how to do payroll yourself
A guide for small business owners
As a small business owner, you know that growing your business is a lot of work. Chances are, you’re also responsible for making sure your business operates smoothly. A growing business needs to be lean where it can, meaning that you’ll have to take on some responsibilities that you might not have experience in. One of these responsibilities is bookkeeping and payroll management. As a vital part of your business, paying employees and running payroll is a task many business owners choose to do on their own. So if you’re thinking about running your own payroll, we’ll outline the necessary steps, including what you need to get started and important considerations you should weigh before getting started. First, we’ll look at what is meant by payroll.
What is payroll?
At its core, payroll is the act of compensating employees. Usually, a business will run payroll for a specific period. During payroll, an employer like you calculates and distributes employees’ wages. Depending on the business, this could be every two weeks or biweekly. D
But payroll is more than that. In addition to distributing wages to employees, payroll also means filing taxes, calculating and taking out deductions for local, state and federal taxes; Social Security; unemployment insurance and any voluntary employee deductions. As your business grows and you hire more employees, the manual payroll process can get even more complicated. That’s why many companies tend to outsource payroll to a third party payroll system provider or an online payroll software. However, if you’d like to do it yourself, let’s look at a few things you’ll need to get started.
What do I need to get started with payroll?
If you plan to run a business payroll, you’ll need to ensure you have a few things to get started. Obtaining these things is generally a one-time endeavor, but you’ll need to make sure you have them before running payroll for the first time. Here’s what you need to do:
Get a Federal Employer Identification Number (EIN)
This is a number that the Internal Revenue Service (IRS) uses to track your company’s payroll taxes and payments. You’ll need this number to pay payroll taxes or hire employees. It’s easy to apply and in many cases can be completed entirely online.
Register with the Electronic Federal Tax Payment System (EFTPS)
This is a free service from the government that allows you to pay your payroll taxes and unemployment taxes online. It’s essential that you utilize this service if you do payroll yourself. If you’re working with a third-party payroll provider instead of doing it yourself, they’ll take care of sending your taxes in for you.
Register as an employer in your state
You’ll also need to register as an employer in your state before running payroll. Each state has different requirements, so it’s best to contact your state directly to understand the requirements further. Most states will require you to register with the agency that collects tax information in your state.
Learn payroll related laws and regulations
The next step is to make sure you’re well-versed in the relevant local, state and federal laws and regulations surrounding payroll. While you’ll have to worry about this less if you work with a payroll partner, doing it on your own means educating yourself on the requirements and laws. You should have a good knowledge of the following:
- Your state, city, or county’s minimum wage requirements
- Overtime calculations
- The information you must provide to employees on a pay stub
- Your state’s payday frequency requirements
- How and when you need to deliver an employee’s final paycheck
- Withholding requirements for state disability insurance
- Local income tax withholding requirements
- Paid and unpaid break requirements
- Workers’ compensation insurance requirements
Decide on a payroll schedule
You’ll also need to decide on a pay schedule. This includes your employees' pay rates, how you’ll pay them and how often. While many businesses complete payroll every two weeks, your payroll needs may be different, and you might elect to pay on a weekly, bi-weekly, or semi-monthly basis.
Gather employee information
Before running payroll, you’ll need to ensure you have the necessary employee data for both full-time and part-time employees.
Whether you’re collecting all of this data yourself or you have an employee self-service portal that gives employees the ability to add or change things like their address or deductions, accurate data helps streamline your payroll and tax filing processes. Each employee will need to fill out the following information:
- W-4 Form for federal withholdings
- State income tax forms (which vary by state)
- I-9 Form to verify employment eligibility
During the onboarding process, it’ll also be helpful to collect any bank account information from new hires to set up direct deposit, as this is the most common and streamlined way for employees to receive their paychecks.
Once you’ve completed these steps, you’re now ready to begin the actual process of running payroll. Let’s take a look at the steps in that process.
DIY payroll: What’s the process?
If you’re choosing to run payroll on your own, you’ll need to follow these steps:
Calculate your employees’ gross wages
The first step in running payroll is to calculate each employee's gross pay during the given time period. For salaried employees, this is a straightforward calculation. Take their annual salary and divide it by the number of pay periods in a year. For example, let’s say you employ someone for $100,000 per year. Assuming you have 26 pay periods in the year, the calculation would look like this:
Total salary / pay periods = gross pay
$100,000 / 26 = $3,846.15 gross pay
If you employ hourly workers, the calculation is a bit more complex. For these hourly, non-exempt workers, you must pay them overtime in accordance with the Fair Labor Standards Act (FLSA). That means if they work overtime, you must pay them time and a half for all overtime hours.
Let’s say you employ an hourly worker at $15 per hour, and during the two-week pay period, they worked 84 hours. To figure out their gross pay, the calculation looks like this:
[Total hours worked (up to 40 per week) x pay per hour] + [1.5 x overtime hours worked x pay per hour]
[80 hours x $15] + [1.5 x 4 x $15] = $1,200 (regular pay) + $90 (overtime pay) = $1,290
As you can see, there’s an extra step required for hourly employees who work overtime. Manually tracking hours can be cumbersome for small business owners like you. And even some state and local rules might have different overtime requirements.
Calculate your employees’ pre-tax deductions and subtract them from gross wages
These pre-tax deductions include contributions to health insurance and some retirement plans and help to decrease taxable wages. They also reduce a business’s federal income tax liability but don’t decrease all payroll taxes. For example, FICA taxes use gross pay to calculate Medicare and Social Security taxes.
Calculate your employees’ federal tax withholdings, state income tax and other state taxes
As an employer, you’ll need to withhold a portion of your employees’ paychecks for all applicable taxes. These withholdings can include:
- Federal income tax withholding.
- Local and state tax withholding.
- Employee half of Medicare and Social Security taxes (FICA) – both the employee and employer pay 7.65% of the employee’s gross income to fund the Medicare and Social Security programs.
- State unemployment tax (SUTA), depending on the state.
- Additional Medicare taxes for high-earners.
Note that these withholdings are from the employee’s paycheck and not what you pay as the employer. You have to pay some taxes, and we’ll look at those in the next section.
Calculate other voluntary and mandatory payroll deductions and subtract them from the paycheck
After subtracting taxes for employees, you’ll need to subtract any post-tax deductions. These deductions can include mandatory deductions like wage garnishments or elective payroll deductions like life insurance plan contributions and Roth 401(k) contributions.
Calculate federal and state employer payroll taxes
Once you subtract these payroll deductions, you’ll need to calculate taxes. As a business, you’ll have to calculate and subtract your tax responsibility as a business. You’ll be responsible for the following payroll employment taxes:
- Federal unemployment tax (FUTA) – 6% of an employee’s salary up to $7,000 of eligible income per employee. Depending on the state your business operates in, the IRS could give you a credit of up to 5.4% when you file your Form 940.
- State unemployment tax (SUTA) – this tax rate varies from state to state, based on various factors.
- Employer half of Medicare and Social Security taxes (FICA) – as stated earlier, both the employee and employer pay 7.65% of the employee’s gross income to fund the Medicare and Social Security programs.
- Local taxes – variable based on the local rules and regulations.
Pay employees and record payroll totals
After doing all of this, you’ll get a net pay amount. This is the actual take home pay an employee will get. You’ll also need to prepare a payroll journal entry for your payroll records. You’ll include all costs to process payroll: wages, employee- and employer-paid payroll taxes, and payroll deductions. Depending on your business’s accounting method, these payroll journal entries will vary in complexity. For those businesses that use accrual accounting, payroll journal entries may be more detailed than those that use cash-basis accounting.
Whether you pay employees by physical check or send pay via direct deposit, you’ll want to make sure that you attach a pay stub to each paycheck. The pay stub is the proof of their work, and shows employees how you got to the final paycheck amount. These details can help an employee double check that they’re receiving the correct paycheck amount or gain a better understanding of where their money is going.
Put money aside to pay the government
Finally, you’ll have to send off tax and benefit payments to the government. Since you’re doing payroll for yourself, you’ll have to submit these payments to the right entities. However, those who use tax software have these payments made on their behalf.
As you can see, payroll is a complex process. On top of doing payroll by yourself, you’ll also need to keep track of filing deadlines and due dates for all taxes and other types of payments. Factoring these steps in, payroll can be an arduous task. It’s why many small businesses work with a payroll partner or utilize payroll software to help streamline their payroll. Being hands-on at your business is great, but payroll may be where you look to find a helping hand.
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