There’s nothing like starting your own small business. Being your own boss means you choose how to run things, and it lets you see your ideas come to life. But, you have a million and one things on your plate. You might decide to hire new employees to streamline business operations. When you become an employer, you need to know how to manage payroll for a small business.
Managing payroll might seem taxing (no pun intended). You are responsible for withholding and depositing payroll taxes. And, there are many payroll-related decisions you must make. Read on to learn how to manage payroll.
How to manage payroll for small business owners
As a small business owner, payroll is your responsibility. There are several steps to managing payroll:
- Collect payroll information
- Choose a payroll system
- Run payroll
- Handle taxes
- Keep records
1. Collect payroll information
Before you hire employees, apply for an EIN (Employer Identification Number), from the IRS. You need an EIN for the documents you send to the IRS and state agencies, like tax returns. To pay federal taxes, register for an EFTPS (Electronic Federal Tax Payment System) account. With EFTPS, you can conveniently pay taxes online or over the phone.
You also need to check if you need employer ID numbers for state and local governments. And, register for your state’s new hire reporting account.
Determine the pay frequency you will use to pay your employee (weekly, biweekly, semimonthly, monthly). And, decide how you will pay them. There are a few different types of payment for employees, like a paycheck, direct deposit, payroll card, or cash. If the employee is paid via direct deposit, collect their bank account information.
Decide if you will give your employee hourly or salary wages. Determine your employee’s status, meaning whether they are exempt vs. nonexempt from overtime wages. Employees are exempt if they earn a salary, are paid at least $23,660 per year ($35,568 in 2020), and have job positions that are considered exempt. Exempt positions fall under executive, administrative, or professional positions.
Collect employee information
Your employee is required to complete paperwork when they begin working for you.
Have your employees fill out Form W-4, Employee’s Withholding Certificate. Form W-4 determines the amount of federal income taxes you need to withhold from employee pay.
New employees also need to fill out Form I-9, Employment Eligibility Verification. This confirms that your employee is eligible to work in the United States. You don’t need Form I-9 to run payroll, but employees need to fill it out before they begin work.
Collect information on benefits. For example, if you offer retirement plans for employees, your employees need to say how much they want to contribute to their accounts.
2. Choose a payroll system
You can determine the amount of time you want to spend managing payroll. There are a few different ways you can manage payroll: by hand, outsourcing payroll (payroll accountants or PEOs), or using payroll software.
Payroll by hand
Choosing to run payroll by hand is the most cost-effective way to manage payroll. But, learning how to do payroll manually leaves your financial records susceptible to mistakes.
When you do payroll by hand, you must figure out the amount of taxes to withhold. And, you are responsible for sending taxes to the appropriate agencies on time. It can be difficult to master the many payroll best practices on your own while trying to run your business.
One of the biggest benefits of outsourcing payroll is the time savings. But, it is the most expensive option for managing your payroll, and it makes you lose the most control.
You can hire a payroll consultant, like a payroll accountant, to help you withhold and deposit taxes. Or, you can use PEO services (professional employer organization) to “hire” your employees so you don’t need to run payroll at all.
Payroll software is a medium ground between doing payroll by hand and outsourcing payroll. Software is cost-efficient. You pay a fraction of the cost of outsourcing payroll. But, it ensures accuracy and can be run in a matter of minutes.
If you decide to use payroll software, compare factors like features, cost, support, ease of use, and security between software providers. You’ll want to make sure your provider has good payroll software reviews before making a decision.
3. Run payroll
After you are set up and have chosen a payroll system, the next step of managing payroll is running payroll.
The payroll system you use (by hand, outsourcing, or with software) will determine how you need to run payroll. Running payroll is the same process regardless of how you do it or who is doing it.
Enter the hours your employees worked during the pay period, account for any overtime if non-exempt, and withhold the appropriate taxes. After you’ve determined the payroll is correct, pay them via their chosen payment method.
4. Handle taxes
As a small business owner, you might not be an expert in taxes—you’re an expert in your own industry. But, handling taxes is all part of knowing how to manage payroll for a small business.
Payroll and income taxes
You are required to withhold, deposit, and report the following taxes from each employee’s gross wages:
- Federal income tax
- State and local income taxes (if applicable)
- FICA tax (Social Security and Medicare taxes)
Federal income tax
Withhold federal income tax based on the employee’s Form W-4 information. In rare cases, an employee will claim to be tax exempt. What does exempt mean on Form W-4? This simply means that you don’t withhold federal income tax for that employee.
Use the income tax withholding tables to determine the amount to withhold. If you use payroll software, the software will automatically calculate the amount to withhold for you.
Your federal payroll tax deposits must follow a semiweekly or monthly depositing schedule. The schedule you must follow is determined by the IRS and depends on the total tax liability you reported on Form 941 during a four-quarter lookback period:
- Monthly: If you reported $50,000 or less in taxes
- Semiweekly: If you reported more than $50,000 in taxes
Report federal income taxes on Form 941 each quarter: April 30, July 31, October 31, January 31.
State and local income taxes
Your business’s locality decides whether you need to withhold state and local income taxes. Check with your state to determine your responsibilities, as well as your depositing and reporting schedules.
FICA (Federal Insurance Contributions Act) tax is made up of Social Security and Medicare taxes. FICA tax is paid by both employee and employer, meaning you must match the amount you withhold for each employee to send to the IRS.
The Social Security tax rate is 6.2% of each employee’s gross wages up to $127,200 (2017 wage base). You also pay 6.2% of each employee’s wages for a total of 12.4% Social Security taxes. After the employee earns the wage base limit of $127,200, stop withholding and contributing. The 2018 wage base is $128,400.
The Medicare tax rate is 1.45% of each employee’s gross wages. You also pay a matching employer portion of 1.45%. There is no wage base limit for Medicare. But, there is an additional employee tax of 0.9% for all wages over $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately). However, you do not match the additional 0.9%.
You must deposit and report FICA tax the same way you do federal income taxes: follow a semiweekly or monthly deposit schedule and report the tax amount each quarter on Form 941.
When you’re an employer, you also need to pay taxes on employee wages. Federal unemployment (FUTA) tax and state unemployment (SUTA) tax are your responsibilities.
The FUTA tax rate is a percentage of employee wages up to the first $7,000 paid to each employee. Most employers pay .06%, unless they live in a credit reduction state. Your state determines your SUTA tax rate.
You must deposit FUTA taxes on a quarterly basis: April 30, July 31, October 31, and January 31. Report FUTA tax on Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. Form 940 is due by January 1 each year.
5. Keep records
Part of understanding how to manage payroll is knowing what to do with records. You need to keep payroll records for each employee.
In payroll records, you must keep documents like the employee’s Form W-4, pre-tax and post-tax wages, and total hours worked each workweek.
You are required to keep payroll records of paid wages for at least three years. And, you must keep records of time cards for at least two years. Check with the Department of Labor (DOL) for more information on payroll record retention.
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