If employees are the heart of your small business, paying them accurately and on time could very well be what keeps things ticking.
Running payroll requires a finely tuned system of checks and balances, attention to detail, and steadfast compliance with federal, state, and local employment laws and regulations. Any mistake along the way can cause problems. This includes calculating and paying employee wages and taxes. These errors can harm your reputation and lead to fines, penalties, and legal issues.
Whether you run payroll yourself, hire a financial expert, or use a payroll service like SurePayroll® By Paychex, read on to learn how to do payroll processing right.
How Does Payroll Processing Work?
When you hire employees, you must pay them for their work and withhold the related small business payroll taxes each pay period. But what is the process of payroll processing? In general, it takes seven 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
- Some may ask, do I need a business bank account to run payroll; the answer is generally yes. You can open your business bank account after you apply for and receive your Federal EIN.
- 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 any applicable requirements at the federal, state, and local levels.
- Decide what benefits you will offer and how much you will need to deduct from each employee’s paycheck for those contributions.
- Consider implementinga 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 banking information, including account and routing number, for employees paid through direct deposit.
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 calculate 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 simple 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 federal, 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. Gross pay includes an employee’s base pay, as well as other payments like bonuses and commissions.
Make sure to pay employees who are eligible for overtime at the appropriate rate.
Below is a very simplified overview of the complex calculations of hourly and salary pay. For a more accurate estimate of net pay, use our free hourly payroll calculator.
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
For a more accurate estimate of net pay, use our free hourly payroll calculator.
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
For a more accurate estimate of net pay, use our free salary payroll calculator.
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
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.
For tips on wrapping up your payroll for the year, see our payroll year end checklist.
Methods of Processing Payroll
How you choose to run payroll depends on several factors, like the size of your business, the number of employees, and specific payroll needs.
Whether you hire an in-house payroll administrator, outsource payroll to a bookkeeper or accountant, or go DIY with payroll software or traditional ledger and paper checks, running payroll requires keen organization and critical information management.
Processing payroll manually or through an automated payroll system generally requires completing the same tasks:
- Collecting important tax forms.
- Tracking employee hours, including overtime, vacation time, and sick time.
- Calculating employee pay.
- Distributing paychecks.
- Calculating, filing, and paying employee and employer taxes.
When it comes to how much you pay for payroll processing, the answer is that it depends on your business needs, employee count, and any additional features you may choose to include. Most providers charge a monthly base fee, plus a per-employee surcharge.
Manual Payroll Processing
Manual payroll processing means you, an employee, or your accountant or bookkeeper calculates employee pay, withholds employee taxes, and files employer taxes either by hand or assisted by desktop software. It could also mean writing or printing employee checks for distribution or overseeing the direct deposit process.
Manual Payroll Processing Pros
- More direct control over payroll processing.
- Little or no capital investment.
- Limited or no technology required.
Manual Payroll Processing Cons
- Takes time away from growing your business and caring for your customers and employees.
- Greater risk of human errors that could lead to costly penalties, fines, and damage the relationship with employees, and impact business reputation.
- Expose your business and employee confidential data to potential security risks.
- Failure to adhere to record-keeping requirements.
- Ability to scale as your business grows and you add employees.
- Complexities associated with wage garnishments, benefit deductions, bonus payments, sales commissions and more.
Payroll Software & Automated Payroll
Unlike manual payroll processing, automated payroll systems handle complex payroll calculations, check processing, tax filing, and help with regulatory compliance. 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.
Automated Payroll Process Pros
- Efficiently performs critical calculations like payroll taxes, overtime, raises, PTO, state reciprocity, and more.
- Conveniently stores critical data and generates payroll reports.
- Reduces the chance of potentially costly errors associated with manually processing payroll.
- Simplifies quarterly and year-end tax filing preparation.
- Frees you to focus on strategic business tasks.
Automated Payroll Processing Cons
- Depending on the provider, the cost.
- Onboarding, or initial setup.
The timing of when you get paid after processing payroll depends on several factors, including the processes of banks and financial institutions. Some payroll services offer expedited payroll.
Outsourcing Payroll to Providers
Running payroll on your own—whether with traditional bookkeeping methods or by using purchased desktop software—may serve you well. Until it doesn’t.
Most payroll providers make transitioning from DIY payroll processing to their platform relatively easy. But how do you know when you’re ready to make the change?
If you recognize one or more of the following, you may be ready to switch from DIY payroll processing to outsourcing to a payroll provider.
- Expertise. Running payroll is so much more than signing a check. When you find yourself spending more time mired in payroll paperwork than growing your business, it may be time to make the switch.
- Adding Employees. Payroll for one is time-consuming enough; adding employees only increases the time spent managing a payroll ledger or populating a spreadsheet.
- Transitioning from Part-Time to Full-Time Employees. Many small business owners embrace part-time workers to help manage seasonal spikes and dips, help with special short-term projects, or pick up a few hours. When those hours extend to full-time, that could complicate payroll.
- Financial Management. Payroll is a significant business expense. Efficient processing ensures accurate financial records, aiding in budgeting and financial planning. This helps in maintaining cash flow and making informed business decisions.
- Employee Satisfaction. Correct and timely payments are crucial for employee morale. Consistent errors or delays can lead to dissatisfaction and high turnover rates, affecting your business's reputation and operational efficiency.
- Integrations. Some payroll providers integrate payroll with additional services like time and attendance, HR support, 401(k), workers’ compensation, and more.
- Employee Self-Service. Some payroll providers offer an employee portal where employees can update personal information, view stubs, manage their withholdings, and more.
- ROI. Between hours spent running payroll and the potential for fines, penalties, and fees, many small business owners view the return on investment for an automated payroll service favorably.
Common Payroll Challenges & How to Avoid Them
Payroll mistakes happen. Unfortunately, they can be expensive. Common payroll mistakes include:
- Errors in Payroll Calculations include calculation of overtime pay, salaries, bonuses, or allowances, or final paycheck; inaccurate tax withholdings; improper handling of garnishments and deductions; failing to account for paid time off; and more. Using an automated payroll provider like SurePayroll simplifies the complexities of payroll and tax management, giving you the freedom to focus on your business.
- A variety of issues contribute to Late Payroll Processing, from basic recordkeeping and organization to time management, or not fully understanding the schedule to file and pay your business taxes. Failing to process payroll on time could lead to legal penalties, fines, and reputational damage for a small business.
- It’s unlikely you started your small business to monitor local, state, and federal employment tax law. It takes considerable time to track, understand, and comply with these laws—but failure to do so could lead to Tax Compliance Issues.
- Employee Classification Mistakes may happen if an employer doesn’t understand the employee classifications requirements under federal and state wage and hour laws—exempt and non-exempt. If you misclassify a worker as exempt and it’s later determined they’re actually non-exempt, you may owe the worker back wages if they worked overtime. This would also impact payroll taxes for the period of misclassification.
Avoid the Mistake. Evaluate each employee using FSLA guidance and applicable state wage and hour laws to correctly classify the employee as exempt or non-exempt.
Best Practices for Efficient Payroll Processing
The best payroll practice is the one that best supports your specific needs. When selecting payroll services, consider the following factors:
- Ease of Use. Choose a user-friendly process that integrates with your existing systems, minimizing the learning curve and maximizing the return on investment.
- Comprehensive Features. Look for payroll software to help reduce errors. Consider features that automate tax calculations and filing, set up direct deposit for faster processing, and offer an employee self-service portal.
- Reliable Customer Support. Check to see if the service offers reliable customer support to assist with any issues, ensuring smooth operations and quick resolutions to problems.
- Scalability and Flexibility. Choose a system that can grow with your business and adapt to changing needs, ensuring long-term viability.
- Cost-Effectiveness. Compare pricing plans to find a solution that fits your budget, providing value without compromising on essential features.
- Time Savings. The time it takes to process payroll depends on the size of your business, the complexity of your payroll structure, the number of employees, and the technology. But how long does payroll take to process? A small business owner can run payroll in just a few clicks with an automated system. Alternatively, manual processing may take much longer and is prone to errors, affecting efficiency.
Conclusion
At its core, payroll processing is the act of managing employee payments. It involves several steps to ensure that employees are paid accurately and on time. This includes calculating earnings, withholding deductions, and ensuring compliance with tax laws. Proper payroll management is not only about distributing wages but also about maintaining employee satisfaction and adhering to legal requirements.
Payroll processing can often seem like a daunting task. Yet, understanding how it works is crucial for any business owner. Using payroll software can significantly simplify the payroll process. It automates many tasks, helping reduce the risk of errors and saving you time.
The benefits of automated payroll include:
- Efficient Data Entry. Enter employee data once. The software saves this information for future payrolls, reducing repetitive tasks and minimizing errors.
- Automated Calculations. The software automatically calculates earnings, taxes, and deductions, ensuring accuracy in every payroll cycle.
- Seamless Direct Deposit. Most payroll systems offer direct deposit, ensuring timely payments to employees and enhancing their satisfaction.
- Supporting Compliance. Payroll software keeps up with changing tax laws, helping to ensure compliance and freeing you from the stress of manual updates.
- Comprehensive Reporting. Easily generate reports for tax filing and financial records, aiding in strategic decision-making and compliance.
Simplify Payroll & Automate Tax Filing. Connect to see how SurePayroll can help you simplify your success.
