Running Payroll Yourself for a Small Business
Your business is growing, and exciting times are up ahead. As you hire people, you need to have in place a system for paying them their wages. You need to learn the ins and outs of running payroll yourself. A growing business often has more capacity than it does cash. Therefore, they often have to take the hard route of doing it all themselves. That includes designing and putting in place a payroll system.
Why You Need a Payroll System
The most obvious reason you need one is to have a system in place to pay your employees. There are bigger reasons, like the mitigation of risk and improving your business operations. If you do not have a system in place, you will have a lot of set-ups and wind-down time to account for every time you need to make wage payments.
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How to Run Payroll for a Small Business
As a small business, you have the following options for running payroll:
Use payroll software – Payroll software can be purchased as a package or can be accessed via the cloud. They do the heavy lifting of calculating pay and deductions, generating pay slips, generating tax returns, and maintaining payroll records for you.
The business owner’s responsibility is usually limited to reviewing and approving the payroll. Payroll software greatly simplifies the process of a business owner taking care of payroll themselves.
Outsource payroll to an accountant – If you do not want to learn how to do payroll for your small business, you can outsource the work to a service provider accountant. The accountant is usually trained to process payroll but can come at a hefty cost, often higher than payroll software. The benefit here is that of having a human interface to answer your questions while they take over the process.
Hire an accountant in-house – If you would like to run payroll in-house, you can also employ an accountant or delegate the payroll to a competent employee. You could train an administrative person to take over the process from you.
Do it yourself – This is the option you might find yourself left with if you have more time than money. Let’s discuss this option further.
How to Run Payroll Yourself
The do-it-yourself option finds most favor with small business owners, at least at the very beginning of their journey. Small business owners may find it frustrating, but it will benefit them, in the long run, to understand the payroll process themselves before hiring out. In fact, the small stages are the best time to learn as it just gets harder when you bring on more employees.
The biggest benefit of doing payroll yourself is that you retain control over the process. You have the ability to review and correct mistakes as they occur without too much back and forth. You also do not have to experience unpleasant surprises when your service provider has made a mistake.
However, the disadvantage of do-it-yourself payroll is the time it takes to set up, and the recurring time it takes to process every pay period. Also, not many business owners understand the tax system as well as trained accountants. They are often at a loss when a tax concern arises and need to approach an outside accountant.
Prerequisites to Run Payroll for a Small Business
Small businesses with several employees may benefit from outsourcing payroll. However, if you have just a few employees and intend to keep your business small, you may be better off running payroll yourself as it will be more cost-effective.
Before you even begin to interview people, there are a few things to set up as a new employer in the way of how to do payroll yourself:
Get an employer identification number (EIN) – As an employer running payroll, you will need to sign up for an EIN with the IRS. It’s a number that is used by the IRS to track your payroll taxes and compliances. Getting an EIN is free and can be easily applied for on the IRS website.
Sign up with the Electronic Federal Tax Payment System (EFTPS) – A big component of running payroll is to be on time and up to date with payroll taxes. The EFTPS is a free government service that will help you pay your federal payroll taxes and unemployment taxes, all from your computer.
Register as an employer – There are state-specific business registration requirements to be made before you can do payroll. Every state has a different procedure to get registered, so make sure to check these out.
Learn federal and state labour laws – Before you do payroll yourself, it’s important to familiarize yourself with the relevant labor laws. Many of these laws have a bearing on how often you process payroll, minimum wage, calculation of overtime, withholding tax requirements, and the information to be included on employee payslips.
Prepare employee paperwork – When you hire a new employee, they will need to complete some mandatory employee paperwork. The paperwork will give you the details you will need to do payroll for your small business. The most important forms you will need to get new hires to fill include:
- Form W-4 – Form W-4 is filled out by employees to let employers know how much tax to withhold on their payments, depending on dependents, filing status, tax deductions, etc. An employee may end up paying more tax at the time of filing their tax returns if they have not filled out the W-4 timely or correctly.
- I-9 Employment Eligibility Verification Form – An I-9 Form is filled out to confirm the employee’s identity and legal authorization to work in the United States. The form is required and mandated by the United States Citizenship and Immigration Services.
- State Tax Withholding Form – Many states allow Form W-4 to be used alone, but some states may have specific tax withholding requirements to disclose by new employees.
- Direct deposit authorization form – This form gives you permission to make direct payments to an employee’s bank account if you plan on making direct deposits.
Choose a pay period – You have to decide how often you will pay your employees. You can opt for weekly, biweekly, semi-weekly, or monthly. You want to carefully consider the period that allows you to collect the funds required to make the payment. However, it also should not leave your employees in the lurch without payment for unreasonably long periods. Some states require that hourly workers get paid on a weekly basis, so ensure you research your state’s requirements for a payroll schedule.
Process to Run Payroll Effectively
Employees expect timely and accurate paycheck delivery. Disruptions and errors can stall your business operations. Before we jump into how to calculate payroll, there are a few foundational basics to keep in mind:
Understand different types of pay – Gross pay refers to the amount received by an employee before deductions. Bonus pay indicates any additional payments received, over and above an employee’s regular pay, usually linked to high performance. Net pay refers to the employee’s take-home pay after deductions. It’s important to differentiate between these different types, so you do not make any payroll errors.
Know actual hours worked by each employee – To run payroll accurately, proper employee monitoring is required. The easiest way to track employee hours is through a spreadsheet. However, that can be a bit time-intensive and may require you to be involved unduly, especially when there are several employees. Picking a solid time tracking software that integrates with the payroll process can be the key since manual methods can result in discrepancies.
Steps to Run Payroll
There are several steps to follow in order to run payroll:
Calculate gross wages – To calculate gross wages for hourly workers, simply multiply the employee’s hourly rate by the number of hours they have worked in the pay period. For salaried employees, simply divide their annual salary by the number of pay periods in the year to get the monthly payable to them. Gross wages include bonuses, tips, commissions, sick and vacation leave, and overtime.
Calculate pre-tax deductions – Pre-tax deductions are voluntarily withheld by the employee and include retirement contributions, health benefits, disability insurance, and commuter perks. These deductions are subtracted from the employee’s gross wages before tax but check whether they are subject to taxes or not. Some employee benefits are exempt from tax.
Federal taxes, social security, local taxes, and Medicare also form part of the pre-tax deductions to be made from employee payroll.
Federal Income Tax and Other Payroll Taxes
Calculate federal tax withholding – There are two main types of federal taxes to be withheld, i.e., FICA payroll tax and federal income tax (FIT). FICA payroll taxes are shared by the employer and employee and go towards the employee’s social security and Medicare. The responsibility falls on the employer to disburse the FICA taxes to the government and show the subtraction in the payslip. FIT is calculated either on the basis of wage brackets or percentage, depending on the employee’s earnings. How it is calculated, as of 2020, also depends on the W-4 filed by the employee.
Calculate state tax withholding – Depending on your state’s local tax laws, you may need to withhold some state taxes from employees’ paychecks.
Calculate wage garnishments – Wage garnishments refer to other deductions that the employee has no say in, and they are mandatorily deducted from the paycheck. Some examples of this are unpaid medical bills, unpaid child support, delinquent student loans, and unpaid taxes. The government will usually notify you if your employee has a wage garnishment.
Making Employee Payments and Pay Period
Once you’ve calculated net pay due to each employee, it’s time to disburse payments. Federal law usually does not require that employers provide payslips, however, there may be some state-specific requirements.
If your state has no pay stub requirements, you are not required to provide a pay stub. You may do so if you and your employee agree on it. In most states, you provide either an electronic or physical pay stub to your employees. Either may work as long as employees have an easy way to print or access it.
There are some states that fall in the category of opt-in or opt-out states. In opt-out states, employers are required to provide paper pay stubs to employees who opt out of electronic pay stubs. In opt-in states, employers provide paper stubs unless an employee specifically opts in for an electronic form.
An automated system can help save on hours of running payroll, especially if you have more than a few employees. Not to mention, it is usually also configured for a lot of federal laws built into the system. This can cut down on a lot of the complexity of setting up the system from scratch.
Maintaining comprehensive and organized payroll records is critical when you learn how to do payroll yourself. Keeping track of how much you have paid an employee is important in case there is ever a discrepancy between net pay and what they expect to receive. Records are also handy in case you ever need to liaise with the IRS.
Record-keeping becomes quite important for payment of payroll taxes. Electronic payment methods of calculating gross pay, deductions, and net pay, usually generate automatic records which can then be stored in some form of cloud storage.
Paper checks and postal checks will require you to maintain some form of ledgers or records. While it may take only a few minutes per employee, these minutes can add up to a long exercise for many employees.
Federal Employer Taxes
As an employer, you are responsible for paying two types of federal taxes: FICA payroll taxes and federal unemployment or FUTA payroll taxes.
The employer pays half of the FICA payroll tax while the employee meets the other half. FICA payroll taxes comprise social security and Medicare. The employer’s responsibility applies only to social security. Medicare is fully borne by the employee.
FUTA payroll taxes go towards the federal unemployment insurances. It applies as a percentage cap on the employee’s wages. Beyond this slab, the employer no longer has to pay FUTA tax. Paying your state employment taxes on time may entitle you to a credit or rebate, so make sure to check what the benefits of paying on time are.
Once you calculate the taxes due, you will have to disburse them to the government. If you do not need to do so immediately, it’s best to transfer it to a separate account to be kept in holding until you need to pay it out.
Quarterly and Annual Tax Forms
The last leg of managing payroll yourself is to develop and put in place a system for your business to regularly file these returns on time. Let’s discuss these tax forms a little more in-depth:
Form 941 – Form 941, the Employer’s Quarterly Tax Return, is required to be completed by an employer every quarter. This form intimates the IRS of how much tax the employer withheld from employee paychecks and how much employer taxes were disbursed during the quarter. Most employers are required to submit Form 941 by the end of the month following the quarter. If the employer has made all their payroll tax payments online on-time throughout the quarter, that employer gets the benefit of an additional 10 days to file the form.
Businesses with seasonal employees, farm employees, household employees, and certain notified people are exempt from the requirement of filing Form 941.
Form 940 – Form 940, the Employer’s Annual Federal Unemployment Tax Return, is required to be completed by an employer every year. An employer is required to file the return if they meet either of the following two conditions:
- The employer paid out at least 1,500 dollars in wages in the year, or
- The employer had any employee work for 20 weeks or more in the year, whether or not the 20 weeks were consecutive.
Form 940 is due to be submitted on 31st January every year, but 10 additional days are given to all those employees who made their FUTA tax payments on time during the year.
Form W-2 – Form W-2 is an annual form that is to be submitted in respect of each employee. It discloses the employee’s wages, deductions, and tax withholding. It is to be submitted by 31st January every year.
Copies of Form W-2 are sent to the employee, the Social Security Agency, and the tax department of the city or state.
State tax forms – You may also need to file quarterly or annual tax forms with your state tax department. Check with the appropriate local department for details on this.
Choose the option that works for you
Running payroll yourself for your small business will make you feel confident in your abilities and give you a sense of ownership for your business. It’s often said that a business owner wears many hats. One of those hats is very often akin to an accountant. As a business owner, you often have to get your hands dirty. But don’t worry, you are totally capable of doing so.
At the end of the day, look into the option that works best for you. After you gain some level of comfort with the process of managing payroll, you may choose to outsource it to a service provider or invest in software. We’ve given you the pros and cons of each of those options, along with a roadmap of how to do payroll yourself. You know what’s best for you, so pick the option that suits you.
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