How to Do Payroll – Everything Small Business Owners Need to Know

Mastering how to do payroll is essential to ensuring your employees are compensated in a timely manner.

But navigating the complex labyrinth of regulations, calculations, and deadlines makes it a daunting task for many business owners. Moreover, any non-compliance or mistakes can lead to hefty fines, and maybe even litigation.

Understanding what payroll management entails is crucial to successfully running payroll. So, to make it easier, we’ve created this guide to show you how to do payroll yourself in 10 simple steps.

Starting with the documents you need, we’ll take you through everything you need to know so you can confidently manage your payroll responsibilities.

So, let’s get started.

Key Takeaways

  • Payroll management is a complex process, involving many calculations, regulations, and deadlines.
  • Before running payroll, gather all necessary documents and set up systems for tracking employee information, such as tax forms and time records.
  • Investing in a reliable payroll software can greatly streamline the payroll process and reduce the likelihood of errors.
  • Payroll regulations are subject to change, so keep yourself informed about updates and adapt your systems accordingly.

How to do Payroll in 10 Steps

Running payroll is a time-consuming process with many nuances. To make it easier, we broke down how to do payroll yourself into 10 simple steps.

  • Preparing for Payroll
  • Calculating Gross Pay
  • Withholding Taxes
  • Employee Benefits and Deductions
  • Payroll Compliance
  • Payroll Processing
  • Issuing Paychecks and Direct Deposits
  • Handling Payroll Taxes
  • Dealing with Payroll Errors
  • Keeping Up with Changes

Now that you have a gist, let’s look at each step more closely.

Preparing for Payroll

Before you start running payroll, you’ll need to set the stage by collecting the necessary documents and setting some ground rules.

Gather necessary information

The first step is collecting your business and employee tax information.

  • Set up your employer identification number (EIN): You can get your EIN from the Internal Revenue Service (IRS). If you don’t have one, you can apply for an EIN for free online or via fax or mail.
  • Gather your employee tax information: Your employees need to submit their W-4 and I-9 to you. They provide details about the employee’s work status, deductions, etc. Contractors or freelancers will need to submit 1099s.
  • Submit time and attendance records: Create a process for tracking your employee work hours. It could be as simple as an Excel sheet or a time tracking software.

Establish a payroll schedule

Next, you’ll need to decide when you want to pay your employees. There are four common pay schedules: weekly, biweekly, semiweekly, and monthly.

If you’re unsure which payroll schedule to go with, we’d suggest choosing the one that ensures your employees get paid within a reasonable time. It’s also a smart move to review whether your choice complies with local and federal laws around payroll schedules.

Choose a payroll system

Finally, you’ll also need to decide on a payroll system. It can be a completely manual process or you can go for a payroll software.

Manual systems, like a simple Excel sheet, are a great way to track employee hours and calculate wages for smaller businesses with a few employees.

Larger businesses, on the other hand, should consider payroll software to automate tasks like calculating wages and maintaining human resource (HR) records. They make it easier to manage wage payments for a large number of employees while ensuring you comply with federal laws.

But before choosing one, thoroughly research your options to find the best one for your needs. Take the time to understand how the best payroll systems in the market, like Rippling and Deel, go about simplifying payroll management.

Calculating Gross Pay

Gross pay is what employees earn before taxes, benefits, and deductions. Its calculated using the following formula:

Gross Pay = Wages/Salaries + Overtime + Bonuses/Commissions

  • Wages/Salaries cover the payment earned for services rendered. It could be a fixed weekly or monthly salary or calculated on an hourly basis.
  • Overtime takes into account work done outside normal working hours. It’s usually calculated using the standard hourly rate or 1.5 times the hourly rate.
  • Bonuses/Commissions include compensation employees earn for going above and beyond expectations and meeting predetermined targets.

Withholding Taxes

Setting aside tax amounts is mandatory while processing your payroll. Depending on the type of business, you’ll have to account for the following taxes:

  • Federal & state income taxes: Income tax is levied at both the federal and state level. You can use the IRS Withholding Estimator to federal tax estimates. State taxes differ by state so you’ll need to check with local authorities.
  • Federal Insurance Contribution Act (FICA): This includes contributions toward both Medicare and Social Security. You have to match your employee’s contribution towards FICA.
  • Other taxes: Depending on your state, you may have to take into account local taxes. For example, states that levy a state tax usually also have taxes at the city, county, or locality level.

Employee Benefits and Deductions

Besides government taxes, you also need to consider deductions for benefits or services rendered at the company level, like:

  • Health insurance: Typically, the health insurance premium is shared between the employer and employee. Businesses cover between 73 to 83% of the insurance premium, with smaller businesses usually covering more.
  • 401(k) contributions: Employees who sign up for a 401(k) contribute a part of each paycheck paid directly into an investment account. As an employer, you have to match the contribution or pay a percentage of it to the account.
  • Loans or advances: This covers contributions towards repaying money employees borrowed from the company.
  • Other employee benefits: This includes deductions for other employee benefits like dental insurance, disability insurance, unemployment insurance, etc.

Payroll Compliance

Payroll compliance is the act of ensuring your business adheres to the payroll and tax regulations of the region. It’s just as complex as calculating payroll taxes and deductions, if not more so. To ensure compliance, you’ll need to educate yourself on:

  • Labor laws: Familiarize yourself with key employment laws like the Fair Labor Standards Act (FLSA), Federal Insurance Contributions Acts (FICA), and Equal Pay Act (EPA). You may also be subject to state level regulations like state-specific income tax, unemployment tax, and minimum wage requirements.
  • Payroll tax regulations: Ensure payroll calculations are accurate and withhold the right tax amounts for the state and federal level. Also, check the deadlines for filing your business taxes to avoid penalties.
  • Employee classifications: Classify your employees accurately so you know for whom, and how much, you have to pay. Companies pay taxes for full-time employees while contractors and freelancers pay taxes themselves.
  • Recordkeeping requirements: There are federal regulations governing how businesses should store payroll records. Use a payroll management system that meets these regulations to avoid problems during audits.

Depending on your organization size, you may have to comply with regulations at a state, federal, or international level. Failure to comply will result in a hefty fine or penalty. You can avoid these mistakes by investing in a payroll system like Paychex with over 200+ experts to help you comply with payroll regulations.

Payroll Processing

Payroll processing involves paying employees for their work after withholding taxes and other deductions. It’s carried out during the payroll period decided by the business beforehand. You have the option to process your payroll manually or using payroll software.

Manual payroll processing requires you to maintain precise records of work hours, wages, deductions, classifications, tax requirements, and more. It’s doable when you’re a small organization with a few employees. But as you grow, managing the records manually will become more challenging.

Instead, we recommend opting for a payroll software from the start. There are plenty of options in the market, catering to specific business sizes. For example, our Sage review finds the software is a great choice for large businesses while QuickBooks Payroll simplifies payroll processing easier for smaller businesses.

Issuing Paychecks and Direct Deposits

The next step is issuing paychecks to your employees. You can choose from two methods:

  • Physical paychecks: You can send physical paychecks to your employee addresses. Though reliable, it is a resource intensive process, and you’d be better off hiring a payroll service to manage your paycheck deliveries, adding to overall costs.
  • Direct deposits: You can electronically transfer wages directly to your employee’s account. Transactions are almost instantaneous and most banks don’t charge for it.

Employees will also receive pay stubs along with their paychecks, outlining information like the gross pay, deductions, and tax withholdings. If you’re looking for a payroll software to streamline your paycheck processing, we recommend ADP for its prepaid paycheck accounts.

Handling Payroll Taxes

Payroll taxes may be deducted from the employee’s paycheck but it is the company’s responsibility to remit the amount to the government. Also, don’t forget to collect and review the required tax forms in a timely manner because most forms, like the W-2, have submission deadlines. Create a tracking system to manage form deadlines and document submissions.

NOTE: Just know, companies only withhold payroll taxes for full-time employees. Independent contractors have to manage payroll tax payments on their own.

Dealing with Payroll Errors

Payroll errors are fairly common, resulting in costly fines and penalties. The most common payroll errors are misclassified employees, incomplete records, payroll non-compliance, and missed deadlines. You can catch these errors by conducting regular payroll edits, starting from the date of hiring an employee till payroll is deposited.

Keeping Up with Changes

To keep up with changing requirements, governments are regularly updating payroll processes and regulations. Keep an eye out for new regulations and align your systems and documents to reflect the change.

Don’t forget to ensure your payroll system meets the new regulations. Good software providers usually update their systems to accommodate regulation updates. Check for system updates regularly to avoid hefty fines or penalties for not adhering to changes.

Conclusion

Payroll management is a complex process with a lot to consider. Breaking it down into steps helps make sense of the payroll process easier.

Start by gathering the necessary documents. Next, calculate employee wages and withhold taxes and deductions. Finally, pay your employees via direct deposits or paychecks. Between all this, you’ll need to ensure compliance with payroll regulations, store payroll data securely, and deal with filing mistakes.

If you’re looking for a payroll system to help you run your payroll more efficiently, check out our list of the 10 best payroll software to find the best one for your business.

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Kevin Cyriac Tom
Tech Expert

Kevin is a seasoned B2B SaaS writer with a passion for crafting engaging BoFU articles, including in-depth product reviews and solution-oriented pieces. His fascination with writing began after he won a second grade creative writing competition, sparking a lifelong love for the power of words. Kevin initially pursued a degree in Mechanical Engineering at the prestigious VIT University in India. But his trajectory took an unexpected turn after a digital marketing internship reignited his love for writing, prompting Kevin to pivot towards content creation instead. Kevin joined multiple B2B SaaS startups as their primary content writer, honing his writing and…