How to Do Payroll for Your Business Step-by-Step

Key Takeaways

• Preparing for payroll involves choosing a payment method, setting a schedule, and registering with tax agencies.
• Accurate tax withholding and timely deposits are essential to avoid penalties.
• Payroll compliance requires employee classification (employee vs contractor) and adhering to local labor laws.
• Time tracking and proper wage calculation help prevent disputes and errors.
• Payroll software (like Gusto) and full-service providers can simplify tax filings and reduce administrative burden.
• Creating a payroll calendar ensures you never miss tax deadlines.
• Outsourcing payroll can offer benefits like penalty protection and expert compliance support.

How to Do Payroll

When learning how to do payroll, taxes are the most important thing to remember. Federal, state, and local taxes are withheld from an employee's paycheck. An employer must know the current tax rates and include income tax, social security, and Medicare fees so he can properly calculate what the payroll tax should be.

Major Steps in the Payroll Process

Be prepared for the task of calculating payroll by first understanding the major steps in the process.

1. Preparation: Prepare for payroll calculation and processing by deciding who will perform the tasks.
2. Payment: Set up a system to calculate pay, write checks, and distribute them to employees.
3. Post-payment: Money must be set aside for taxes. Perform a payroll register, make tax payments, and send payroll reports before deadlines are met.

Classify Employees Correctly

One of the first steps before calculating payroll is properly classifying workers as either employees or independent contractors. Misclassification can lead to significant tax penalties. Employees are subject to income tax withholding, Social Security, and Medicare taxes, whereas independent contractors are responsible for their own tax obligations. Use IRS Form SS-8 if you need help determining a worker's status​

Payroll Basics

The employer must calculate an employee's pay, deduct taxes, and give him his paycheck on schedule. The company then needs to pay the federal and state taxes withheld from an employee's paycheck as well as payroll taxes.

Paying payroll taxes is necessary to keep your business running. To do that, tax forms must be completed and filed, so the government knows that your employees are getting paid and paying their taxes. Make sure there are not any errors with hours, wages, withholdings, taxes, or health care benefits. If calculations have errors or deadlines are missed, the business will face harsh penalties.

Set Up Direct Deposit

Setting up direct deposit allows employees to receive their wages quickly and securely. Employers can work with their bank or payroll service provider to set up electronic payment systems. Direct deposit reduces the need for paper checks, minimizes fraud risks, and improves employee satisfaction​

Before Hiring Employees

Hiring employees is a big decision. In addition to receiving regular pay, employees have other rights afforded to them. Employers must stay competitive by offering good benefits. For example, employers are not legally required to offer paid time off, but most businesses do. An employer needs to make sure he is staying within the bounds of the law and should consult this checklist for what he needs to do before hiring employees.

• Learn the legal responsibilities of an employer.
• Have all pre-employment tasks completed first.
• Understand payroll and payroll processing.
• Decide when to pay employees, when to pay overtime, how hours will be tracked, what paid time off will be provided, etc.
• Choose an accounting system.
• Gather required paperwork for new employees to sign, and make sure forms are fully completed. These include:
  • W-4 form
  • Employment application form
  • I-9 form

Stay Compliant with Labor Laws

Employers must ensure compliance with federal, state, and local labor laws when hiring employees. This includes adhering to minimum wage laws, overtime rules under the Fair Labor Standards Act (FLSA), anti-discrimination laws, and providing necessary employee notices. Displaying required posters at the workplace is also mandatory to inform employees of their rights​.

Hiring the First Employee

Before the new employee starts working, the employer should have completed the following tasks:

• Apply for an employer identification number from the IRS. This is your tax ID. All businesses that have employees require a federal EIN.
• Register for state taxes so you can pay them on behalf of the employee.
• Learn the federal and state unemployment tax rates (FUTA/SUTA).
• Establish workers' compensation insurance, which protects workers when injuries are sustained on the job.
• Make sure mandatory notices and posters are displayed at the workplace.

On your employee's first day, complete the following:

• Complete, sign, and store a federal W-4 form.
• Obtain direct deposit information from the employee.

Within the first three weeks of employment, complete the following:

• Have them complete and sign an I-9 form within three days to confirm that your new employee is eligible to work in the United States.
• Verify their identity and work eligibility with two forms of ID or a passport.
• Within 20 days, register your employee with the state's New Hire Reporting Program.

Report New Hires Promptly

Federal law requires all employers to report newly hired and rehired employees to a state directory within a certain number of days (typically 20 days). This helps child support agencies track parental responsibilities and helps prevent fraudulent unemployment insurance claims​.

Payroll Methods

There are several methods to do payroll, each with their own benefits and drawbacks. Employers can choose to do payroll themselves by hand or with payroll software. If they do it by hand, they're in control of everything themselves, but it can be quite time consuming. They won't, however, have to spend any extra money on payroll calculations.

With payroll software, the employer can run payroll from their computer fairly easily. The employer is more in control and calculations are done much faster than when performed manually. Software can get expensive depending on which is chosen, but often the price is worth it considering the time saved. When you use payroll and accounting software together, the two programs can operate seamlessly like Intuit and QuickBooks. With this method, you have total control and quick access to all the company's payroll and financial data. Expenses update automatically, so you don't have to worry about double entry.

If you hire an accountant, they will take care of everything for you. Taxes are handled, and an accountant will be well equipped to handle your business's finances and payroll. However, this kind of delegation removes control from the employer and increases company spending in the way of accounting services.

Full service payroll allows you to outsource the payroll responsibilities to vendors. Most will cover tax penalties and the employer will still have direct access to the company's account. However, some vendors will require complete control to be relinquished and it can be pricy.

Choosing a Payroll Frequency

Choosing how often to run payroll is a critical decision. Common payroll frequencies include:

• Weekly: Employees are paid once a week (52 pay periods per year).
• Biweekly: Employees are paid every two weeks (26 pay periods per year).
• Semimonthly: Employees are paid twice a month (24 pay periods per year).
• Monthly: Employees are paid once a month (12 pay periods per year).

Each schedule has different impacts on administrative workload and employee satisfaction. Biweekly and semimonthly schedules are the most common​.

Running Payroll

Each of the methods mentioned work a little differently, so understanding the steps required is important. Calculating payroll yourself saves the cost of hiring a third party, but doing so is time-consuming and could result in errors. Errors can be extremely costly since they can incur expensive fines. If an employer decides to calculate their own payroll, they will have to do all the calculations, wage distribution, and tax filing. An employer should follow these steps:

1. Request that employees complete the W-4 form: This allows the employer to track their filing status and personal allowances. If the employee claims a higher number of allowances or dependents, less payroll taxes are withheld.
2. Obtain an Employer Identification Number: An employer identification number, or EIN, is used by the IRS to identify your business. Some states also require a state employer identification number.
3. Create the payroll schedule: Decide when payday will be scheduled and determine tax payment and tax filing deadlines.
4. Calculate withholdings: Determine how much of your employee's pay needs to be withheld for taxes. This can be done easily using the IRS Withholding Calculator, and states tend to offer a similar resource.
5. Deductions: Subtract pre-tax deductions, then employment taxes, and then post-tax deductions.
6. Pay your taxes: Pay your federal, state, and local taxes on time.
7. File necessary tax forms and W-2s: Typically, each quarter you need to file a federal tax return along with any state and local returns. Annual filings and W-2s should be prepared and filed by the end of the year.

When using a payroll service, calculations are performed automatically, and the company's payroll tax filings are sent to the IRS for the company.

Signing up for a payroll service can take only a few minutes. You'll need your employees' names, addresses, social security numbers, and tax withholding information. The Department of Labor requires employers to keep track of wage records for up to two years. If you track hours through software, you can import them to a payroll service. Keep track of your payments, as the IRS could request an audit for payroll as far back as three years. Some full-service payroll companies will do this for you.

Employers can also choose to hire an accountant. Accountants are highly trained and reliable, and can take care of all payroll-related matters for you. They only require employee information and time cards. With payroll accuracy guaranteed, this frees up time for the employer to focus on running the business. The accountant has to be paid, however, and their wage plus potential benefits can be very expensive. It's important to consider the cost difference of hiring an accountant or delegating payroll to an employee who already does something else. With payroll software, a small business won't need someone to focus on payroll full time.

Understanding Gross Pay vs. Net Pay

Gross pay is the total amount earned by an employee before any deductions, including regular wages, overtime, bonuses, and commissions. Net pay is the amount the employee takes home after taxes and deductions, such as 401(k) contributions and health insurance premiums. Clear communication of these amounts on pay stubs is crucial to maintain transparency and trust​​.

Payroll Tax Deposits

The IRS requires payroll tax deposits monthly or semi-weekly. The deposit will be the same as the amount kept from employee pay for state and federal income taxes. These taxes pay for Medicare and social security, and also include amounts deducted from employee pay and amounts employers owe as individuals.

As an employer, you will still be required to make federal unemployment tax payments on a regular basis. In addition, the employer must make state tax and locality tax payments as well. Each county or city may also have specific tax requirements for operating in their jurisdiction.

Understand Federal, State, and Local Tax Obligations

Beyond federal taxes, employers may also be responsible for:

• State income tax withholding (if applicable).
• State unemployment insurance (SUI) payments.
• Local taxes such as city, county, or school district taxes. Always check with state and local authorities for specific requirements. Not complying with local tax obligations can result in heavy fines and back payments​.

Tax Reporting for Payroll 

Companies must submit reports for payroll taxes on a regular basis. You can submit a quarterly report to the IRS using Form 941, which shows the amount of payroll tax liability and how much was paid on that liability the previous quarter. Form 944 handles unemployment tax reporting and shows the liability as well as how much has already been paid. State laws may require additional unemployment and workers' compensation reports.

Maintain Payroll Records

Employers must keep payroll records for at least three years under the FLSA. Required records include:

• Employee's full name and Social Security number.
• Address, including zip code.
• Birth date (if under 19 years old).
• Sex and occupation.
• Time and day of week when employee’s workweek begins.
• Hours worked each day and total hours each workweek.
• Basis on which employee’s wages are paid (e.g., $10 per hour, $500 per week).
• Regular hourly pay rate.
• Total daily or weekly straight-time earnings.
• Total overtime earnings for the workweek.
• All additions to or deductions from the employee’s wages.
• Total wages paid each pay period.
• Date of payment and the pay period covered by the payment

Create a Register for Payroll 

It's important to keep track of all information on payroll for every employee. The best way to do this is to maintain and create a payroll register. If you're using an accounting system online, you probably already have a payroll register as part of the package of reports. The register makes it much easier to have year-end payroll totals and reports, which is necessary for tax purposes and accurate reporting.

Create a Yearly Tax Calendar

Keeping up with a month-by-month payroll tax calendar, either in payroll software or manually, will make things much easier. You can keep track of payroll tax dates during the year. Just make sure you add in the state's payroll tax dates to complete your calendar. When you use payroll software, however, you are less likely to miss dates since most payroll software will send you alerts ahead of time.

Why Consider Payroll Software

Payroll software can save you a lot of time and money with its convenience and price compared to an accountant. One of the best and most affordable programs is Gusto. Gusto automatically runs payroll and tracks bonuses, vacation/sick days, and more. Gusto handles benefits and allows the company to add workers' compensation coverage, combining HR and payroll and streamlining the hiring process.

This payroll software is especially useful for small businesses because of its reduced cost compared to Intuit and SurePayroll. Gusto also handles W-4s, W-2's, New Hire Reports, federal and state payroll taxes, and other business tax needs. Having efficient payroll software is like having a cheap yet effective accountant on the team.

How to Do Payroll With Gusto in 9 Steps

If you decide to use Gusto for your payroll needs, there are a few steps you'll have to follow:

1. Basic Information: When you sign up, you'll have to enter some basic company information like the business's name and address.
2. Adding Employees: You can easily add employees to payroll. You just need their name, address, email, hire date, and salary/wage.
3. Federal Tax Setup: Here you need to enter the federal and, if necessary, state tax information. You'll need to know the company type (LLC, S-Corp, etc.) and the corresponding federal deposit schedule.
4. State Tax Setup: Enter your state employer ID number and the state unemployment tax rate or SUTA.
5. Bank Account Setup: For this part, all you need is your company's bank account and routing number.
6. Choose Your Pay Period: Weekly and biweekly pay periods are most common.
7. Sign Company Forms:
   • Company Direct Deposit Authorization: With this, Gusto is able to transfer money in and out of the company bank account to pay employees and taxes.
   • Reporting Agent Authorization: This allows Gusto to pay all payroll taxes automatically.
8. Purchase Workers Compensation Insurance: Gusto also acts as an HR department. Get workers comp insurance in case anything happens to your employees.
9. Add Benefits: Add exciting benefits with Gusto to take advantage of all the benefits this payroll software can offer.

Frequently Asked Questions

1. What is the easiest way to learn how to do payroll?
   The easiest way is to use payroll software or hire a payroll service, which automates calculations, tax filings, and direct deposits.
2. How often should I run payroll?
   Payroll can be run weekly, biweekly, semimonthly, or monthly, depending on your business needs and state regulations.
3. What documents are needed when hiring an employee for payroll?
   You'll need a completed W-4 form, an I-9 form, and potentially direct deposit information.
4. What happens if I make a payroll mistake?
   Payroll mistakes can lead to fines, back pay, and employee dissatisfaction. It's important to correct errors quickly and communicate openly with affected employees.
5. Can I do payroll manually?
   Yes, but it can be time-consuming and prone to errors. Manual payroll is typically only advisable for very small businesses with simple structures.

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