Running payroll for the first, second, or even third time can be complicated and confusing. If you’re overwhelmed thinking about your employer responsibilities, you’re not alone.
Registering for accounts, setting up payroll, withholding taxes, and maintaining organized records is a lot for new employers to take in. But once you are set up and have the process down to a science, you might not be as stressed out about running payroll.
If you recently became an employer, you need to learn how to run payroll. Failing to run payroll accurately can result in labor law violations, tax penalties, and fines.
Follow these steps to avoid making payroll mistakes before, during, and after running payroll.
Before you can run payroll, there are a few things you need to do besides hiring your first employee. Payroll preparation can be tedious, but it’s necessary to comply with employment laws.
To set up payroll correctly, register for accounts, make payroll decisions and gather employee information.
You don’t automatically become an employer when you hire your first employee. You need to register with entities like the IRS, state governments, and, in some cases, workers’ compensation insurance.
To run payroll, you need to apply for an Employer Identification Number (EIN) with the IRS. Your business’s EIN identifies your business when you file tax forms. You should also sign up for an Electronic Federal Tax Payment System (EFTPS) account with the IRS to pay federal taxes.
Register for accounts with your state, including a withholding account with the state department of revenue and a state unemployment account with your state’s department of labor. You might need to register for further accounts, depending on your state.
Obtain workers’ compensation insurance. You must get workers’ compensation insurance through your state if your business is in a monopolistic state (North Dakota, Ohio, Washington, and Wyoming). Otherwise, you can shop around for workers’ comp.
The next part of setting up your payroll is determining what type of employee you’re going to hire, how often you’re going to pay them, and how you’re going to pay them.
What type of employee are you going to hire? Decide whether you are going to pay your employee an hourly or salary wage, what their pay rate is, and whether they are eligible for tips or commissions. If you decide you are going to pay your employee a salary instead of an hourly rate, you must know whether the employee is exempt or nonexempt from overtime wages.
Next, decide on a pay frequency and payment method. Will you run payroll weekly, biweekly, semimonthly, or monthly? And, will you pay the employee via direct deposit, check, payroll card, or cash?
You should also decide on a payroll method, such as handling payroll by hand, hiring an accountant or bookkeeper, or using payroll software.
Once you are registered for accounts and have decided how you’re going to run payroll, you can hire the employee. But before they can start working for you, you need to gather employee information.
You need to know how much to withhold from your employee’s wages for taxes. Because federal income tax withholding depends on factors like the employee’s family status and withholding allowances, the employee must fill out Form W-4, Employee’s Withholding Allowance Certificate.
Your employee may also need to fill out a state tax withholding form. These forms vary by state.
If you offer employee benefits, like health insurance or retirement plans, the employee must fill out forms indicating their participation, too.
Although unrelated to running payroll, make sure you also collect Form I-9, Employment Eligibility Verification, from your employee and report new hires to the state.
Once you’ve set up payroll for your small business, it’s time to run it. You will run payroll a certain number of times each year, depending on your pay frequency.
For every payroll you run, you need to do the same three things: calculate the employee’s gross wages, withhold taxes and other deductions, and pay the employee.
The first part of running payroll is to calculate how many hours your employee worked during the pay period and multiply that number by their hourly pay rate. If the employee worked more than 40 hours, be sure to calculate their overtime wages.
Multiplying the employee’s hourly pay rate by the number of hours worked during the pay period will get you their gross wages.
Let’s say an employee worked 80 hours during a biweekly pay period, and they earn $12.50 per hour. The employee’s gross wages are $1,000 ($12.50 × 80).
Before you can pay your employee, you need to withhold taxes and other deductions from their wages. Keep in mind that you also must pay taxes on the employee’s wages.
Withhold federal income and FICA taxes from the employee’s wages. You may also need to withhold state and local income taxes.
How much you withhold for federal income tax depends on the employee’s pay and how many allowances they claimed on Form W-4. Use the income tax withholding tables in IRS Publication 15 to determine how much to withhold.
FICA tax consists of Social Security and Medicare taxes. You must withhold 7.65% of the employee’s pay for FICA tax. And, you pay a matching percentage of each withholding. There is also a Social Security wage base and an additional Medicare tax you should familiarize yourself with.
You must pay federal and state unemployment tax based on your employee’s wages. Do not withhold federal unemployment tax from the employee’s pay. Generally, you will not withhold state unemployment tax from the employee’s compensation, but your state requirements may be different and require the employee to also pay a percentage of state unemployment taxes.
Make sure you also withhold other applicable deductions, such as health insurance premiums, retirement plan contributions, and wage garnishments.
After you withhold taxes and other deductions from the employee’s gross wages, the remainder is known as their net, or take-home, pay.
Regardless of whether you’re using software or doing payroll by hand, check your numbers to ensure you entered the correct information.
Distribute wages to your employee. Many states also mandate that you provide pay stubs to employees. Pay stubs list each employee’s gross wages, deductions, and net pay. That way, your employee can see how much you withheld and verify their paychecks are accurate.
For accurate payroll calculations, use payroll software. Software can cut down the amount of time you spend running payroll and keep your more organized.
After running payroll, your employer responsibilities aren’t finished. You must file and deposit taxes. And, you must keep payroll records.
Remit federal tax withholdings (FICA and federal income taxes) and your contributions (FICA and federal unemployment taxes) to the IRS. Your deposit due date depends on your deposit frequency. Deposit frequencies include monthly or semiweekly. The frequency you use is based on a four-quarter lookback period.
File Form 941, Employer’s Quarterly Federal Tax Return, or Form 944, Employer’s ANNUAL Federal Tax Return, to report federal income and FICA taxes. Form 941 is due quarterly by April 30, July 31, October 1, and January 31. Form 944 is due annually by January 31.
File Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, by January 31 to report your federal unemployment tax liabilities.
State depositing and filing deadlines vary, so check with your state for more information.
Don’t forget to store documents in a safe location. Retain payroll records for at least three years. You also need to hang onto records showing how you determined wages for two years. And, store employment tax records for at least four years after filing.
Rachel Blakely-Gray is a content writer at Patriot Software, who offers accounting and payroll software for small business owners. At Patriot, Rachel enjoys providing actionable, growth-oriented content.