How to Do Payroll: A Step-by-Step Guide for Employers

Setting up and managing payroll can feel overwhelming, especially for new business owners. However, getting payroll right is crucial to avoid errors, delays, and potential legal issues. Whether you handle payroll yourself or outsource it to a provider, understanding the process will ensure smooth and accurate payments for your employees.

This guide covers everything you need to know about running payroll, including:

  • What you need to run payroll
  • How payroll is calculated
  • Managing tax withholdings
  • Payment methods
  • Record-keeping requirements
  • Whether you should do payroll yourself or outsource it

By the end of this article, you’ll have a clear roadmap for setting up and managing payroll efficiently.

What Do You Need to Run Payroll?

Before processing payroll, you need to establish your business as an official entity with the appropriate regulatory bodies. Here’s what you need to do:

  1. Obtain an Employer Identification Number (EIN): This is required by the IRS for tax reporting. You can apply online through the IRS website.
  2. Get a State or Local Tax ID: Depending on where you operate, you may need a state-specific tax ID for payroll tax compliance.
  3. Register for Tax Withholding and Other State Programs: Check your state’s labor and tax regulations to ensure you comply with all requirements, such as withholding state income tax or contributing to unemployment insurance.

Once these steps are completed, you can start gathering essential information to process payroll accurately.

How is Payroll Calculated?

When calculating payroll, it’s important to consider more than just wages. Here are the key steps:

1. Determine Employee Compensation

  • Hourly Employees: Multiply the number of hours worked by their hourly wage.
  • Salaried Employees: Divide the annual salary by the number of pay periods in the year.
  • Overtime: For non-exempt employees, overtime is typically paid at 1.5 times the regular hourly rate for hours worked over 40 per week.

2. Deduct Taxes and Other Withholdings

From an employee’s gross pay, you must deduct:

  • Federal Income Tax
  • State and Local Taxes (if applicable)
  • Social Security and Medicare (FICA taxes)
  • Health Insurance Premiums
  • Retirement Contributions (e.g., 401(k))

The remaining amount after deductions is the net pay, which is the amount employees take home.

Managing Tax Withholdings

Each pay period, you must withhold and submit taxes to the IRS and state agencies. Employers typically need to:

  • File Form 941 (Employer’s Quarterly Federal Tax Return) to report federal tax withholdings.
  • Deposit payroll taxes either semi-weekly or monthly, depending on IRS guidelines.
  • File state-specific tax reports as required.

Failure to submit taxes on time can result in IRS penalties, so it’s crucial to stay on schedule.

Methods of Paying Employees

Once you’ve calculated net pay, you need to distribute wages. Here are common payroll payment methods:

  1. Direct Deposit: The most convenient and widely used method, allowing employees to receive payments directly into their bank accounts.
  2. Paper Checks: Some businesses still use checks, but they can be time-consuming and prone to errors.
  3. Payroll Cards: A debit card employees can use to access their wages, useful for those without bank accounts.
  4. Cash Payments: While legal, this method is discouraged due to compliance and record-keeping challenges.

Be sure to check state laws regarding pay stub requirements and payment methods to stay compliant.

Record-Keeping Requirements

Employers must maintain payroll records for at least three years to comply with the Fair Labor Standards Act (FLSA). These records include:

  • Employee time cards and work schedules
  • Pay stubs and payroll tax filings
  • Wage adjustments and deduction details

Proper record-keeping ensures compliance and protects your business in case of audits or disputes.

Can You Do Payroll Yourself?

Yes, many small businesses handle payroll internally, but it requires time and attention to detail. Common options include:

  1. Manual Payroll Processing: Suitable for very small businesses but prone to errors.
  2. Payroll Software: Automates calculations, tax filings, and direct deposits, reducing errors and saving time.
  3. Outsourcing Payroll: Hiring a payroll provider ensures accuracy and compliance, allowing business owners to focus on growth.

A QuickBooks study found that business owners spend nearly five hours per pay period managing payroll. If payroll becomes too time-consuming, outsourcing may be a cost-effective solution.

Final Thoughts

Setting up and running payroll doesn’t have to be daunting. By following this guide, you can ensure accurate and timely employee payments while staying compliant with tax laws. If managing payroll feels overwhelming, outsourcing to a reliable payroll provider may be the best choice for your business.

Whichever method you choose, staying informed and organized is the key to smooth payroll management.