Your small business is up and running, and you’re ready to start hiring employees. With employees comes payroll, an essential and complex task. From tracking time to withholding and making tax payments, each aspect of running payroll requires the utmost attention to detail.
Why Your Small Business Needs Payroll
Payroll can be time-consuming and complicated. Even small businesses can benefit from payroll software to help process and record employee benefits, taxes and payroll. Creating a plan for how you’ll process payroll benefits employers and employees. Here’s how.
Efficient and accurate payroll protects employee benefits and plays a key role in employee satisfaction. Important benefits such as health, disability and unemployment insurances, as well as retirement plan contributions are calculated and managed through payroll. The employee contributions are deducted from employees’ gross pay and errors with insurance payments and retirement plans can be costly and problematic for employers and employees. And paying employees accurately and on time helps keep employees satisfied. Payroll errors can quickly deplete morale and drive staff to look for work elsewhere.
Businesses must comply with labor laws and payroll tax requirements. These complicated requirements can vary from state to state and are subject to change. Non-compliance penalties from the IRS and other tax agencies can be severe, and labor law violations can lead to problems with the Department of Labor (DOL) and even lawsuits from employees. Payroll software can help you stay up to date with the changing regulations and process an accurate and legally compliant payroll.
Efficient payroll management helps businesses optimize cash flow and performance. Payroll is one of a business’s largest recurring expenses. You need enough working capital, or money on hand, each pay period to meet your obligations. Understanding your payroll costs also helps you manage your workforce more efficiently. You want to have enough employees to get the job done correctly without wasting money on unnecessary labor. But you also need enough cash on hand to hire new employees or make additional investments if business picks up.
Set Up a Payroll System
Before you can start paying your employees, follow a few steps to set up your payroll system. Rather than attempt all these steps with manual calculations and spreadsheets, consider a payroll processing software solution to simplify the process.
- Obtain an employer identification number (EIN). An EIN is a nine-digit number the IRS assigns to your business to identify it on tax documents, similar to the way a Social Security number is used to identify an individual. Business owners may need to get an EIN before they can apply for business licenses, open a business bank account or file payroll taxes. Apply for an EIN online through the IRS website.
- Set up a payroll schedule. Determine how frequently you’ll pay employees. Many businesses pay employees every two weeks (bi-weekly). Some states have minimum pay frequency requirements, so before deciding on a payroll schedule, make sure you comply with all regulations. Decide how you’ll pay employees, whether by direct deposit, paper check or reloadable pay card. Because employees rely on their paychecks, it’s important to consistently pay on time.
Understand wage laws. Wage laws at the federal and state level, such as minimum wage and overtime rules established by the Federal Labor Standards Act (FLSA), help protect employee well-being. Under the FLSA, employers must track and keep records of all employee time worked, pay at least minimum wage and pay overtime if employees work more than 40 hours per week and are non-exempt. For employees to be exempt from the FLSA, they must be paid a salary, or a fixed sum each year regardless of how many hours are worked, that’s more than $684 per week ($35,568 per year) in most states. In some states, such as California, Washington and New York, that minimum requirement is even higher.
If your company hires freelancers or independent contractors, they will also have their own sets of rules and regulations. From the perspective of the IRS, freelancers are self-employed, so they are not subject to the same minimum wage or overtime laws as non-exempt hourly employees.
Abide by tax regulations. Like wage laws, payroll tax regulations exist at the federal, state and local level. After your employee’s gross pay is determined, calculate these taxes and withhold the amount from paychecks to submit to the appropriate agency. Plan and budget for the following taxes.
- Federal income tax
- Federal Insurance Contributions Act (FICA) taxes
- Federal Unemployment Tax Act (FUTA) taxes
- Any other relevant state or local taxes
- Establish a benefits package. Decide which benefits you’ll offer. Consider health insurance, retirement plan contributions and paid time off. Plan contributions are deducted from paychecks. And paid time off needs careful tracking. If you have a human resources department, work with them to create and administer these benefits.
Businesses are not responsible for withholding or paying any taxes for independent contractors. And they usually don’t qualify for other employee benefits, because they are not technically employees of the company. Instead of filling out a W-4 form that details withholdings, freelancers fill out a W-9.
Payroll management software can help you be more efficient, better understand the costs associated with payroll, maintain accuracy and ensure compliance with tax regulations.
What’s Included in a Payroll System
The payroll system you set up will need to track employee time, calculate deductions, process payroll taxes and benefits, make payments to employees and submit the appropriate taxes. Each payroll system has a few components.
Time tracking: Establish a time-tracking system for your hourly employees and train them how to use it. Consider factors like overtime pay and time-off requests. Payroll and time tracking software can help automate and streamline these processes
Wages: The payroll system will calculate wages or gross pay by using the hourly rate and the number of hours worked. And for salaried employees, their annual salary will be divided by the number of pay periods.
Withholdings: Payroll software will calculate the appropriate tax obligations using information found on each employee’s W-4, as well as other federal, state and local laws. It will automate the payments to your taxing authorities and keep records for compliance purposes. It can also process deductions for wage garnishments, if necessary.
Benefits: Much like taxes, the payroll software system will deduct the employee’s share of benefits before a check is cut to ensure prompt payment.
Other useful features: Top-tier payroll software integrates with other business software like HR and accounting software to solve other common payroll and financial challenges.
Establish Payroll Policies and Procedures
After deciding on a payroll system, establish standard policies and procedures to manage payroll tasks in an efficient and timely manner. Here are some of the details about your pay period and benefits you should communicate to all employees:
- How your payroll works. Train employees on time tracking procedures, who to speak with if they have payroll issues and other company policies, like paid holidays. Consider a payroll software system with a user-friendly interface that all your employees, regardless of technical ability, can easily access and use to report time, request time off and securely view other important payroll information.
- When the payroll period is. Pay frequency largely depends on what works best for your business and employees, though some states also have minimum pay period laws. Most employers opt for a bi-weekly pay period, with Friday the most popular payday. Employees rely on their paychecks and it’s important for them to know when to expect a paycheck. And you need to know when you’ll be processing payroll so you can make sure your business has enough funds to cover the cost.
- How benefits work. What kind of health plan are you offering? How much will be deducted from each check to cover the premiums? What about retirement contributions? Is there an employer match program if employees contribute to their retirement funds? After the benefits plan is established, communicate it during your onboarding processes.
How to Run Payroll
Now that your payroll processes are established and you’re set to begin, there are a few steps to keep in mind. The first step is to find out how many hours your employees worked.
Using a time-tracking system
Keep track of the time worked by each employee. A time-tracking system will help you calculate wages for employees paid on an hourly basis. It can also be used by salaried employees if they bill time to specific projects or clients. Use a payroll software solution with time tracking and reporting features.
After you have a complete record of hours worked and salary for employees, you’re ready to start processing payroll. Here are the steps to follow for efficient payroll processing:
- Calculate wages. Either hourly or salary, find the gross pay for each employee. Don’t forget to calculate overtime pay when applicable.
- Calculate net pay. Deduct all required payroll taxes, benefits contributions and wage garnishments from the gross pay. While this can be done manually, payroll software can automate this step.
- Pay employees and distribute paystubs if required. Some states don’t require paystubs, but even where not required it’s a commonly accepted best business practice to share them with employees after each pay period. This can be done electronically or with hard copies.
- Deposit all payroll taxes. This includes the federal income, FICA, FUTA and local taxes that are withheld from employee pay as well as the employer’s share. Again, payroll software can automate this process by filing and depositing payroll taxes for you.
- Keep records. Stay compliant with IRS, DOL and local regulations.
- File all required tax forms. This is done quarterly for federal income taxes and FICA, and annually for FUTA. Local and state filing frequency will vary.
Managing Payroll Taxes
Keeping track and correctly paying all payroll taxes is no small feat, because you may be subject to multiple taxes at federal, state and local levels. Here’s a quick overview of payroll taxes that businesses must track:
- Federal income taxes: Each employee will be taxed differently based on their incomes and their withholdings from their IRS Form W-4. Online calculators and payroll software can help with this complex calculation.
- FICA taxes: These fund Social Security and Medicare and the amount is split evenly by the employer and the employee. For Social Security, employers and employees each pay 6.25% of gross pay each for a total of 12.4% on up to $137,700 of employee earnings. The amount paid into employees’ Social Security during their careers determines how much benefit they receive after they retire. And Medicare taxes are 1.45% for both the employer and employee.
- FUTA taxes: FUTA is paid by the employer. The FUTA tax rate is 6% on the first $7,000 in wages paid in a calendar year, unless your state receives a tax credit lowering your total FUTA payment.
- Other tax considerations: Pay relevant state and local income taxes, plus additional financial obligations like disability insurance, worker’s compensation and state unemployment insurance.
In addition to paying these taxes, businesses must report them in accordance with IRS schedules. All businesses must manage payroll taxes with utmost accuracy to avoid IRS penalties and issues with employees. The IRS requires payroll taxes to be paid on specific dates, either bi-weekly or monthly, and you can face steep fines if you miss those deadlines—up to 10% penalties. If you find yourself low on funds and can’t cover all your expenses, there are better ways to solve cash flow problems than skipping your tax bills. And no employee wants to be hit with an unexpected tax bill because their employer used an incorrect withholding calculation.
The Importance of Keeping Payroll Records
Federal and state agencies have laws that require you to keep specific payroll records in case the agencies need the information.
Under the FLSA, employers must keep certain records for all non-exempt workers for three years, such as employee name, address and occupation, as well as payroll details like hours worked and wages earned.
According to IRS regulations, all records of employment taxes must be kept for at least four years and should be available upon request for IRS review. The IRS also requires businesses to maintain information for each employee including wages, withholding certificates and dates and amounts of tax deposits made on their behalf. Violating payroll recordkeeping requirements can lead to costly fines with the IRS and the DOL. And if any disputes arise, clear, accurate records can help protect your business.
Beyond legal reasons, good payroll recordkeeping practices can help you better understand key business metrics like productivity levels, employee absences and payroll costs.
Use a Payroll Point Person or Manager
Keeping up with changing payroll practices and regulations is a common payroll challenge. One solution is to assign someone to be your payroll point person or hire a payroll manager. If you’re running payroll manually or are using a payroll software solution, the role of payroll manager may be a full-time job. And even if you’re outsourcing payroll, a payroll point person can help oversee the process as well as the timely exchange of information between your business and the service provider.
Payroll managers typically handle the following tasks:
- Processing payroll
- Deducting benefits contributions
- Ensuring payroll tax compliance
- Understanding and following wage laws
- Paying all necessary taxes
- Submitting payroll reports to the IRS and other government entities
- Keeping all required and helpful records
- Respond to employee payroll inquiries
Payroll managers improve inefficiencies in the payroll process. And they work closely with accounting to develop strategies around workforce management to improve your business’s financial health.
At what point should a small business appoint a payroll point person or hire a dedicated payroll manager? When payroll becomes a headache and starts to impede on other projects. If you start to have payroll errors or you’re struggling to keep up with rules and regulations, consider hiring a payroll manager. And as your business continues to grow, consider expanding the role and creating a dedicated payroll team.
10 Payroll Tips for Small Businesses
The following 10 tips can help your small business manage payroll successfully.
Get your finances in order. Set a payroll budget and estimate how much payroll will cost. Be sure to add at least 20% on top of an employee’s base pay to account for taxes, benefits and other payroll fees. Understanding your business’s cash flows will help keep your finances healthy and help ensure you have enough cash to pay employees on time.
Become familiar with labor laws on a federal, state and local level, and always stay on top of changes. Non-compliance can lead to severe penalties.
Educate yourself about your business’s IRS payroll tax obligations, plus any state and local tax requirements. Like labor laws, these are subject to change, and penalties can be severe.
Keep careful track of all payroll tax payment and reporting deadlines. Payroll taxes must be filed with the IRS by certain dates, otherwise you’ll incur penalties that increase according to how late your tax payment is.
Know which payroll records you need to maintain to adhere to IRS and DOL requirements, and how long you need to keep them.
Always classify workers correctly. Employees file a Form W-2, which is used to determine how much money to withhold for federal income taxes. Independent contractors, on the other hand, are responsible for the entirety of employment taxes and nothing is withheld from their pay, so they file a Form W-9.
Don’t put off using a payroll software solution; managing payroll is faster, easier and more accurate with a system that can simplify processes.
Make sure your payroll solution meets your needs. Identify important features and make sure they’re included in your software. For example, if you’d like to integrate your payroll processing software with your business accounting or human capital management software, make sure that’s an option. Ask for a product tour and get to know the software before you buy it.
Integrate your payroll solution with other business software, such as accounting systems or HR systems. This makes it easier for small business owners to view the big picture, such as how payroll affects cash flow.
Always double check data entry, even if you’re using payroll software. Timesheets, payroll calculations, benefits calculations, deductions, time-off requests, IRS forms and any other payroll documentation must be accurate and double checking your work can help you avoid costly mistakes.
How Software and Automation Can Help Small Businesses with Payroll
Managing payroll can be one of the most tedious and time-consuming aspects of running a small business, given the repetitive details and need to keep up to date with changing wage and tax laws. However, payroll software can greatly increase efficiency and help reduce headaches through automation. For example, payroll software can:
- Accurately calculate paychecks, taking into account all the necessary factors, including wages, tax withholdings, location and benefits contributions. It eliminates manual tallies.
- Calculate overtime, holiday pay and after-hour bonuses if applicable. Whether it’s just to follow company policy or to comply with federal or state regulations, payroll software makes tracking even complex schedules much easier.
- Track time off requests for vacation or sick days. Payroll software can also handle benefits like the accrual of paid time off that may need to be paid out if an employee leaves the business.
- Stay up to date with tax and wage laws on federal, state and local levels. Save time and ensure compliance.
- Automatically pay employees via direct deposit or pay cards.
- Reduce human error. Manually entering payroll information can be time consuming and prone to mistakes, but automation can handle the detail while enabling payroll managers and employees to focus on more valuable tasks.
Because managing payroll is a critical administrative task that must run accurately and on time each and every pay period, it’s important to set up a system that works for your small business. Payroll software and automation can greatly improve efficiency and accuracy while helping your business stay compliant with dynamic and challenging federal, state and local tax regulations. It saves you and your payroll managers from getting caught up in the minutiae of overly complex processes. Powerful payroll software also integrates with accounting solutions to take your business to the next level.