 annual salary / 26 pay periods = $1,730 gross pay for one pay period
Step 4: Tax Withholding and Deductions
Next, calculate each employee’s pre- and post-tax deductions and tax withholdings.
Pre-Tax Deductions
Employees' contributions to employer-sponsored retirement plans are usually deducted from their pre-tax wages (or gross pay).
Tax Withholding
As an employer, you are also responsible for withholding, depositing and reporting employment taxes, including:
- state income and local income taxes, where applicable
- employees’ share of Social Security and Medicare taxes (called FICA)
You must also deposit and report the employers’ share of:
- FICA
Failure to properly withhold and deposit these taxes can result in significant penalties.
Voluntary Deductions
After taking out employment taxes and pre-tax deductions, you may need to deduct money from each employee’s check to cover their share of any benefits you offer, such as:
- Life insurance
- Disability coverage
- Flexible spending accounts
Involuntary Deductions
Some employee paychecks may be subject to wage garnishments. In this case, you would deduct some of the employee’s post-tax earnings to pay a debt such as alimony or child support.
Step 5: Pay Employees
After calculating the taxes and deductions from each employee’s gross pay, you will pay them the remaining amount. This is their net pay, which people often call take-home pay.
You will pay employees based on the method they selected, such as direct deposit, paper check or pay card.
Step 6: File Payroll Taxes
Next, you must file the payroll taxes with the proper tax agencies. When you file, use the correct forms to report withholding activities to the proper federal, state and local tax authorities.
- Form 940: Use this form to report your annual Federal Unemployment Tax (FUTA) liability.
- Form 941: This is the employer's quarterly federal tax return. It reports income taxes and Social Security and Medicare withheld from employees' paychecks. You also use this form to pay the employer’s portion of Social Security or Medicare.
- Form 944: If your annual taxes for Social Security, Medicare and federal income tax are $1,000 or less, you might be able to pay them annually with Form 944.
You must deposit federal employment taxes electronically through the IRS Electronic Federal Tax Payment System (EFTPS). Check with your state to determine how to report and deposit state employment taxes.
Step 7: Maintain Payroll Records
You must also maintain compliance with various federal and state recordkeeping laws to avoid potential penalties and fines in the case of an audit.
Simplify Payroll & Automate Tax Filing
The easy, affordable solutions from SurePayroll help simplify the complexities of payroll and tax management, giving you the freedom to focus on your business.
Have questions? Connect to see how SurePayroll can help you simplify your success.
How to Run Payroll FAQs
What are common payroll mistakes?
Common payroll mistakes include misclassifying employees, miscalculating payroll taxes, underestimating employer taxes, late tax payments, incorrectly processing wage garnishments, paying bonuses incorrectly and poor recordkeeping.
What is the easiest way to do payroll?
Automating payroll, tax calculations and payments with a payroll service like SurePayroll is one of the easiest ways for small business owners and household employers to simplify payroll, HR and benefits.
Do I need a business bank account to run payroll?
Yes, you need a business bank account to run payroll. You can open your business bank account after you apply for and receive your Federal EIN.
