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Payroll 101: How to Set Up Payroll for a Small Business

If you’re about to run payroll for the first time, you might be overwhelmed. There are so many new terms and processes to learn. You have to learn how to set up payroll, get employee information, run payroll, and pay and file taxes.

To help you figure out all the basics of payroll, this article breaks down all the steps you need to take and the basic words you need to understand. Once you go through this quick payroll 101 course, you’ll be set to run payroll on your own.

Before you run payroll

Before you can run the first payroll for your business, there is a lot of payroll preparation you need to do. Luckily, you only have to do most of the tasks in this section once.

Gathering payroll information

You need to gather some payroll information and register for several accounts before you can run payroll. Each of these accounts is needed to run payroll and pay taxes. The things you need to register for include:

Be aware; there may be other accounts you need to register for. This is not an all-inclusive list.

You also need to get information from your employee to run payroll.

The employee must fill out Form W-4, the personal allowances worksheet. On the form, the employee can claim allowances that affect how much federal income tax withholding you take out of their wages. Depending on where your business is located, your employee might also need to fill out a state withholding form.

If you offer small business employee benefits, you need the election information for each employee. You need to know how much you must withhold for the benefits, and whether the withholdings are pre-tax vs. post-tax deductions.

There are other forms and tasks you need to do when you hire an employee, such as filling out Form I-9. While these tasks don’t directly affect your ability to run payroll, you must still complete them.

Payroll decisions

There are some decisions you need to make before you run the first payroll.

Exempt vs. nonexempt

You need to determine if an employee will be exempt vs. nonexempt from overtime wages. To be exempt, an employee must meet the following three criteria:

  1. The employee must earn at least $23,660 per year or $455 per week
  2. The employee must earn a salary
  3. The employee must have job duties that are considered exempt

If the employee does not meet the criteria, the employee is nonexempt and you must pay the employee overtime wages for overtime hours worked.

Employee wages

You must also figure out if you will pay an employee a salary vs. hourly wages. If your employee is exempt, you must pay the employee a salary. But, if your employee is nonexempt, you can choose whether you pay a salary or an hourly wage.

You should also decide if your employee will earn other wages, such as tips or commissions.

Pay frequency

Pick a pay frequency. The pay frequency determines how often you will pay your employee. Common frequencies include, monthly, semimonthly, biweekly, and weekly.

Paying your employee

After you figure out what type of wages you are going to give your employee and how often, you need to select how you will pay the employee. You can pay your employee with a written or printed check, direct deposit, or payroll card. If you use direct deposit, you will need extra information, such as a bank account number and routing number, to complete your payroll.

Setting up your payroll

Once you get all the information you need and make your payroll decisions, it’s time to set up your payroll. To run payroll, you can either hire an employee or accountant, do payroll by hand, or use online payroll software. Payroll software is less expensive than hiring someone and less time exhaustive than doing payroll by hand.

You need to add all your information to whatever payroll system you use. That way you are prepared the first time you need to run payroll.

Now that you’ve completed all your payroll preparation, you are ready to run payroll.

Running payroll 101

When you reach the end of a pay period, it’s time to run payroll. How you run payroll depends on what payroll method you use. Despite the differences, there are basically three steps of running payroll.

Payroll 101 infographic

1. Entering numbers and running payroll

To start your payroll, you need to gather and calculate employee hours and wages. You need to know how many hours your employee worked during the pay period. You can use time and attendance software for small business to help with employee attendance management. You also need to know your employee’s hourly wage or per pay period salary. Using that information, you will calculate the employee’s earnings. Make sure you include overtime wages and any other earnings.

After you calculate the employee’s gross wages earned, you need to subtract taxes and other deductions. You can learn more about withholdings below.

If you use payroll software, the software will automatically and accurately do calculations for your employee’s wages and withholdings.

2. Approving payroll

Once all the calculations are done, you should double check the results. This step is easy to skip over, but you shouldn’t. If you do manual payroll calculations, you should make sure you did the math correctly. If you use payroll software, you should make sure you typed in numbers correctly, such as 40 hours instead of 400.

When you are approving payroll, look over the paycheck totals. The net pay and the withholdings should be the same or similar to previous paychecks.

3. Paying your employee

After you approve payroll, you need to get the wages to your employee. Use the payment method you chose earlier to distribute the wages.

Taxes

As an employer, you must withhold and contribute to employment taxes. The main payroll taxes you need to know about include:

  • Social Security and Medicare taxes
  • Federal, state, and local income taxes
  • Federal and state unemployment taxes

Each tax has its own rate and rules. Check them out in the chart below:

Tax Tax Rate Wage Cap Who Pays?
Social Security 6.2% (employee)
6.2% (employer)
$127,200 Employee
Employer
Medicare 1.45% (employee)
0.9% (additional Medicare tax)
1.45% (employer)
No wage cap
Additional Medicare tax starts at:
$250,000 if married filing jointly
$125,000 if married filing separately
$200,000 for everyone else
Employee
Employer
Only the employee owes additional Medicare tax
Federal Income Tax Varies based on income and withholding allowances No wage cap Employee
State and Local Income Tax Varies by state and locality
(Does not apply to all states and localities)
No wage cap Employee
Federal Unemployment Tax (FUTA tax) 0.6% $7,000 Employer
State Unemployment Tax/Insurance Varies by state Varies Employer

After you withhold the taxes, you have to deposit them on a regular basis. There are also forms you need to fill out. Here is what you need to know:

Tax Deposit Frequency How to Deposit Form to File Filing Deadline
Social Security, Medicare, and Federal Income Tax Monthly or semiweekly
(depends on a lookback period)
electronic funds transfer using EFTPS, a tax professional, or a payroll tax filing service Form 941 Quarterly:
April 30
July 31
October 31
January 31
State and Local Income Tax Varies Varies Varies Varies
Federal Unemployment Tax (FUTA tax) Quarterly, due on:
April 30
July 31
October 31
January 31
EFTPS, a tax professional, or a payroll service Form 940 January 1
State Unemployment Tax/Insurance Varies Varies Varies Varies

For more information about employment taxes, check the IRS website and your state tax website.

Form W-2

At the end of every year, you will have to get Form W-2 sent out to your employees, and to the federal and state governments. Form W-2 is basically a summary of what you paid your employee during the year. The form also lists how much you withheld for each tax.

You must send Form W-2 to the employee, the Social Security Administration, and your state government (if required) by January 31 of the following year.

You can save time on your payroll by using Patriot’s payroll tax services. A simple guide will help you set up the software. Then, you can easily run payroll with speed and accuracy. When it’s time to deposit and file your taxes, we’ll take care of them for you. Test out the software for free!

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