The prospect of preparing payroll can be frightening to anyone who’s never done it before.
However, prior to making that commitment, it’s important that you learn exactly what the employee payroll process entails and what you, as an employer, are ultimately responsible for.
At a glance: How you can process payroll yourself
- Step 1: Have necessary information such as EIN and state tax I.D numbers
- Step 2: Set up a payroll bank account for direct deposit and tax remittance
- Step 3: Collect completed tax forms (I-9, W-4, W-9) from employees and contractors
- Step 4: Choose a payroll schedule (weekly, bi-weekly, etc.) and timekeeping system
- Step 5: Collect time cards or timesheets and calculate gross pay
- Step 6: Calculate all necessary deductions and pay employees
- Step 7: Calculate tax reports and remit required tax
How to do your own payroll
It’s not always easy, and it’s sometimes confusing, but yes, you can complete payroll in-house.
The following steps will guide you through the entire process, from preliminary tasks to processing a payroll.
Step 1: Have your EIN and state tax ID numbers ready
In order to process payroll and the necessary payroll taxes, you will need to have both an Employee Identification Number (EIN) and your state tax ID numbers handy.
Your EIN is used to pay federal income taxes, while your state ID is used for state taxes, unemployment taxes, and to provide your state with new employee information.
If you’re an existing business, you should already have these numbers. If you’re a brand new business, you will need to have these numbers before you hire any employees.
Step 2: Set up a payroll bank account
While you should already have a business bank account set up, it’s a good idea to open a second account for payroll and payroll taxes. This is the account that your employees would get paid from whether they have direct deposit or you pay them with a check.
This would also be the account that you would remit your payroll taxes from. While you can certainly process and remit taxes from your main bank account, for better record-keeping purposes, it’s best to have two separate accounts.
Step 3: Collect completed tax forms from employees
Your employees are required to complete the following forms prior to your paying them:
- W-9 (for contract employees)
The I-9 must be completed no later than the employee’s first day of employment. The W-4 should also be completed on your employee’s first day of employment, but you must have the completed form in hand before you begin to process payroll.
If you hire contract employees, they must fill out a W-9, which you will need in order to provide them with a 1099 at the end of the year.
Step 4: Choose a payroll schedule and timekeeping system
You have many options available when it comes to choosing a payroll schedule, though some are better suited to hourly than salaried employees.
|Pay Frequency||Number of Pay Periods Annually||Best Suited For|
Be sure to choose the schedule that works best for you because it can prove difficult for both you and your employees should you change the schedule later. You also need a timekeeping system for your employees.
This can range from an old-fashioned time clock to a spreadsheet, or an automated online timekeeping system. Also keep in mind that even if your employees are all salaried, you may still need to track their time, depending on the requirements of the state where your business is located.
Step 5: Collect timesheets and calculate gross pay
Once the payroll period comes to a close, you will need to collect and review timesheets. Once this is complete, you can begin to calculate gross pay. In order to calculate gross pay for salaried, exempt employees, you will take their yearly salary and divide it by the number of payroll periods in the year.
For example, if Sara’s annual salary is $50,000 and she is paid semi-monthly, you would use the following calculation to arrive at her gross pay:
$50,000 24 = $2,083.33
Calculating payroll for hourly, non-exempt employees is a little different, since you also have to take potential overtime into consideration. Let’s take a look at John. John is paid bi-weekly and he earns $15 per hour.
Remember that if an hourly employee works more than 40 hours in a single week, any hours worked over 40 need to be calculated as overtime hours.
If John worked 45 hours his first week, and 40 hours his second week, his total number of hours worked would be 85 for the pay period. You would calculate John’s gross pay as follows:
80 x $15 = $1,200 (regular hours)
5 x $22.50 = $112.50 (overtime)
Gross Pay = $1,312.50
Step 6: Calculate all necessary deductions
By law, employers are required to withhold the following deductions from your employee’s checks:
- Federal income tax withholding based on W-4 information
- Social Security and Medicare taxes (FICA)
- State tax withholding
- Local tax withholding, such as city or county taxes
You would need to check with your state to see if you are required to withhold any other payroll taxes.
To calculate net pay, you would need to refer to the W-4 that your employee provided you, using that information to calculate federal tax deductions based on (PDF).
Let’s go back to Sara. Remember, her gross pay is $2,083.33. Sara is single and claimed 0 deductions on her W-4. Therefore, her federal withholding is $250.00.
Next is FICA, which combines Social Security and Medicare taxes. FICA is currently taxed at 7.65%, with Social Security taxed at 6.2% of wages, while Medicare is taxed at 1.45%.
That makes Sara’s FICA deduction 159.37. Sara lives in Texas, where there is no state income tax, so here is how you would calculate her paycheck:
|Federal Tax Withholding||$ 250.00|
If Sara lived in another state with income tax, that would also need to be deducted from her check. Once you’ve calculated net pay, you’re ready to pay your employees, either by direct deposit or by check.
Make sure that you schedule your pay run to ensure that the direct deposit will be in your employee’s bank account on the scheduled pay date.
Step 7: Calculate and pay all payroll taxes
Calculating and remitting payroll taxes is one of the main reasons why business owners turn to payroll software and services.
As an employer, you’re responsible for preparing a report and remitting payment for a variety of taxes withheld from employee checks, as well as your portion of any taxes due including:
- Payroll taxes to the IRS, which include both federal withholding as well as the employee and employer portion of FICA. Both income taxes and FICA tax payments are due either semi-weekly or monthly, depending on how much you owe. You will be notified of your payment schedule by the IRS.
- Federal Unemployment Tax Act (FUTA) is paid to the federal government, which funds state unemployment programs. FUTA payments are due quarterly.
- State Unemployment Tax Act (SUTA) is a tax collected by your state that funds unemployment. These payments are also due quarterly, but check with your state to make sure.
- Any city, county, or local taxes, as determined by the location of your business.
As an employer, you are also responsible for filing IRS Form 941 quarterly, which reports the total federal withholding tax and both employee and employer FICA tax. You will also need to file IRS Form 940 - Employer’s Annual Federal Unemployment Tax (FUTA), annually.
You will also need to check with your state to determine what state forms are required.
Should you use payroll software to run your company’s payroll?
Are you feeling a little overwhelmed right now?
If so, you may want to consider using payroll software to manage payroll, track taxes, and pay your employees.
There are plenty of benefits to using payroll software or services including:
- Reduced workload: Using a payroll service, all you typically need to do is enter pay information for each employee and the software or service does the rest.
- Reduction in mistakes: Though mistakes can still be made, the number of payroll errors drops dramatically when you use payroll software.
- Calculation and filing of all payroll taxes: This is the number one reason why small businesses turn to payroll software or services to manage their payroll. All you need to do is provide the service with the appropriate tax ID numbers, and it does the rest. For instance, payroll software providers such as RUN Powered by ADP and Paycor include complete tax calculation and filing with all of their small business plans.
- More free time: Instead of spending hours and hours running payroll, completing reports, and remitting tax payments, you can spend that time growing your business.
Yes, you can do payroll yourself, but there is a better way
Even the smallest businesses can benefit from using payroll software to process payroll. The services provided are well worth the often minimal cost.
For the smallest businesses with no room in the budget for payroll software, be sure to check out Payroll4Free, a completely free payroll software that will also calculate and remit payroll taxes for a small monthly fee