How To Do Payroll Guide: How To Set Up and Process Payroll for a Small Business

Processing payroll is an essential part of operating any business that has employees. But it doesn't come without its challenges. And the more employees you have, the more complicated the process can become. And, if things go wrong during the payroll process, they often come at a high price.

To help prevent this from happening at your company, read this overview on how payroll works, how to run and manage payroll, and what your options are for completing the process.

How Does Payroll Processing Work?

Once you have hired employees, you must pay them for the work they perform and handle applicable taxes each pay period. There are many steps involved in completing these tasks, which we will cover in detail. These and other responsibilities comprise the payroll process, which you or another staff member can do, or you can find an accountant or payroll provider to handle these tasks for you.

How To Set Up Payroll

Setting up payroll for your small business may be easier when you have all the necessary information on hand, including specific information on your business, employees, pay and benefits, and your payroll bank account. Some basic steps explaining how to set up employee payroll for small businesses are below.

1. Gather Required Business Information

Before getting acclimated with payroll basics or getting started, the following business items should first be in place:

• Obtain a Federal Employer Identification Number (FEIN): This is assigned by the IRS and is used to identify a business entity. You need this 9-digit number to pay federal taxes, hire employees, open bank accounts, and apply for business licenses and permits. You can do this online on the IRS website.
• Register with your state and local government: Depending on your business structure and location, you must register for a state ID number to pay your business's state taxes. Tax obligations and steps to get an ID number differ at the state and local levels, so check with the appropriate agencies.
• Look into workers' compensation coverage: This coverage is mandatory in most states. However, rules vary from state to state regarding how many people a business can employ before it is required. Nonetheless, it's strongly recommended that you have workers' compensation coverage if you have employees.
• Report new hires: State and federal laws require employers to report information on new and rehired employees to the appropriate agency, generally within 20 days of beginning employment. Some states require reporting this data sooner.

2. Ensure You Have All Employee Information Needed To Process Payroll

There are also specific pieces of employee information you'll need to gather before getting payroll started. They include:

• Employee classification: Any employee you bring on board must be classified correctly as either nonexempt or exempt from overtime and minimum wage protections under federal, state and local law. This will help you determine the right way to pay your employees.
• New-hire documents (Form W-4, Form I-9, etc.): Although certain forms are completed by nearly all new hires, they may vary from company to company due to industry-specific regulations, company benefits, and policies. In addition, for employers with more than one location, different state and local laws may require employees at only one worksite to complete certain documents. You must complete all required new-hire forms as part of the onboarding process.
• Payment method: Depending on the options you offer, you will have various tasks to complete to successfully deliver paychecks via direct deposit, paper checks, or paycard. Learn more about employee pay options that may be available to your business.

3. Choose Desired Pay Periods

Companies can typically choose which pay period(s) they want to set up for paying employees, including weekly, biweekly, semimonthly, or other cycle frequencies. There can also be different pay schedules for different employees, such as one type of pay period for employees paid on a salary basis and another for employees paid hourly.

Remember that the state(s) in which you operate may have specific pay requirements, such as a specific number of days within which an employee must receive payment for earned wages after a pay period ends. You may choose different pay periods for groups of employees, but these frequencies should stay consistent.

4. Factor in Any Employee Benefits

Part of setting up payroll for small business requires knowing how much to deduct from each employee's paycheck for benefits contributions. These can include statutory benefits and any supplemental benefits you might offer, such as health insurance, disability coverage, and retirement plans. How much to withhold depends on the type of benefits plan, the level of coverage an employee chooses, and whether they are pre-tax or post-tax deductions.

5. Create a Payroll Bank Account

It's a good idea to set up a bank account used only for paying employees and making tax payments that is separate from any other business bank accounts. It's not required as part of the payroll setup process, but it's a valuable bookkeeping practice that can help you keep accurate payroll records.

How To Process and Run Payroll

Employees depend on and expect timely, accurate delivery of their paychecks. Any disruptions or errors can prevent your process from running smoothly and could lead to turnover. When learning how to run payroll, the following factors are foundational basics with which you must become familiar.

1. Accurately Track Time Worked

Processing payroll effectively relies on accurately tracking the time worked by employees. There are various methods for tracking time worked, including time and attendance software that may integrate with payroll systems or having employees track their time manually. Keep in mind that, like payroll, manual methods for tracking time worked by employees can lead to inaccuracies. This is why, when evaluating your payroll process, you may also want to assess whether a time and attendance solution best fits your business.

2. Ensure You Understand Different Types of Pay

Before you can calculate your employees' wages, it's essential to understand the different types of pay so you can mitigate payroll errors.

• Gross pay: An individual's total earnings before taxes and other deductions are withheld for a given pay period.
• Net pay: The amount an individual takes home after deductions.

3. Calculate Employee Wages

Many calculations and factors impact an employee's wages, including:

• Determine your business's payroll schedule: A payroll schedule establishes employee pay dates, after taking into consideration state pay frequency laws, tax payment due dates, tax return filing deadlines, etc. You'll also want to account for scheduling special payrolls, such as for seasonal or annual bonuses.
• Calculate gross wages: Calculate gross wages in compliance with applicable federal, state, and local laws.
• Account for overtime pay: On the federal level, if an employee worked over 40 hours in a single workweek and is classified as nonexempt, they are eligible for overtime pay. However, note that certain states have different overtime requirements.
• Comply with wage garnishments: A wage garnishment is any legal or equitable procedure where some portion of a person's earnings is withheld by an employer for the payment of a debt such as alimony, child support, student loan default, or other circumstances. If notified by an enforcement agency, employers should immediately start the wage garnishment process to ensure that payments are sent to the appropriate agency or creditor. This helps protect the business from any legal repercussions for not responding to the order.
• Factor in benefits contributions: Account for benefits contributions such as workplace-sponsored retirement plans, health, life, or disability coverage, and flexible spending accounts. In such cases, you'll need to calculate and deduct each employee's individual contributions from each paycheck.

4. Deduct Payroll Taxes

Employers generally must withhold federal and state income tax from all employees' taxable wages based on what employees enter on their withholding form(s). Here's a brief explanation of a few mandatory payroll taxes:

• Federal income tax: This is withheld from an employee's wages, reported to the federal government, and applied to the employee's calculated tax liability at the end of the year.
• Social Security and Medicare taxes: The employer and employee generally pay these taxes equally to fund these entitlement programs.
• Federal unemployment tax: This is paid to provide funds for paying unemployment compensation to workers who lost their jobs.

Some employers must also pay the state unemployment (SUI) tax. Except for in a few states, SUI taxes are not deducted from an employee's wages.

5. Pay Your Employees

Once you've deducted the proper taxes and withheld any deductions from employees' gross pay, their take-home or net pay is what remains. You'll pay employees according to their pre-selected receipt method, such as direct deposit, a paper check, or a paycard. Depending on your jurisdiction, you may need to include specific information on pay stubs typically provided to employees when wages are paid, either electronically or in paper form. Employees should review their pay stubs and report any payroll mistakes.

6. File Taxes

Once you have deducted taxes from your employees' paychecks, you must file them with the appropriate tax agencies. In doing so, you must use specific required forms to report withholding activities to the proper federal, state, and local tax authorities:

• Form 940, an employer's annual FUTA tax return
• Form 941, an employer's quarterly tax return reporting withholding and the employer's share of FICA (Federal Insurance Contribution Act)
• Form 943, the employer's annual return for agricultural employees
• Form 944, used for small employers eligible to pay employment taxes annually rather than depositing them according to a schedule
• Form 945, a federal income tax return used to report non-payroll payments, including pension distributions

Payroll taxes must be deposited electronically through the Electronic Federal Tax Payment System, or EFTPS. Small employers who can pay their employment tax when filing their annual employer tax return can use EFTPS. For state employment taxes, check with your state to determine how to report and deposit employment taxes.

7. Properly Document and Store Payroll Records

Proper bookkeeping is one of the most critical tasks for a small business doing payroll. Good records are necessary to prepare tax returns, IRS and insurance audits, and bank financing. That's why it's essential to get started with a sound accounting system and maintain your backup records in a logical and organized manner. "One of the most common issues we find is that companies do not have a good recordkeeping system in place, so we always want to encourage clients to review their current process and identify areas of opportunity to prevent issues down the road," noted Paychex multi-product services supervisor Nicole Hurley.

Learn more about bookkeeping basics and which records you need to keep and for how long.

8. Report Any New Hires

All employers must follow the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of 1996, which requires an employer to report all their new hires to the appropriate state agency within a pre-selected period. As part of the onboarding process, all new hires must be reported within 20 days if your business sends the information by mail or twice a month if you send this information electronically. Non-compliance with this federal regulation could result in monetary or non-monetary civil penalties by the state.

Most of this information can be found on the W-4 once an employee is hired, but you should check all paperwork to be sure.

Should a Small Business Owner Put Themselves on Payroll?

A business owner has a few options to withdraw income from the business. Owners can opt to take a regular salary instead of or in addition to an owner's draw, which is money withdrawn from the company for personal use with no taxes withheld. When a business owner is on payroll and takes a salary, they are treated as any other W-2 employee. Once this salary level is set, it must be paid consistently with the appropriate amount of taxes withheld on both the employee (who, in this case, is the owner) and the business side.

Depending on the structure of your business, specific methods for paying yourself as a business owner are ideal when factoring in flexibility, IRS regulations, and tax implications.

How Long Does Payroll Take To Process?

The timeline for processing payroll can vary depending on your payroll schedule, bank's policies, and the employee pay method. For example, once you've completed the initial setup for direct deposit and processed a successful payroll, employees can see funds posted up to 2 days prior to the check date and no later than the check date, depending on the banking institution. Most banks usually need at least 2 business days' notice before processing direct deposits, so it's important to plan and ensure you submit your payroll in enough time for it to be processed and received by banks before payday. For an added fee, some banks can accommodate real-time or same-day ACH.

With paper checks, employees may have to wait for the check to arrive in the mail and then take it to the bank to deposit, which can take more time.

Can You Process Payroll by Yourself?

Running payroll is essential to operating any business with employees, regardless of size or industry. Business owners have several options for running payroll, including outsourcing the process. Depending on your chosen method, consider factors such as how much control or oversight you want to have, cost considerations, and time commitments.

Business owners who want to manage payroll themselves must become familiar with the terminology, options, and basics of running payroll, as well as some payroll-related laws to help avoid making costly payroll mistakes. So, while you can certainly figure out the process, doing payroll yourself can be difficult.

In the event of a payroll mistake, the consequences can be costly. Even if these errors are caught before submission, they can still cause countless hours of reprocessing employee paychecks and tax returns.

Unpaid taxes or wages can result in hefty penalties, and mistakes in employee paychecks can result in additional penalties in certain jurisdictions while eroding worker morale and harming your business reputation. Understanding the ripple effect that payroll inaccuracies can have on a business, today's leading payroll processing companies, such as Paychex, have developed tools such as pre-check services to help improve payroll accuracy by providing employees with a chance to report concerns with their paycheck before payday giving their employer the chance to resolve what could otherwise be costly errors. Advanced HR features and technology, such as letting employees quickly review and approve their paychecks before payday, are typically unavailable when doing payroll alone which could make your business more vulnerable to payroll errors, miscalculations, and penalties.

Is Doing Payroll Yourself Worth It?

Given its complex nature, processing payroll on your own can cost more overall than what you may save initially. Plainly speaking, doing payroll yourself may not be worth it.

If part of your consideration is wondering how long payroll processing takes, consider that it can take hours of your already busy workweek to do payroll yourself. The process also gets more complex as you add more employees to the payroll. This may contribute to a recent finding that nearly 80% of small businesses surveyed in the 2023 Paychex Pulse of HR Survey said they plan to digitize their HR efforts this year.

Benefits of Outsourcing Payroll

There's too much at stake for business owners to commit time-consuming (and potentially expensive) payroll processing errors. Consider the benefits of using payroll services from a professional provider:

• Time saved: Payroll outsourcing can make the entire process more efficient, because no matter how many employees a business has, processing payroll demands time and attention to detail. This often comes at the cost of valuable time that could otherwise be spent on more pressing business priorities. Outsourcing payroll to a reputable provider gives owners more time to focus on what matters most. In many cases, they'll also have various options available to maximize time saved throughout the pay period.
• Greater efficiency: Look for a provider that allows you to import multiple files at one time, from one location, so you don't need to wait for each file to complete before processing a new one.
• Money saved: Costs saved on printing and distributing paychecks and generating reports for in-house and accountant use.
• Greater security: Protection against identity theft, embezzlement of funds, and tampering with records for personal gain.
• Professional know-how: Payroll providers with expertise in running payroll can help at any point in the process.

Keeping up with the complexities of employee withholdings, minimum wage legislation, and IRS forms can be daunting. Outsourcing payroll can also help lighten the burden that often comes with payroll tax compliance, including mitigating your business's risk of penalties for late or inaccurate payments. "Paychex is dedicated to being an integral payroll partner, assisting companies with the complexities that exist within the payroll world and allowing businesses to be confident in their ability to pay employees timely and accurately," said Hurley.

How To Process Payroll With Paychex

Payroll tasks can be particularly complex among the many items on small business owners' to-do lists. There are many risks and costs to handling these administrative responsibilities alone, perhaps most significantly the time they can take away from your busy workdays.

Paychex makes it easy for businesses of all sizes to process payroll using their Paychex Flex platform or mobile app. To get started, businesses input employee information, work hours, and any additional pay details into the system. Paychex Flex then calculates necessary taxes and deductions, helping with state and federal regulations. Once the payroll is reviewed and approved by you, payments can be directly deposited into the employees’ bank accounts or distributed via various other payment options.

The information in these materials should not be considered legal or accounting advice and it should not substitute for legal, accounting and other professional advice where the facts and the circumstances warrant. It is provided for informational purposes only. If you require legal or accounting advice or need other professional assistance, you should always consult your licensed attorney, accountant or other tax professional to discuss your particular facts, circumstances and business needs.