- How to set up payroll for your small business for the first time
- What are the downsides to setting up payroll on your own?
- The best payroll processing tools for your small business
Q: Can I do my own payroll for my small business?
A: Yes! Nothing is stopping you from handling this process entirely on your own. That said, manually tracking hours and calculating tax withholdings can be tedious. In addition, small errors can lead to serious legal issues. A much better solution is to use a payroll processing service.
If there’s one thing employees care about, it’s getting paid.
According to a recent Gallup poll, pay is the number one priority for employees searching for their next job in the United States.
As recently as 2015, pay ranked fourth for workers seeking new jobs. Things are quickly changing, and with unparalleled inflation levels, employees know that they need a living wage.
It’s a job-seekers market, and employers are offering higher wages to compete.
If you’re running a new company, you need to learn how to set up payroll for small business to make sure your workers get what they deserve.
But how do you set up payroll for small business?
- How to set up payroll for your small business for the first time
- What are the downsides to setting up payroll on your own?
- The best payroll processing tools for your small business
How to set up payroll for small business for the first time
Your first step should be to check with your local state laws that affect payroll.
Each state may have slightly different rules when it comes to tax withholding, social security, and so on. Learning how to set up payroll for small business means familiarizing yourself with the various tax laws of the states in which you’re operating.
Pay stubs play an important role in this process. While there is no federal legislation that forces employers to give their employees pay stubs, the subject falls under the Fair Labor Standards Act (FLSA).
The FLSA establishes many things, including:
- Minimum wage
- Overtime pay eligibility
- Recordkeeping obligations
- Child labor standards
According to the FLSA, you need to keep your employment records for at least three years. Your records should include:
- Number of hours worked
- Total wages paid
- Collective bargaining agreements
- Sales and purchase records
These records must be kept at the place of employment or the central records office. Note that even though you are required to keep these records, your employees do not automatically have the right to see their wage information whenever they want.
According to the FLSA, you must keep the following information about your employees:
- Full name
- Social security number
- Full address
- Birth date if younger than 19
- Gender
- Occupation
- Wage structure (hourly, piecework, etc)
State laws may enforce additional rules when it comes to pay stubs, and employers may be forced to provide them to their employees.
There are three types of states when it comes to pay stubs:
- State with no pay stub requirements
- Access states
- Access/print states
States with no pay stub requirements don’t require you to provide pay stubs to your employees. Access states require you to provide either electronic or paper pay stubs to your employees.
Finally, “access/print” states require the provision of either electronic or paper stubs – but the electronic versions must be easily accessible and printable.
Each pay stub must contain the following information:
- Wages
- Hours worked
- Rate
- Gross wages
- Deductions
- Net wages
Another thing to consider is FICA – otherwise known as the Federal Insurance Contributions Act.
This is deducted from each paycheck automatically. According to the US government, 6.2% of all gross wages go towards Social Security Tax, while a further 1.45% goes towards Medicare tax.
Now here’s the important part:
The employer matches these percentages for a total deduction of 15.3%.
The purpose of FICA is to provide benefits for retirees, children, and the disabled. The logic is that although this money is deducted from paychecks, workers benefit collectively from the programs that it funds.
There are many other payroll taxes to consider, including:
- The Federal Unemployment Tax Act: This tax funds federal unemployment programs.
- State Unemployment Tax Act: This tax funds state unemployment programs.
- Federal Income Tax: You can collect and remit federal income tax on behalf of your employee – but only if they give you permission. This information will be included in their W-4 form.
- State and Local Taxes: You will likely need to withhold these taxes from your employee’s paychecks.
Here are some additional state-specific payroll laws you should research before you learn how to set up payroll for small business:
- Your state’s minimum wage
- How overtime is calculated in your state
- Your state’s payday frequency requirements
- Laws relating to an employee’s final paycheck
- Whether you’re required to withhold money for state disability insurance
- Whether you need to withhold local income tax
- Your state’s laws regarding paid and unpaid breaks
- Your state’s requirements for workers’ comp insurance
- Any additional tax withholding requirements in your state, including family leave, employment insurance tax, and so on
Filling out the necessary paperwork
Another important step is to have your employees fill out their W-4 forms. Without this form, it is impossible to withhold the necessary taxes from their paychecks.
Also known as the Federal Income Tax Withholding Form, the W-4 allows you to calculate the correct amount of tax you should be withholding.
You should also consider the I-9, which verifies that employees are legally permitted to work within the United States.
Finally, you might also want to encourage your employees to fill out direct deposit forms with their banks, as this will allow you to transfer money into their accounts quickly and easily.
It’s best to obtain these forms as soon as possible after you hire a new employee.
Classifying your employees
You’ll also need to properly “classify” your employees.
Generally speaking, workers can be divided into two categories:
- Independent contractors: Independent contractors are paid more informally, and these “freelancers” do not have the same rights as employees.
- Employees: Employees may be paid salaries or hourly wages. They have access to several rights and benefits, including protection against discrimination, social security, and much more.
So why not just classify all of your workers as independent contractors? After all, this strategy would significantly lower the chances of discrimination lawsuits – and it would make everything much easier.
The answer is that if the IRS believes that you’re incorrectly referring to your employees as independent contractors, you may experience serious legal consequences.
In the legal world, this is known as “misclassifying” your employees.
If one of your workers has all the attributes of a normal employee, you should treat them as such. That being said, you are perfectly within your rights to label freelancers as independent contractors.
Creating your own tracking system
One of the most complex aspects of payroll is tracking all of the various information that needs to be recorded.
First, you’ll need to determine how often you want to pay your employees. The two most common options are bi-monthly or weekly – but check with your state’s requirements before making this decision.
If you haven’t already, you need to obtain an Employer Identification Number. If your business is totally new, you might need to apply for an EIN for the first time.
The EIN is sometimes referred to as a “Form SS-4” or a “Tax ID.” You can obtain this number from the IRS through a relatively simple online application.
Remember, you cannot pay your employees without a valid EIN. In addition, various states may require separate business identification numbers for tax purposes as New York, Massachusetts, and South Carolina.
Next, you’ll need to track your employees’ hours. This is one of the most difficult aspects of your payroll system. Not only do you need to track regular pay, but you also need to keep track of overtime hours, paid time off, and anything else that needs to be taken into account.
In addition, you need to keep track of employee-deductible expenses, like health insurance.
When you’ve calculated your employees’ total hours within a given pay period, multiply these hours by their hourly age while remembering to factor in overtime.
Finally, you can subtract their federal and state tax withholdings and other deductions to leave you with their net pay.
All that remains is to retain your employment records in case you ever get audited by the IRS. As previously mentioned, you are required to keep these records for at least three years.
At the end of each quarter, you are required to file Form 941 with the IRS. Also known as the “Employer’s Quarterly Federal Tax Return,” Form 941 tells the IRS exactly how much money you withheld from your employee’s paychecks.
Form 941 also tells the IRS how much employer taxes you paid during the quarter.
The only people not required to file Form 941 are:
- Businesses with seasonal employees
- Businesses with household employees
- Businesses with agricultural employees
- Any business owner who has been instructed to file Form 944 instead of Form 941
Another important form is Form 940. This form tells the IRS how much FUTA tax payments you have paid. You are only required to fill out this form if:
- You paid at least $1,500 in employee wages during the past year
- At least one of your employees worked for 20 or more weeks during the past year
Form W-2 is another important consideration as you learn how to set up payroll for small business. This form informs the IRS of your employee’s yearly wages, deductions, and tax withholdings.
Copies of your W-2s are provided to your employees, the Social Security Agency, and your local tax department.
Here’s an example of how you might calculate employee gross pay:
Let’s say your employee earns $60,000 per year and is paid twice a month.
This means that his gross pay each pay period is $2,500.
Using this gross pay, we can calculate the employee’s federal withholding.
The IRS provides wage bracket method tables for manual payroll systems. Using this table, you can determine how much federal tax you should withhold from each check.
Based on 2020 data, that number would be about $200.
Calculating FICA withholding is a little more challenging.
6.2% of $2,500 is $155, and this goes towards Social Security.
1.45% of $2,500 is $36.25, and this goes towards Medicare.
Add these two numbers together, and you are left with a total FICA withholding of $191.25.
Next, you’ll need to calculate the state and local tax withholdings.
If your employee works in New Mexico, you would deduct $64.67 – plus 4.9% of whatever exceeds $2,183. This would leave you with a total amount of $80.20.
What are the downsides to setting up payroll on your own?
Trying to figure out how to set up payroll for small business? Free options are limited to doing payroll by yourself – by hand.
It might be free, but is it really the most beneficial?
It is a highly tedious process – especially when you’re calculating overtime, tax deductions, social security, and all manner of other details by hand. Trying to figure out how to set up payroll for a small business can take hours, days, or even weeks to fully go through each employee’s payroll requirements.
If you try to figure out how to do payroll for small business on your own, you can easily make mistakes. These mistakes can lead to non-compliance audits by the Department of Labor. These audits can be incredibly costly.
In some cases, your employees can recover damages of up to $5,000 if you failed to provide them with pay stubs.
These disgruntled employees may also quit due to disputes over payroll, resulting in your business missing out on important talent.
And of course, the IRS can also take legal action against you, resulting in fines or even criminal charges.
The best payroll processing tools for your small business
Although hiring an accountant is certainly an option, the most realistic choice for most small businesses is payroll software.
The cheapest plans are extremely affordable, and they can address many of the major issues you might experience when doing payroll by hand.
With fewer mistakes and a faster overall processing time, payroll software is an obvious choice.
So which payroll companies should you choose?
We’re glad you asked…
Gusto
Gusto bills itself as an “all-in-one HR platform,” and payroll is only one of its many services.
It also has features related to talent management, onboarding, attendance, and much more.
That being said, Gusto’s “full-service payroll” system is one of its most popular features, and it features a considerable degree of automation.
Gusto automatically files your payroll taxes, resulting in a “set-it-and-forget-it” experience with their patented AI system called “AutoPilot.” Benefits and time tracking are built in, and pricing is very transparent.
Customers report that it takes an average of 13 minutes to run payroll with Gusto.
The good news is that Gusto integrates well with QuickBooks and many other apps, which means that switching over is easy.
With Gusto, there’s also no need to search for your state’s tax requirements because all of the necessary information for all 50 states is built right into the system.
Pricing starts at just $46 per month – an affordable sum for most small businesses.
Paychex
Paychex is another “all-in-one” solution that offers features for HR management, benefits, and payroll.
One of the cool things about Paychex is that it’s designed for a wide range of work environments – including onsite, remote, and hybrid.
According to Paychex, you can enter and run payroll in just “two clicks” with their free mobile app.
Paychex also keeps track of changing laws and regulations in your local state, allowing you to stay one step ahead of the tax authorities. With Paychex, you no longer need to constantly research these changing laws.
In addition, Paychex has a service designed specifically for small businesses called “Small Business Payroll.”
Paychex Flex Essentials will be more than sufficient for many small businesses, and it costs just $39 per month.
Resourcing Edge
Another stellar option is Resourcing Edge.
This company describes itself as an “industry leader in human capital management solutions.”
Their services include benefits, compliance, HR, recruiting, and of course, payroll.
Using Resourcing Edge’s online “re360” program, you can access a wide range of data at any time with your phone, tablet, or computer.
A considerable degree of customization is possible, and you can create a payroll system that fits your unique needs.
Resourcing Edge also gives you access to W-2 stubs for all your employees, and you can easily handle requests for vacation, sick time, or time-off.
Resourcing Edge also offers powerful compliance solutions, allowing you to control overtime with notifications and real-time updates.
Another key feature is the ability to carry out ACA calculations and continuous system updates.
You’ll need to contact Resourcing Edge for a quote on pricing.
Moving forward with your new payroll system
With a payroll system that works like a well-oiled machine, your business can continue full steam ahead.
Further reading
- Three-in-Ten US Jobs Are Held by the Self-Employed and the Workers They Hire
- What Is Payroll? Everything You Need To Know
- What does it mean to be ‘Customer Facing’?
- Small businesses still struggle to find enough workers
Not only will this allow you to make your business as efficient as possible, but it’ll also keep your employees satisfied. At a time when employees are constantly jumping ship and looking for better opportunities, this is incredibly important.
Remember, it might be cheap to do your payroll services by hand, but that doesn’t mean it’s the best option.
To avoid legal issues and time-consuming, tedious details, choose payroll software instead.
While you’re at it, check out the business tools offered by Alliance Virtual Offices
A live receptionist can answer your business calls, saving you time and boosting your customer service considerably.
A virtual address can improve your business’s reputation while allowing you to cash in on unique tax benefits in a different state.
To explore these options further, check out Alliance Virtual Offices today.
