Small Business Payroll 101: A Beginner’s Guide

Running a small business involves many moving parts, and payroll is one of the most crucial. Whether you have one employee or a growing team, getting payroll right is essential to keeping your workforce happy and your business compliant. In fact, 49% of workers say they would look for a new job after just two payroll errors (HR Dive). That’s why understanding how to handle payroll effectively is vital for small business success.

If you’re wondering how to set up payroll for your business, there are different options to consider. Each method has its pros, cons, and cost implications. This guide will walk you through the basics of Small Business Payroll 101, helping you decide the best payroll method for your needs.

Option 1: Managing Payroll In-House

Handling payroll on your own may seem like a cost-effective solution, but it comes with significant responsibilities. You’ll need to stay updated on tax laws, track employee hours, process paperwork, and ensure payroll taxes are calculated correctly.

Steps to Process Payroll Manually:

  1. Obtain an Employer Identification Number (EIN) – Register with the IRS and your state’s tax agency.
  2. Classify Employees Correctly – Determine whether your workers are full-time employees or independent contractors.
  3. Collect Required Forms – Employees must complete a W-4 form, while independent contractors need to submit a W-9.
  4. Determine Pay Schedule – Decide whether you’ll pay employees weekly, biweekly, or monthly.
  5. Calculate Gross Pay – Track hours worked, overtime, and any bonuses.
  6. Deduct Taxes and Benefits – Withhold federal, state, and local taxes, along with deductions for benefits.
  7. Pay Employees – Issue paychecks or set up direct deposit.
  8. Submit Payroll Taxes – Remit withheld taxes to the IRS and relevant state agencies.
  9. Keep Payroll Records – Maintain detailed payroll records for compliance and auditing purposes.
  10. Prepare Year-End Forms – Issue W-2s to employees and 1099s to contractors.

Pros of In-House Payroll:

  • No additional service fees.
  • Full control over payroll processing.
  • Can be manageable for very small teams.

Cons of In-House Payroll:

  • Time-consuming (small business owners spend an average of 5 hours per payroll run, which adds up to 21 days per year – QuickBooks Payroll Study).
  • High risk of errors and IRS penalties.
  • Complex tax regulations require constant monitoring.

If managing payroll alone seems overwhelming, consider outsourcing to a professional.

Option 2: Hiring an Accountant or CPA

If you prefer not to handle payroll yourself but still want a human touch, hiring a Certified Public Accountant (CPA) might be a good option.

Benefits of a CPA for Payroll:

  • Ensures tax compliance and accuracy.
  • Saves time by handling calculations, tax filings, and payroll reports.
  • Provides expert advice on tax deductions and benefits.

Downsides of Hiring a CPA:

  • Higher costs compared to software solutions.
  • Less direct control over payroll operations.
  • If you switch to in-house payroll later, you’ll need to learn the process from scratch.

CPAs are a great option for businesses that want professional oversight but aren’t ready for a full payroll service provider.

Option 3: Using a Payroll Service Provider

For many small businesses, partnering with a payroll service provider is the most efficient way to handle payroll.

What Payroll Services Offer:

  • Automated payroll processing, including direct deposit.
  • Tax filing and compliance management.
  • Employee record-keeping and reporting.
  • Benefits and HR support (in some cases).

Advantages of Payroll Service Providers:

  • Saves time and reduces administrative workload.
  • Ensures accuracy and compliance with tax laws.
  • Many providers offer HR tools to help with hiring, onboarding, and benefits management.

Potential Downsides:

  • Monthly service fees.
  • Less direct control over payroll processing.
  • Some providers may charge extra for additional services like multi-state tax filings.

Despite the cost, many small business owners find payroll services to be the most hassle-free option.

Common Payroll Mistakes to Avoid

Regardless of how you choose to handle payroll, be mindful of these common errors:

  1. Misclassifying Employees – Incorrectly labeling workers as independent contractors instead of employees can lead to IRS penalties.
  2. Incorrect Tax Withholding – Failing to withhold the right amount of federal, state, and local taxes can result in hefty fines.
  3. Missed Payroll Deadlines – Late payments can upset employees and cause tax penalties.
  4. Not Keeping Proper Records – Payroll records should be retained for at least three years for compliance purposes.

Benefits of Outsourcing Payroll

If you’re considering outsourcing payroll, here’s why it might be a smart move:

  • Saves Time – Focus on growing your business instead of processing payroll manually.
  • Minimizes Errors – Automated calculations reduce the risk of costly mistakes.
  • Ensures Compliance – Keeps up with ever-changing tax laws so you don’t have to.
  • Offers Scalability – Easily accommodates a growing workforce.

Handling Payroll for Different Employee Types

Small businesses often employ a mix of full-time, part-time, and contract workers. Each type requires different payroll considerations:

  • Full-Time Employees – Must receive a W-2 form, with payroll taxes withheld and employer contributions calculated.
  • Part-Time Employees – Similar to full-time employees but may not qualify for full benefits.
  • Independent Contractors – Receive a 1099 form, and taxes are not withheld by the employer.

Proper classification is crucial to avoid legal issues and fines.

Final Thoughts

Payroll is an essential part of running a small business, and getting it right is crucial for employee satisfaction and compliance. Whether you choose to process payroll manually, hire an accountant, or partner with a payroll provider, understanding your options will help you make the best decision.

For most small businesses, outsourcing payroll is the most efficient and reliable choice, freeing up valuable time while ensuring accuracy and compliance.

Need help managing payroll? Consider using a trusted payroll provider to streamline your process and focus on what truly matters—growing your business