If you’re starting your own business or your existing business has grown to the point where it’s time to hire employees, then you’ll have to learn how to set up and manage payroll. Unfortunately, managing payroll isn’t as simple as just paying your employees what they’re owed. Taxes make things much more complicated. We’ve put together a guide to help make setting up and managing your company’s payroll a little easier.
Setting Up Your Payroll
Setting up your payroll isn’t actually as difficult as you might think if you just follow these steps:
Employee Identification Number
Job one is to apply for an employee identification number (EIN). An EIN is a nine-digit number that the IRS uses to identify businesses. Whenever you send certain documents to the IRS or to state agencies, you’ll be required to include your EIN. To apply for an EIN, you will need to fill out the Form SS-4, which is available on the IRS website.
Depending on your state, you may also need to apply for employer ID numbers for state and local governments. One thing that every state does require is new hire reporting. As a result of the Personal Responsibility and Work Opportunity Reconciliation Act passed in 1996, you will need to report any new employees you hire to the state, whether your company is private, public, non-profit, or government-backed. For every hire you report, you’ll need to provide certain information (as mandated by state guidelines). This information typically includes your business name and address, a contact person and phone number, your EIN, and a state employer ID number if it was required. To report new hires, you will need to set up a new hire reporting account with your state.
Once you have your employer ID numbers, decide how and when you will pay your employees. You can pay your employees via paycheck, cash, direct deposit, or payroll card (which is a prepaid card onto which you can load your employee’s wages or salary). As for the frequency at which you pay your employees, most businesses pay their employees weekly, bi-weekly, or monthly.
Salary status refers to whether you will pay your new employees a yearly salary or an hourly wage. If they are being paid hourly, it means that they are likely nonexempt and their wages need to meet the federal or state minimum wage requirements (whichever is higher). Employees that are exempt must be paid a yearly salary and must make at least double minimum wage as well as meet other qualifications to be exempt.
Collect Employee Information
Once you’ve hired an employee, provide them with the proper paperwork. This paperwork includes a Form W-4 (also known as an Employee’s Withholding Allowance Certificate), which identifies the amount of payroll taxes you should withhold from their pay. New employees will also need to fill out a Form I-9 (also known as an Employment Eligibility Verification form), which confirms that they are eligible to work in the U.S (technically, Form I-9 isn’t needed to run payroll, but it is still required along with other new hire forms).
If you are offering benefits, such as health insurance plans or retirement plans, then new employees should provide information on how much they want to contribute to their accounts every paycheck.
Types Of Payroll System
Once you have all the information that you need, it’s time to begin setting up your payroll. These are the three most common ways that small businesses manage their payroll:
The most affordable way to manage payroll is to do it yourself. While you can save some money by doing this, if you’re unfamiliar with payroll processes you might want to consider your other options. When you manage your company’s payroll manually, it means you’ll be responsible for paying your employees what they are owed and on time. Additionally, you will be required to calculate how much of their paycheck must be withheld for state and federal taxes, and for properly submitting those taxes to the IRS. This can be time-consuming work–and any mistakes made managing your payroll could result in penalties from the IRS and other agencies.
Implementing a payroll software makes things a lot easier to manage on your own. Payroll software doesn’t cost too much and will not only help make your payroll process much more efficient (you won’t spend nearly as much time calculating payments and taxes since this can be automatic using payroll software), but it will be much more accurate as well, helping to greatly reduce the risk of mistakes. There are numerous payroll software programs available, so perform your due diligence looking for the right one. Besides comparing cost, look at features, user-friendliness, customer support, and security features. Take a look at some online reviews before choosing a payroll software as well.
The most popular option is to outsource your payroll. Many businesses (including small businesses) choose to outsource their payroll despite the expense. This is because they will not have to put as much time into managing payroll, allowing them to focus on other business-related matters. By outsourcing your payroll, you also won’t have to worry about making any mistakes or trying to use a software program you don’t fully understand.
Whoever you outsource to, whether it’s a professional employer organization or a payroll accountant, will take care of everything, including calculating taxes, withholding taxes, and depositing taxes. They will also stay up-to-date with all local, state, and federal regulations to ensure your company’s compliance.
Run Your Payroll
Depending on how you’ve decided to manage your payroll (whether it’s manually, using software, or by outsourcing), you’ll be responsible for a number of tasks when running your payroll. No matter what method you use, you will have to report the hours that your employees worked every pay period, including any overtime hours that the employee worked if they are nonexempt. You will also need to ensure that they will be paid in the way that they’ve chosen to be paid (such as by paycheck or direct deposit, for example). If you’re not outsourcing your payroll, then you will also be responsible for calculating the amount of taxes that need to be withdrawn from every paycheck.
Manage Payroll Taxes
Taxes are arguably the most challenging part of managing your payroll. Not only are you responsible for withdrawing the proper amount of taxes from every paycheck and depositing them as well as reporting them to the IRS, but if you make any mistakes, you could end up having to pay costly penalties. As a result, small businesses that manage their own payroll, whether manually or using a software, spend countless hours making sure they get it right. According to the 2018 taxation survey conducted by the National Small Business Association, almost a third of all small businesses spend a minimum of 40 hours a year managing their federal payroll taxes alone.
Unless you’re outsourcing your payroll, below are all of the taxes that you will be responsible for withholding from your employee paychecks as well as depositing and reporting them to the IRS.
Federal Income Tax
To identify how much federal tax you need to withhold from an employee’s paycheck, you will need to use the wage bracket or percentage method found in the IRS’s Publication 15. This amount will also depend on the number of personal allowances that each employee claims on their Form W-4. If you use a software program, this will be calculated for you automatically.
You will have to deposit federal payroll taxes on a semi-weekly or monthly depositing schedule, which is determined by the IRS. If you reported $50,000 or less in taxes on Form 941 during the four-quarter lookback period, you will deposit federal payroll taxes once a month. If you reported more than $50,000, you will deposit those taxes semiweekly.
Federal Insurance Contribution Act (FICA) taxes consist of Medicare and Social Security taxes. Both you and your employees must pay FICA taxes. Basically, you will match the amount that you withhold from your employee’s paycheck to send and report to the IRS. The amount that both you and your employees must pay is as follows:
- Medicare tax – Medicare tax accounts for 1.45 percent of an employee’s gross wages, which you must match. If the employee makes $200,000 or more, they must pay an additional 0.9 percent in tax (if single–$250,00 or more if married and filing jointly); however, you don’t have to match this additional tax.
- Social Security tax – Both you and your employee must pay 6.2 percent of their gross wages up to $132,900 in Social Security tax each. Once an employee reaches that limit, you will stop withholding and contributing.
State And Local Income Taxes
State and local income taxes vary from state to state. Some states don’t charge local income taxes or state income taxes. In California, you will withhold, deposit, and report state income taxes from your employees’ paychecks. The withholding amount is based on the tax bracket your employees fall into. There are 10 California tax brackets, and these can change from year to year.
There are several other payroll taxes that you will be responsible as the employer. These include the State Unemployment Tax (SUTA) and the Federal Unemployment Tax (FUTA). The FUTA tax rate is generally 0.06 percent and is a percentage of employee wages up to the first $7.000 that you pay to each employee. These must be paid on a quarterly basis and reported on Form 940. In California, employers must SUTA on the first $7,000 in wages paid to each employee in a year. The maximum SUTA is $434 per employee per year.
In California, employers are also required to pay a State Disability (SDI) tax and an Employment Training Tax (ETT). The ETT tax is paid on the first $7,000 in wages paid to each one of your employees in a single year. The SDI tax is paid on the first $118,371 in wages paid to each employee in a single year.
Another important aspect of managing your payroll is keeping accurate records. You will keep payroll records for every one of your employees, including important employee documents such as Form W-4s, pre-tax and post-tax wages, and the total number of hours they worked every week. You will need to keep the payroll records of ex-employees for a minimum of three years.
If You Choose to Manage Your Own Payroll, It Still Pays to Get it Checked
Managing your payroll is not something you should take lightly. It’s well worth the expense to outsource your payroll. If you decide to manage your payroll in-house, then at least invest in a payroll software to help reduce the risk of errors and to make the process more efficient. Remember, if you manage your payroll manually or through the use of a software program, you can still get it checked by a professional payroll accountant or service. Even if you do the majority of the work, getting it checked can help identify any mistakes that you might have made and can save you a significant amount of money in potential fines.
Managing payroll should be done with caution and handled by someone you trust. Talk to our advisers to see what suits your business best.