Payroll isn’t nearly as simple as just paying your employees. Payroll management encompasses several different steps and responsibilities. Each part of the payroll process requires you to take certain actions or make decisions that impact how your employees are paid and ensure that your business is compliant with any government regulations that apply.
As a small business owner, it’s your responsibility to either take care of each of these steps—or find someone that you trust to manage payroll for you. Here’s a guide to help you learn what it takes to properly manage payroll for a small business.
Set Up Your Payroll
You first need to set up your payroll system before you can begin to manage anything. Setup is largely divided into two parts, both of which contain multiple aspects that you must address:
- Account registration and key payroll decisions
- Collection of required information
Account Registration and Key Payroll Decisions
Employee Identification Number
Before you start, you’ll need to apply for an Employer Identification Number (EIN). An EIN is a unique nine-digit number assigned by the IRS to identify each business. As a result, it’s required that you include your EIN when you send certain payroll documents to the IRS and state agencies. While not every business requires an EIN, it’s required if you can answer yes to any of the following questions:
- Do you have employees?
- Do you operate your business as a corporation or a partnership?
- Do you file any of these tax returns: Employment, Excise, or Alcohol, Tobacco and Firearms?
- Do you withhold taxes on income, other than wages, paid to a non-resident alien?
- Do you have a Keogh plan (a retirement plan for self-employed people)?
- Are you involved with any of the following types of organizations?
- Trusts, except certain grantor-owned revocable trusts, IRAs, Exempt Organization Business Income Tax Returns
- Real estate mortgage investment conduits
- Non-profit organizations
- Farmers' cooperatives
- Plan administrators
You’ll need to register for an Electronic Federal Tax Payment System (EFTPS) account to pay federal taxes. EFTPS is free and allows owners a convenient way to pay online or over the phone. To register, you’ll need to provide three pieces of information:
- An EIN or a Taxpayer Identification Number (TIN)
- A bank account number and routing number
- Your name and address
You also have some setup work depending on your state, as your state may require you to have employer ID numbers for state and local governments. Also, each state has its own new hire reporting process. You can find each state’s new hire reporting site online, where you’ll be able to register your business and gather state-specific information on the following:
- Contact information
- Reporting time frame
- Data elements, both mandatory and optional (ex. employee name, address, etc.)
- Method of transmission
- Whether the state requires the reporting of independent contactors
In addition to applying and registering for various identification numbers and payroll accounts, you’ll need to decide on how often your employees will be paid and exactly how you’ll pay them. Typical pay frequencies range from weekly to monthly, while payment methods include:
- Direct deposit
- Payroll card
Another important decision revolves around which of your employees will have hourly or salary wages, as well as their exemption status. Nonexempt employees must be paid at least the minimum and receive overtime pay. Exempt employees are not eligible for overtime and must meet the following requirements:
- Be paid on a salary basis
- Make at least $23,660 per year or $455 per week
- Hold positions that are considered exempt, such as executive, administrative, or professional roles
Collection of Employee Information
With everything the preceding registrations and payroll decisions behind you, it’s time to collect employee information. Existing employees will need to fill out Form W-4 to determine how much they’ll individually have withheld in payroll taxes. These amounts are calculated based on how much each employee earns and their specific withholding allowances. In addition to Form W-4, new employees are required to complete Form I-9 to verify their employment eligibility before they start work.
Benefits information also plays a key part for payroll management. If your employees pay into benefits like health insurance and retirements plans, you’ll need to know how much to deduct from their paychecks for each item. As each employee may have different ancillary benefits or contribute varying amounts to their accounts, you’ll need to have that information ready when it comes time to run payroll.
Once you have all the payroll information you need, it’s time to determine how you to want to manage your payroll. There are three main options to choose from:
- Manual payroll
- Payroll software
- Outsourcing payroll
Choosing to manually manage payroll is the least expensive option of the three, but it also places all the burden on your shoulders. If you’re a payroll expert, this may not be an issue. If you’re like most business owners and don’t have extensive payroll training, it forces you to learn key payroll procedures, such as how to submit taxes appropriately and how to calculate the amount of payroll taxes that need to be withheld from each paycheck. Without extra care and proper payroll best practices, this can leave you exposed to costly mistakes and penalties from the IRS.
Investing in payroll software can give you the tools to take some of the pain out of payday preparation. Software gives you the ability to handle many of the payroll management processes online instead of on paper. This can help you limit the amount of time that you spend on payroll management while making it easier to handle complicated parts of the process, such as keeping track of critical payroll deductions. Of course, this means that you’re still the person who needs to take care of payroll management and any compliance concerns.
Outsourcing can be more expensive than managing payroll by yourself, but it can end up being one of the most cost-effective solutions based on the amount of time you’ll save and the number of compliance issues and potential fines you can avoid. When you outsource payroll administration to an outside company, such as a Professional Employer Organization, you have access to payroll and other human resources experts who can take care of every function of payroll management, such as processing paychecks, handling payroll taxes, and keeping records. While a PEO manages these processes, you still retain full control and direction over your employees.
After you collect all the necessary payroll information and choose a payroll system, you have all the tools to finally run payroll for your business. What you must do and how much time you must commit to it all depends on your method of payroll management. If you outsourced your payroll, your payroll partner will manage some of these responsibilities for you, such as calculating taxes based on the data you provide. Of course, it’s often best for you to maintain responsibility for other aspects of running payroll since you know your employees better than any outside partner. This includes handling the following processes:
- Enter the hours worked for each employee for the duration of the current pay period
- If an employee is non-exempt, account for any overtime worked during the pay period
- Review payroll for accuracy and pay your employees in accordance to how they’ve chosen to be paid (paycheck, direct deposit, etc.)
If you choose to handle payroll on your own, you’ll have to handle all the above responsibilities, as well as managing tax calculations and other key compliance functions for every payroll period. It also means that you’re on your own to create a system to help you organize and report data, which an outside company can provide.
Handle Payroll Taxes
The National Small Business Association’ 2018 taxation survey found that one third of small businesses spend at least 40 hours per year managing federal payroll taxes alone—and some took even longer. Part of this is due to the fact that there are multiple taxes that employers need to manage. This includes the following taxes, all of which need to be withheld, deposited, and reported from each the gross wages of each employee:
- Federal income tax
- FICA tax (Social Security and Medicare taxes)
- State and local income taxes (if applicable)
In addition, there are some other employer taxes, such as SUTA and FUTA, that you’ll need to pay based on employee wages, but that are not withheld from your employees’ paychecks.
Federal Income Tax
Any wages or other forms of pay made to an employee are subject to federal income taxes. The taxes that are withheld are determined by several factors, including how much each employee is paid, the number of personal allowances an employee claims on Form W-4, and other details. It’s uncommon, but there are times where an employee may claim to be tax exempt. If this is the case, you don’t need to withhold any federal income tax from that employee’s wages.
How to Calculate Incomes Tax Withholdings
There are multiple ways that you can calculate withheld income taxes. The two most common are the percentage method and the wage bracket method, which use specific tables to calculate the tax deductions based on factors like employee allowances. The wage bracket method is based on finding which wage range each employee falls under and identifying how much you should withhold based on that employee’s total allowances. The percentage method calls for you to first identify the amount for one withholding allowance based on an employee’s payroll period (weekly, monthly, etc.) and then multiply it by that employee’s total number of allowances. Once that’s done, you can subtract the total from the employee’s wages and find the withholding total from a range of wages.
The IRS provides tables to help determine the withholding amounts for each method, as well as details and examples of how they are applied, in Publication 15. Payroll software or professional payroll experts will be able to save you from having to calculate federal income tax withholdings manually.
How to Determine Tax Depositing Frequency
The frequency for which you make federal payroll tax deposits depends on your past tax liability. The IRS reviews what you reported on a four-quarter lookback period on Form 941 and determines your depositing schedule based on the amount of taxes you reported. These taxes need to be reported four times each year (April 30, July 31, Oct. 31, Jan. 31).
If you reported $50,000 or less in taxes or are a new business without four quarters of reported taxes, your deposits must be made monthly. These are due by the first of the following month. If you reported more than $50,000 in taxes, your deposits are semiweekly. The due dates for these deposits depend on the days that your employees are paid:
- If payday is Wednesday through Friday, taxes must be deposited by the following Wednesday
- If payday is Saturday through Tuesday, taxes must be deposited by the following Friday
The Federal Insurance Contributions Act (FICA) tax covers two separate taxes: Medicare and Social Security. In total, you need to withhold 7.65 percent of your employees’ wages per paycheck to account for FICA, which accounts for both Medicare and Social Security. FICA taxes follow the same depositing and reporting schedule as federal income taxes.
Medicare taxes calls for employers to withhold 1.45 percent from each paycheck. In addition, you also need to match that percentage as separate payment that is not withheld from your employees’ wages. The Medicare tax applies to wages of up to $200,000 for single employees, $250,000 for a married employee who files jointly, or $125,000 for employees who are married, but file separately. Any wages above those thresholds are subject to an additional 0.9 percent deduction from every paycheck that you don’t have to match.
Social Security taxes call for you to withhold 6.2 percent of each employee’s gross wages up to the 2018 wage base of $128,400. Like Medicare taxes, Social Security taxes also call for you to pay an additional matching portion of 6.2 percent in taxes.
State and Local Income Taxes
While federal income taxes and FICA taxes are applied to each state, state and local income taxes can differ greatly depending on your location. In fact, you may not even have to withhold any state or local income taxes depending on your state. There is a total of nine states that do not have any income tax or have income tax that doesn’t apply to employment income.
- New Hampshire (dividend and interest income only)
- South Dakota
- Tennessee (dividend and interest income only)
Of the remaining 41 states with state income taxes, 16 also require employers to withhold local taxes as well. These states are:
- New Jersey
- New York
- West Virginia
Of the states with state and local taxes, each one will have its own specific rates. Some of which will have a flat withholding rate, while others will have multiple brackets that will affect your deductions. The Tax Foundation lists the state rates and brackets as of 2018, but you’ll want to check with your state to determine your responsibilities when it comes to withholding rates and depositing schedules.
As an employer, you are responsible for paying two different taxes on employees’ wages:
- Federal unemployment (FUTA)
- State unemployment (SUTA)
FUTA is used to fund the federal government’s oversight of each state’s unemployment program and is reported as part of Form 940 and filed quarterly by the same dates as Form 941. This is typically 6 percent of wages up to the first $7,000 paid to each employee. However, the IRS generally gives you a credit of up to 5.4 percent when you file your Form 940, unless you are in what is considered a credit reduction state. Employers in these states will not receive as much credit back because their states have unpaid loans. The Department of Labor (DOL) keeps track of current credit reductions and potential reductions in the future.
SUTA is the state counterpart of FUTA. Each state will require you to sign up for a SUTA account after you’ve hired your first employee. These can be found on your state’s government website. At this point, the state will give you an initial unemployment tax rate. These rates can vary greatly on several factors, including how long your business has been around and your industry. Each state can also place different wage bases on SUTA, which you’ll learn after you sign up for your state account. As for filing and reporting these taxes, you’ll be required to fill out a quarterly return for your state. Some states will accept online electronic fund transfers, but you’ll need to check with your state for exact payment options.
Keep Payroll Records
Payroll responsibilities include keeping detailed records on file. The Fair Labor Standards Act (FLSA) requires you to keep accurate records for your non-exempt employees. These records include:
- Employee's full name and social security number
- Address, including zip code
- Birth date, if younger than 19
- Sex and occupation
- Time and day of week when employee's workweek begins
- Hours worked each day
- Total hours worked each workweek
- Basis on which employee's wages are paid (e.g., "$9 per hour," "$440 a week," "piecework")
- Regular hourly pay rate
- Total daily or weekly straight-time earnings
- Total overtime earnings for the workweek
- All additions to or deductions from the employee's wages
- Total wages paid each pay period
- Date of payment and the pay period covered by the payment
In addition, you also need to store these records for extended periods of time in case the DOL needs to review anything. Payroll data should be stored for at least the last three years, while documents involving wage computations should be kept for at least two years.
Need a Trusted Payroll Partner?
Managing payroll for a small business takes a lot of time and hard work. After all that, payroll administration can still leave you exposed to costly non-compliance penalties and angry employees if you don’t make sure every aspect of the process is handled perfectly.
If you’re looking for a payroll partner that can professionally manage payroll for your business, GMS can help. As a PEO, we can decrease your workload and liabilities so that you can focus on growing your business. Contact GMS today to talk to one of our experts about how we can strengthen your business through payroll administration.