Payroll: The Complete Guide for Small Businesses

Efficient payroll is crucial for paying your employees on time and for compliance. Learn how to implement a system that works for your business!
by
Finance
June 22 | 10 min

As a growing small business owner, there will be a time when you’re going to have to hire additional help. If you’re at the point where you’re ready to take on employees, that’s great news since it means you’re doing pretty well. Now it’s time for payroll. 

If you’ve never hired anyone before, paying your employees isn’t necessarily as straightforward as it may seem. Depending on your industry and even government regulations, requirements around how you correctly administer your payroll may be more than issuing paychecks. 

Setting up payroll and administering it accurately, as much of a hassle it may seem in the beginning, will save your business both time and money. To help you get started, we’ll go over in detail what you need to set up payroll and a few tips on ensuring you’re meeting regulations to prevent any IRS penalties. 

Gather all Vital Information

Before actually setting up payroll, you’ll need to ensure you have important details. That way, you’ll be ready when registering for the right types of accounts and to confirm your employees get paid properly. 

Register for an EIN

Getting an Employer Identification Number (EIN) — some call an EIN an Employer Tax ID — is crucial so that you can start hiring employees. This number is used to report pertinent information, like your taxes to the IRS and state agencies. Think of it like your Social Security number, but for businesses. 

Applying for an EIN is easy — you can do it online. Information you’ll need to provide includes your information and the form generally takes less than 15 minutes to complete. 

Obtain a State Business ID

Depending on your location, some local and state governments may require you to register for an ID number to process taxes. Not sure? Check your local or state government offices to see if you need one. 

Registering for one probably shouldn’t take you much longer than registering for your EIN. 

Gather Relevant Employee Information

Since you’re the employer, you’ll be the one who is going to have to file taxes and reports. When you onboard new employees or contractors, make sure to keep detailed records of the following:

  • Full name of employee or contractors
  • Date of birth
  • Up-to-date address
  • Start or end date of employment
  • Form W4 for employees or W9 for contractors
  • Form I-9 if necessary to verify employee eligibility to work in the U.S.
  • Social Security number or EIN
  • Benefits forms (if relevant) such as ones for health insurance and employer-sponsored retirement plan.

Some states may require other forms or information, so ensure that you have what you need to remain compliant. For now, the above information is good enough to get payroll set up.

Classify Employees Correctly

Ensuring you clearly label the people who work for your company as an employee or independent contractor is paramount. Since there are differences — even different legal definitions — classifications will impact how you’ll have to withhold taxes and even their payment structure. 

If you accidentally classify someone as an independent contractor when they should be an employee or vice versa, you may end up paying back payroll taxes. Or, you could end up having to pay them back to contractors who are responsible for their own taxes. Plus, it could mean you need to amend your taxes, which could result in penalties or interest on back taxes. 

What we’re getting at here is, double-check everything to make sure you have workers who are classified correctly. If you’re unsure, you can fill out Form SS-8 and the IRS can help you determine what’s what. 


Setting Up Payroll

Once you’ve gathered all of the above information, you can officially set up your payroll. The good news is that once you have these steps in place, onboarding future employees and contractors will seem like a breeze.

 Determine a Pay Period

Sounds simple, but picking a day and how often you pay employees and contractors is going to ensure there’s consistency. Plus, wouldn’t you want to know the exact days you get paid?

When choosing the right payroll schedule for your business, first check with your state.  Department of Labor or state tax office to see if you’re required to meet any regulations around payroll schedules. 

Otherwise, it’s really up to you and how your business works best. Look at your business systems to see how they can fit into the overall schedule, or start by seeing how your cash flow is doing. 

Since payroll is one of the largest expenses for many small businesses, ensuring that it won’t mess with your cash flow is important to ensure your organization is running smoothly. Some areas to look at include when your business receives an influx of income and when other bills are due. 

Let’s not forget about your contractors or employees. They work hard so that your business is in tip-top shape. Perhaps making them wait a month to get paid may be too long. Whatever you choose, tell those who work for you what the payroll schedule is to help them plan. 

Choose a Payroll System

You have a few options when it comes to payroll: do it manually, use payroll software, hire a payroll service or an accountant.

Manual Payroll

Doing it manually is the least expensive option since you’re doing it yourself — spreadsheets are fairly simple to use. However, doing payroll this way carries some risks, mostly to do with human error.

You’ll also need to spend some time entering information manually and ensure you’re adhering to federal and state regulations. This includes tax deductions, pay calculations, and more. If you make any errors or fail to account for anything, you could get into hot water. You could even end up paying employees or contractors the wrong amount.

Use Payroll Software 

If you still insist on doing it yourself, paying for payroll software can save you time by ensuring you get all the details correct. Choosing the best one will ensure that it can be easily used and grow with your business. There are plenty of payroll software options that suit all kinds of budgets, so the chances of you finding one are pretty high.

When doing your research, start by asking for recommendations from your professional network, or read reviews online. 

Once you’ve narrowed down your list, here are some questions to ask yourself to make your final decision:

  • Can I use the software easily? – Even if you end up outsourcing this to another employee or a bookkeeper, it’s important you know how to use the payroll software yourself. Take a look at some of the features to see whether you’ll be able to use them. Ask if you can download a trial or a demo of the software to try it out. 
  • Can I train someone to use it? – Take a look at the payroll software’s customer service to see if it offers help features or other ways to guarantee a seamless customer experience. This could mean having a live chat function and clearly labeled navigation links and buttons. 
  • Does it have the features I need and want? – If you want to be able to check in on the go, having a mobile app is useful. Think of what else you want, such as the ability to sync on the cloud or having a more involved onboarding experience. 
  • Will it adapt to future business needs? – Your business will grow, so having payroll software that does will mean you’re not scrambling to find a new solution in a few years and taking up time you could be spending elsewhere.

Hire a Payroll Service

Hiring a payroll service will cost you more, but it may be worth it since it’ll save you time. There are some services that are actually accounting firms, or there are companies only managing payroll directly for companies. These organizations will be up to date on federal, state, and any local regulations on top of having a process to get your workers paid. 

 

Specifically, payroll services usually offer the following:

  • Detailed payroll reports
  • Payslips
  • Payment to employees
  • Ensuring your payroll is compliant
  • Calculating payment such as deductions and benefits

Research these types of services much like you do with payroll software. 

Hire an Accountant

The most expensive option would be to hire an accountant, though this person can make it easier since you can have them help you file your business tax returns and other types of tax-related planning. Since services will vary depending on the accountant or firm, you’ll want to be clear as to what services you want.

At a basic level, accounts will help you with making on-time payments, keeping detailed employee and payroll records, and providing payslips and checks (when necessary). However, you’ll also want to keep these types of records, especially if you’re legally bound to do so. 

Start Paying Employees

Now comes the best part: paying your employees and contractors. All the hard work you’ve done so far — gathering relevant information and choosing the best payroll solution for your business — finally feels like it’s worth it. 

As you implement your payroll system, share relevant details with those who will get paid such as what they should expect for compensation and payment schedule. To make it easier on yourself in the future, you can add some of these details in an employee handbook. 

Of course, this is only the beginning of payroll — having a solid ongoing process helps prevent bumps along the way. 

Process Related Payroll Tasks On Time

Ensure that you’re paying employees and contractors on time and in the correct amounts. It’ll keep them happy and leave you feeling frazzled if you’ve accidentally overpaid or underpaid someone. Your state may also have legal requirements about paying on time and how soon you need to provide payment to employees who are leaving. 

Another important payroll task is to file payroll taxes. You want to be on the good side of the IRS, so file and pay them on time. Otherwise, you may be fined the Failure to Deposit Penalty, which could be as high as 10% of the amount owed.

Keep and Store Meticulous Payroll Records

Every W2 employee needs their federal income tax, Medicare, and Social Security withheld from their paycheck. You’re not required to do so for contractors, but that doesn’t mean you should keep detailed records of payment. 

Having these records in place will make it easier for you to know how much you need to pay in taxes, especially each quarter when you need to indicate how much taxes you’ve withheld from employees. 

Whenever you collect information or forms from those who work for you, you’ll want to have a secure place to store and organize them — typically, up to four years is enough. Forms include any W2s, W4s, I-9s, and any state tax forms. Don’t forget records of pay stubs, tax deposits, timesheets, and any employee overtime.

Even if you terminate an employment contract, keep relevant files on record. Check with your local labor office to see what records you need to keep track of to remain compliant. 

Keeping good records also extends beyond payroll records. Having your financial statements such as cash flow and profit and loss statements ensures that any mistakes are corrected. That way, you will submit your payroll taxes correctly, preventing you from spending too much time and money on related tasks in the future.

Create a Payroll Checklist or System

Having a smooth payroll process can be a lot to handle. Even if you hire out a portion of it, you’ll still need to have the right forms and information on file. Having a checklist or established system in place will save you time and help get all the payroll details correct. The simplest way to do it is to create a checklist as you go, and review it every once in a while to see whether you need to make any changes.

All of the above information can feel overwhelming. Understand that setting up payroll correctly is done once. Afterward, getting into a routine of handing off information to your accountant or entering it into your software won’t take as much time. Over time, it may take even less.

 

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