Normal guy standing behind counter and POS system

10 steps to Payroll Processing

Tuesday, April 29, 2014
Ask any small business owner, and they'll confirm that payroll processing is one of the most daunting tasks a business has to deal with.

Every month, employees anticipate payday with excitement and joy. Sadly the feeling isn't shared across all departments, and the same can't be said about staff in payroll departments.  

As others wait in anticipation, the HR and finance departments slowly lose their sanity.

Just how hard can payroll processing be?

It's hard and time-consuming to track regular time,  overtime, gross wages, and deductions for all employees in a company. And it doesn't help that mistakes here can be costly.

 Above that, payroll processing also means navigating the murky waters of the American taxation system, making sense of the ever changing regulations and finding the time needed to actually handle payroll.

Since payroll processing is a challenging process for most people to wrap their heads around, we've created a 10-step checklist that breaks it down for you. Let’s start with the basics—what is payroll processing?

Payroll processing is the compensation of pay and benefits 

Payroll processing refers to the task of managing the payment of wages, salaries, and remunerations to your employees.

While it may sound simple enough, it is not a straightforward task. 

Payroll processing involves:

  • Timely filing of forms and documentation
  • Compliance with  ever changing regulations
  • Calculating both employee and employer taxes and tax returns
  • Calculating normal time and overtime hours compensation
  • Staying up to date with varying tax rates, changing forms, and updated regulations

10 steps to processing payroll

This step-by-step payment processing guide will give you the know-how of payroll processing from the moment you onboard an employee to when your check lands in their bank.

Step 1: Employee forms and verifications

Every employee and employer has to go through a process before becoming part of the "system." 

Most of your employees probably have all this sorted out. However, it's crucial to double-check for any new hires that may have slipped through your department's hands.

Once your employees are part of the system, they're now part of the American workforce in name and paper.

To do this, you have to:

  • File or sign up for an employer identification number (EIN)

An employer identification number is a unique number that the IRS uses to identify your business or any other entity that partakes in paying employees.

Without an EIN, your business cannot partake in the payroll processing process. If your business doesn't have an EIN, feel free to apply for one here on the IRS website

Have all your employees complete an I-9 and W-4 Form

  An I-9 form shows that your new employee is legally allowed to work in the United States. The W-4 form helps you determine the amount of taxes that are withheld from each individual's paycheck based on their unique family situation. Both of these federal forms are required. 

Step 2: Calculate the employee's gross wages

Calculating your employee's gross wages is fairly straightforward. For your hourly employees, the use of  time cards will make this task much easier. 

Use the formula: (Total hours worked * hourly rate) + overtime pay + premiums dispersed

For your salary employees, you can use the formula:(Annual salary/number of pay periods each year)

Step 3: Calculate the employee's pre-tax deductions

A pre-tax deduction refers to any money you withhold from your employee's gross salary before you withhold taxes from your employee's salary.

Pre-tax deductions vary from company to company. That said, the deductions in your company will be different from deductions in another company.

A few examples of pre-tax deductions include:

  • 401k
  • Health insurance and dental insurance
  • Charity contribution and other commitments
  • Child care expenses 

Step 4:Calculate federal taxes to be deducted

Federal income tax withholding and calculations are among the most complex aspects of payroll processing. 

Each of your employees will have a different federal tax withdrawal amount. This is because the IRS uses different factors to calculate federal taxes. These include:

  • Your employees number of dependents
  • Your employee's filing status ( breadwinner or head of household)
  • Tax filing and payment frequency

To calculate your employee's taxes, you'll need to look up IRS publication 15 and IRS publication 15T that goes into further detail of your tax calculation.

Using the IRS withholding calculator, you can also calculate the federal and state taxes to withhold from your employee's paycheck.

Step 5: Calculate manual payroll taxes

As you saw above, payroll taxes refer to a percentage that you withhold from an employee's pay and pay it to the government on their behalf.

FICA stands for Federal Insurance Contributions Act. It is a mandatory deduction whose funds are used to run massive social programs such as social security and Medicare.

With FICA taxes, your employees pay half of the taxes; you, the employer, match their contribution by paying the other half.

Social security

The current rate for social security taxes is 6.2% for the employer and an additional 6.2% for the employee. That's a total of 12.4% in social security taxes.


The current rate for Medicare is 1.45% paid by your employees and another 1.45% that you pay as the employer. The total amount you pay for medicare taxes is 2.9%.

Calculating social security and medicare taxes

The total taxes you and your employees pay for social security and Medicare add up to a total of 15.3%.

To calculate the total your employee pays for FICA taxes, use this formula:

(Gross pay*6.2) for social security taxes

(Gross pay*1.45) for medicare taxes

Step 6: Calculate any other taxes

Federal and FICA taxes are just the beginning. You still have to calculate state and local taxes for the jurisdiction where you run your business operations.

State income tax varies from state to state. In California, your employees could be paying upwards of 13%. 

However, in Texas, there isn't state income tax.

The Bureau of Labor has a chart that provides a comprehensive breakdown of every state's taxation requirements.

Step 7:Calculate your employee's post tax deductions

Post-tax deductions refer to the money you take out of your employee's salaries after their tax payments.

The post-tax deductions that you take from your employee's pay vary from state to state.

That established, you must look into your state's regulations for insight when calculating and withholding post-tax deductions.

Some of the post-tax deductions that you may have to withhold from your employees pay include:

  • Wage garnishments
  • Roth 401k plans
  • Employer-sponsored pension plans
  • 529 college savings plans
  • Union dues
  • Charitable donations

Step 8: Pay employees and record totals

By this stage, you've calculated both the pre-tax and tax deductions for your employees. With that data, you can now go ahead and pay your employees the money that you owe them, depending on your payroll schedule.

This is their net pay, which is the amount that eventually lands in their bank accounts.

To calculate the net pay of your employees, you can use the following steps:

  • Calculate your employee's gross wages
  • Subtract pre-tax deductions and non-taxable arrangements
  • Withhold taxes from taxable wages
  • Subtract post-tax deductions to arrive at net pay

You can then pay your employees either monthly, semi-monthly, or bi-weekly depending on your pay schedule.

As you go about this process, ensure that you're doing your best to keep accurate records. Records are critical for maintaining an IRS-compliant payroll processing. 

You also need to ensure that you remain compliant with your state's paystub requirements throughout the entire process.

Step 9: Calculate your employers payroll taxes

Once you’ve made it to this step, you only have one payroll calculation left. 

This is calculating the taxes that you owe as an employer.

Most of this will be because of the payroll taxes you have to match as an employer. These are:

Social security taxes

As an employer, you'll have to match 6.2% of your worker's compensation or earnings as social security taxes.

However, there's a catch. Social security taxes have a wage base that is set at $142,800 for 2021. 

This means that you don't get to match taxes for those employees who earn more than $142, 800.

To calculate your social security taxes, use the formula:

(Taxable Income (up to $142800*6.2%)

Medicare taxes

As an employer, you have to match 1.45% of your employee's remuneration as Medicare taxes. However, unlike social security, Medicare doesn't have a wage base.

Instead, it has an additional tax for high-earners which is an extra 0.9% for your employees earning more than $200k.

To calculate your medicare taxes, use the formula:

(taxable income*1.45%) 

This formula applies to all your employees regardless of whether they earn above or below $200k. This is because the additional 0.9% for each dollar above $200k is paid only by your employee.

Self employed and independent contractors

Although self-employed people fall under small business owners, they pay different employers' taxes.

Self-employed people pay a total tax of 12.4% for Social Security and 2.9% for Medicare.

If you're a self-employed small business owner earning below $200k, you can use this formula to calculate your employer taxes.

(taxable income*15.3%)

 If you happen to make upwards of $142,800, you stop calculating social security for any dollar above that threshold.

On the other hand, if you earn more than $200k, you can calculate your additional medicare taxes by multiplying all earnings above the threshold by 3.8%.

Once you're done calculating these taxes, you can pay them through direct deposit, which is the most preferred method of filing taxes.

Step 10: File quarterly and annual tax forms 

The last step in the payroll processing task is filing your quarterly and annual tax forms and keeping accurate payment records.

These forms include:

Form 940

An IRS form 940 is an annual tax report that you have to fill if you're a business that has employees.

Form 941

Form 941 is an IRS form that serves as an employer's quarterly federal tax returns. The IRS form 941 is the form you, the employer, use to report and pay federal and payroll taxes to the US government.

Automate the payroll process with payroll software

One word can describe manually processing payrolls, inefficient. We can all agree that some things don’t belong in this decade.Flip phones, typewriters, manually reading timesheets, and typing social security numbers are high on this list.

This is where payroll software comes in, and as you're about to see, it can do wonders for your payroll processing.

What is payroll software?

Payroll software refers to a system that helps create an efficient payroll processing process by removing mundane and repetitive tasks.

Payroll software works by automating the payroll automating process. By doing this, the software does the heavy lifting on your behalf, only giving you a mildly supervisory role.

An efficient payroll service will allow you to sit back and relax as it handles:

  • Calculating hours worked and deductions for accurate employee payments 
  • Year-end tax filing and forms
  • Payroll tax filing and deposits
  • W-2 printing mailing and reporting

Implementing payroll software is easier than it seems

Transitioning from a manual spreadsheet-based system to a modern payroll system isn't as complicated as people make it.

In fact, with recent advances in payroll software, transitioning or upgrading a payroll provider has never been easier. Simply verify your employee information before importing this data to your new automated system, 

Henceforth, all your new employees will be onboard into your new payroll processing system seamlessly.

How payroll software can help you avoid costly mistakes

Manually processing payroll yourself comes at a price. It can lead to costly errors with fines from the IRS, losses, and lawsuits.

Leveraging payroll software is one of the most significant ways to close in on the margin of error and create a foolproof payroll system.

Payroll software increases accuracy by:

  • Tracking your payment schedule 24/7 and accurately calculating your tax payments
  • Reporting all taxable compensation that makes compliance easier
  • Automating mandated garnishment hence reducing chances of error


Get started today with Heartland payroll solutions

Heartland is the point of sale, payments, and payroll solution of choice for entrepreneurs that need people-powered technology to sell more, keep customers coming back, and spend less time in the back office.

Nearly 1,000,000 entrepreneurs trust Heartland to guide them through market changes and technology challenges, so that they can stay competitive and focus on building remarkable businesses instead of surviving the daily grind. Learn more at