As your business grows, you'll eventually reach a point where you can no longer do it all by yourself. Hiring employees will become necessary for any flourishing small business, and when that time comes for your company, you’ll need to set up payroll – which requires far more than just issuing paychecks.
When paying your employees, there are many federal, state, and sometimes local requirements regarding how payroll is administered. Understanding the ins and outs of the payroll process is crucial for keeping your small business in compliance with these ordinances. Below, learn about what you need to know about payroll taxes, relevant tax forms, and other important considerations for processing your small business’s payroll yourself.
What you need to know about paying employees
Paying your employees involves several main components, including properly issuing paychecks according to employee preference and state law, filing the correct tax forms, and withholding the correct deductions from your employees’ pay.
The term “payroll taxes” comprises state and local income taxes when applicable, as well as Social Security and Medicare taxes you are required to withhold from salaried employees who receive W2 forms from your company. You may additionally need to withhold state unemployment insurance taxes, depending on where your business is based. Note that for 1099 employees, you do not need to withhold payroll taxes.
To properly execute payroll, you may need to work with some of these tax forms:
- Form W-4, completed by your employees so you can withhold the correct federal income tax
- Form I-9, indicating that your employee can legally work in the United States
- Form W-2, issued annually to every full-time or part-time employee to show how much was earned in wages and how much tax was withheld
- Form W-3, a summary you file with the federal government detailing the taxes paid to the Social Security Administration (SSA) during the prior tax year
- Form 1099, issued annually to every independent contractor to show how much the contractor was paid
- Form 8109, used to process and submit your bi-weekly or monthly tax deposit payments
- Form 941, filed quarterly to indicate the payroll tax liability for which your business is responsible
- Form 940, filed quarterly to indicate the unemployment tax liability for which your business is responsible
The Eight Steps of the Payroll Process
When running employee payroll for a small business, you will need to adhere to the following steps.
1. Employee intake forms
Make sure that all new employees fill out the following forms:
- IRS W-4 (Employee Withholding Certificate). New employees must complete this form to indicate how much your business should withhold from their paychecks. You, rather than your new employee, must submit this form to the IRS.
- I-9 (Employment Eligibility Verification). New employees must complete this form to confirm their legal ability to work in the United States, and you must file this form with the IRS on your new employee’s behalf.
- State registration forms. You must fill these forms out for your new employees to ensure that your company properly complies with local, state, and federal income tax, unemployment insurance tax, and workers’ compensation insurance regulations.
2. Obtain an employer identification number (EIN)
From the moment your business brings on its first employee, your company needs an employer identification number (EIN). Without an EIN, your business cannot properly process taxes or receive valid tax identification. To obtain an EIN, file an application with the IRS and be prepared to provide:
- Your business structure as defined by the Small Business Administration (SBA)
- Your business address
- Your reason for requiring an EIN, such as hiring your first employee
- All relevant additional details about your business
You may also need an employer identification number issued on a state level. Check with your state authorities for more information.
3. Establish a payroll schedule
How often you plan to issue paychecks is a key consideration both for your employees and your own accounting. Depending on where your business is based, whether your employees are salaried or hourly, and your industry of operation, your business may be required to pay employees weekly, bi-weekly, monthly, semi-monthly, or at some other frequency. Check your state regulations to determine the payroll schedule appropriate for your business.
4. Classify your employees
Your employee payroll tax obligations may differ depending on how you categorize your employees. You should thus be certain to classify your employees properly when you set up your company’s payroll process. The seven most common employee types are:
- Full-time employees
- Part-time employees
- Temporary employees
- Contract employees
- Seasonal employees
- Shift workers
- Freelancers
5. Calculate all taxes
The first four steps of the payroll process are completed at the outset of launching your business or as part of onboarding a new employee. Calculating and paying taxes are regular, recurring business operations that happen every time you run payroll for eligible employees in your small business. To calculate taxes, determine the number of:
- Hours the employee worked. While this number should remain constant for full-time, salaried employees, it may differ by payroll report for other categories of workers, especially hourly employees.
- Overtime days worked. In almost all states, non-exempt employees who work more than 40 hours during a workweek must be paid overtime at one-and-a-half times their usual pay rate.
- Sick leave and vacation days worked. Be sure to pay your employees appropriately for these days, as outlined in your employee handbook’s leave policy. Keep in mind that many states have sick leave or vacation leave laws your business must follow.
Once you have tallied all employee time worked, you must then multiply your employees’ hourly wages for the period by the number of hours worked. For salaried employees, assume a constant rate of payment every pay cycle unless you need to deduct wages for days taken off or add more wages for overtime hours. The amount determined from these calculations is known as gross pay.
Once gross pay is determined, apply the following deductions:
- Municipal, state, and federal income taxes
- Medicare and Social Security taxes
- Court-ordered wage deductions for child or spousal support
- Premiums for benefit plans such as medical insurance
- Contributions to retirement funds
- Voluntary charity donations, if applicable
The amount you pay your employees after these deductions is known as net pay.
In addition to gross and net pay determinations, you must calculate taxes that your business pays independently of employee payroll. These taxes are primarily Federal Unemployment Tax Act (FUTA) taxes, often known more simply as unemployment taxes. Instead of deducting these taxes from your employees’ paychecks, you pay them directly, with rates that vary based on your company’s size and the incomes you pay your employees.
6. Pay taxes
Once you have calculated the taxes your business owes, you must pay them by your deadline, which varies based on your business classification. Most taxes can be paid online by registering for an IRS Freefile Fillable Forms account.
7. File tax forms
You must pay taxes every time your company runs payroll, and you must file tax returns quarterly and annually. Use these forms to pay your required taxes:
- Form 8109. You file this form to process your bi-weekly or monthly tax deposit payments.
- Form 941. You file this form quarterly to indicate your payroll tax liability.
- Form 940. You file this form annually to indicate your unemployment tax liability.
Alongside your tax payments, you must file the aforementioned forms. You must also file certain other forms annually:
- Form W-2. Filed annually, this form tells the IRS how much tax you withheld from your employees’ paychecks throughout the year. Each employee receives a copy of this form detailing all their annual withholding.
- Form W-3. This summary form is supplemental to Form W-2 and is filed to the government alongside your W-2. Unlike Form W-2, your employees do not receive copies of this report.
- Form 1099. Form 1099 details all payments made to an independent contractor, for whom you withhold no deductions on any paychecks. Your independent contractors will receive copies of this form.
8. Prepare your annual filings
After filling out the required tax forms, you must also prepare and submit your company’s required annual tax filings. Only after you do so can you consider your payroll report for the tax year complete.
Alternative options to running payroll yourself
If doing payroll yourself seems overwhelming, you have other options. You can use a payroll software platform, also often known as a payroll service, to streamline and automate your employee payments and tax filings. You can also hire an accountant to keep your company’s payments, taxes, and other payroll concerns on track.
Whether you ultimately choose an alternative option or administer payroll yourself, it is vital to understand all work that goes into paying your employees beyond just sending a check. Whether you choose to go it yourself or bring an outside expert into the fold, proper payroll keeps your business running smoothly – for both your employees and your business.
