Learn About Payroll

Payroll 101: The 8 Steps to Processing Payroll

1. How to decide if you have payroll processing responsibilities

As a small business owner, one of the first questions you may have is, “Do I need to process payroll?” The easy answer? If you have employees, or use independent contractors, then you need to run payroll. It’s no shock that the IRS expects you to play by their rules – when it comes to taxes, employee paperwork and reporting regulations.

Your payroll responsibilities include withholding, reporting and paying federal, state and local taxes on time and using the proper forms. If you make an error in any of these areas, your small business could face hefty government fines.

Not every small business owner needs to process payroll. If you are an “owner-only” business, you may not have to run payroll. But chances are you’ll still be liable for self-employment taxes.

The key point to remember is that if you have any employees or employ any independent contractors, then you must process payroll.

2. Should you consider outsourcing payroll?

Processing payroll yourself is a complicated, time-consuming task that takes time away from what you really want to do – make money and grow your small business. Turning your payroll hassles over to an outside payroll service can:

  • Save you hours of time each pay period
  • Help you avoid payroll errors
  • Protect you from costly IRS penalties

Traditional (you’ll phone or fax in payroll) and online payroll services (you’ll enter payroll information using your Web browser) calculate wages and deductions and, most importantly, relieve you of the burden of payroll tax management. Most services offer protection against IRS fines, too. Processing payroll yourself is a risky proposition at best. Not yet convinced? See why workz.com agrees that outsourcing payroll makes perfect sense.

3. What you’ll need to start processing payroll

If you’re a start-up business owner planning to process payroll in-house, chances are you have a lot to learn. Don’t feel bad – payroll is one of hardest administrative tasks small businesses face.

For starters, you’ll need to:

You’ll also need to collect forms and information for each employee, including an I-9, W-4, plus benefits, banking and deduction information. Deciding on a payroll frequency – weekly, bi-weekly, semi-monthly or monthly – is entirely up to you, and may depend heavily on your cash flow situation.

If, like I do, you find even the table of contents to the IRS Publication 15, Circular E incredibly daunting, you may want to consider outsourcing payroll to a reliable payroll service provider.

4. How to determine employee earnings

Paying your employees is one of the most important tasks of processing payroll – after all, they don’t come to work each day only for the love of the job (as much as you might hope that’s true). They expect to get paid on time and accurately.

Calculating your employees’ paychecks is relatively simple if all of your employees are salaried. But you may have a combination of salaried and hourly employees, independent contractors and employees who receive commissions or bonuses.

Here are some of the extra steps you may need to take when processing payroll:

  • Checking the time records of hourly employees
  • Calculating overtime pay for hourly employees
  • Adding commissions or bonuses
  • Counting sick, vacation or personal days

5. Understanding your payroll processing obligations

Your payroll processing obligations – and hassles – basically come down to 3 things: taxes, taxes, taxes. Empagio’s thorough study of why many companies choose to outsource payroll emphasizes the relief you’ll feel from handing off your tax headaches.

Why is it so important to understand payroll tax obligations? Because small business owners who fail to comply with government regulations could face civil or criminal penalties.

You’ll need to know the rules for dealing with your employees’ tax withholdings, depositing and filings. There are complex regulations about when you must deposit federal, state and local taxes and which forms to use for each. And I haven’t even touched on SUI rates and rules…

6. New hire reporting

When you hire a new employee – you guessed it – the government needs to know. You’re responsible for reporting your new hire to the appropriate federal and state agencies. And, you need to do it on their schedule.

There are forms to be collected from the employee, like the I-9 and W-4, and rules associated with how long you need to keep each form on record.

I strongly recommend that you create a formal process for collecting, storing and submitting new hire information so you stay on the government’s good side. And if, like many small business owners, you wear more proverbial “hats” than you do clothing, a reliable payroll service can take new hire reporting off your plate.

7. What you need to do when you pay an employee

Seems like a no-brainer, right? Not so much.

You’ll need to withhold employee federal income tax based on the number of withholding allowances and marital status of the employee. You’ll also need to withhold the correct amount of state and local income tax.

I’ve included a quick way to estimate an employee’s net pay here. Look for a more detailed sample calculation in a future post.

It’s important to remember that the laws for state and local withholding can get tricky – for example, there are 9 states that don’t require you to withhold state taxes.

You’ll also need to decide whether to pay your employees with paper checks or by direct deposit, which today is considered the preferable method. I found an interesting article (from 2004, but still relevant) on the benefits of using direct deposit, for both employers and employees.

8. Making payroll tax deposits

By now I’m sure you have the idea that tax regulations are the most complex – and crucial – part of payroll processing. Keeping track of payroll tax deposits requires fairly extensive tax knowledge and the memory of an elephant.

When and how you make your federal tax deposits depends on the amount of tax you have to deposit. Plus, you need to use the correct forms for annual and quarterly deposits. And remember – I’m just talking about federal taxes. You still have to worry about state and local tax requirements.

Failure to make timely, accurate deposits can result in fines that make credit card penalties look cheap. Using a payroll service protects you against tax penalties, and may even help you sleep better at night.

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