Running small business payroll can sometimes feel like you’re trapped in an acronym menagerie.
FICA. FUTA. FLSA. FEIN. SUI.
Don't get lost in the lingo.
You can learn how to do payroll yourself. It just takes a bit of time to understand key terms and learn the steps involved.
Running payroll efficiently is a key task for small businesses. It helps you pay employees accurately and on time. It can also help you comply with tax and employment laws. Efficient payroll processes can help contribute to a favorable business reputation, employee satisfaction, and proper financial reporting.
It all comes down to payroll setup.
The best way to do payroll for small business is the way that works best for you.
You can handle payroll yourself or hire someone to do it. Either way, payroll can be easy and efficient for your business.
Read on if you’re ready to learn how to manage payroll for a small business.
Understand the Basics of Payroll for Small Businesses
Setting up and running payroll involves steps like calculating wages, deducting taxes, filing taxes, and maintaining records. These essential tasks help support compliance with applicable requirements, strengthen employee trust, and help protect the reputation of your small business.
Payroll Terminology
Terminology. That’s the answer, if you’re already asking, what do I need to know first about how to do my own payroll?
Common payroll terms include gross pay, net pay, wages, benefits, payroll taxes, and payroll deductions.
- Gross Pay. The income an employee earns before taxes, benefits, and other payroll deductions.
- Net Pay. Wages less all deductions and taxes.
- Wages. The monetary compensation an employer provides to an employee in exchange for work performed.
- Benefits. Employers give employees non-wage compensation through benefits. These benefits can include health insurance, life insurance, retirement plans, and profit sharing. Employers provide benefits over and above monetary compensation.
- Payroll Taxes. The taxes taken from employee paychecks can include federal, state, and local income tax withholding. This includes Social Security (also called Old Age, Survivors, and Disability Insurance or OASDI) and Medicare. Employers may also manage paying FUTA (Federal Unemployment Tax Act) and SUI (State Unemployment Insurance).
- Payroll Deductions. Employees can have some amount taken from their paychecks. These deductions can be voluntary or involuntary and include benefits like 401(k) retirement plans and health insurance. This may also include wage garnishment for items like child support and alimony.
How to Do Your Own Payroll in 7 Steps
Whether you’re a payroll expert or just learning how to process payroll for small business, you may have contemplated these questions:
- Can I do payroll by myself?
- Can I do my own payroll for free?
- Can payroll be self-taught?
The answer to all the above is yes.
You can either process payroll yourself or hire a service like SurePayroll® By Paychex. The choice depends on your time, skills, interest, and if you think it’s the best use of your time.
Read on for seven steps on how to process payroll for small business.
Step 1: Get an EIN and Understand State Requirements
You need to register your business if you’re a new small business owner. This could be as an LLC, partnership, corporation, or tax-exempt organization. Make sure to do this with your state.
You’ll need legal entity documentation to apply for your Employer Identification Number (EIN), also known as a Federal Employer Identification Number (FEIN).
Any U.S. business with employees needs an EIN. This nine-digit number helps a business operate legally in the United States.
A business needs an EIN to open a business bank account, engage workers, and obtain loans. You must also file taxes and obtain business licenses and permits. Getting an EIN through the IRS is easy and free.
Register for state tax accounts, required for withholding state income taxes.
Small businesses may need one or more local permits or licenses to operate. This depends on state and local rules, as well as the type of business activities.
Types of state and local licenses and permits include a business license, sales tax permit, and resale permit. They also include a doing business as (DBA) license, professional licenses, and building-related permits.
Step 2: Classify Your Workers Correctly
Labels matter.
One common error involves confusing worker classifications.
According to the U.S. Department of Labor, “Misclassification occurs when an employer treats a worker who is an employee under the FLSA as an independent contractor.”
It’s critical to understand the criteria for classifying employees versus independent contractors. Factors include the level of control over work, financial arrangements, and the relationship between the parties.
Misclassifying employees as independent contractors is a problem. Misclassified workers may be entitled to unpaid minimum wage and overtime pay under the FLSA, as well as other benefits and protections for employees under federal, state, and local laws.
Fines for misclassified workers include, but are not limited to, a $50 per unfiled W-2, plus an additional fine of 1.5% of the wages paid.
Another common mistake employers make is classifying employees as "exempt" from the Fair Labor Standards Act (FLSA).
The FLSA sets rules for minimum wage, overtime pay, recordkeeping, tip earnings, hours worked, and child labor. This applies to most private companies and federal, state, and local governments.
Under the FLSA, covered employers must pay their non-exempt employees at least the minimum wage for all hours worked and overtime pay for any hours worked over 40 in a workweek. The non-exempt employee might also qualify for FLSA benefits and company policies. These include options like working from home and flexible hours.
Unlike non-exempt employees, the FLSA does not require employers to pay exempt employees overtime pay. Typically—but not always—an employer pays an exempt employee a salary that does not fluctuate regardless of the hours worked by the exempt employee. Learn more.
An employer must provide year-end tax forms to all employees and independent contractors they paid more than $600 in a year.
- Employees receive Form W-2.
- Independent Contractors receive Form 1099-NEC.
Step 3: Collect Employee Tax Information
One of the first steps to onboard a new employee is to have them fill out a W-4 form. People also call this form the Employee’s Withholding Certificate. It informs the employer about the amount of tax to deduct from an employee’s paycheck. Each employee determines the withholding amount by filling in their personal details.
While not a tax form, Form I-9 verifies a new employee's eligibility to work in the United States. Both the employee and employer must complete the I-9 form, and the law requires the employer to keep the completed form on file. Some online payroll services include new hire reporting as part of their small business plans.
Accurate payroll records can help ensure compliance with legal requirements. Proper documentation can also assist with any disputes with tax authorities.
It’s also important to understand any required state-specific tax forms, information, and payroll calculations.
Be sure to maintain organized records. Documentation can show that a business follows employment and tax laws. It can also help protect a small business from fines.
Accurate records also help in employee management. Maintaining clear records of employee hours, payments made, and any deductions can help resolve any payroll discrepancies quickly.
Records play a vital role when preparing annual tax documents. They simplify the process of generating W-2 forms. They also ensure that tax filings are correct, minimizing the risk of errors.
Small business owners should maintain the following records:
- Employee tax forms (Form W-4)
- New employee employment eligibility verification (Form I-9)
- Detailed payroll reports (hours, pay rates)
- Tax payment receipts.
Consistent record keeping also helps analyze business costs. Regular review of payroll data can reveal trends in labor costs. This insight allows for more informed financial planning.
Maintaining accurate records fosters trust with employees. It reassures them that someone manages pay and withholding taxes correctly, contributing to a positive work environment.
Step 4: Decide on a Payroll Schedule
No matter if you have one employee or many, you must follow tax and employment laws. You also need to meet payroll obligations on time. The first step is selecting the best pay schedule for your business.
So, what is the best payroll period for paying employees? The short answer: The one that works best for your cash flow.
A weekly pay period means employers pay employees once a week. This usually happens on a set day, like every Friday. This can offer employees a steady cash flow. But it can be costly and demanding for you.
A weekly payday means you need to process payroll every week. This includes making sure tax withholdings are correct and managing benefits. You will do this 52 times a year.
Employees on a biweekly pay schedule receive their pay every two weeks. This means they receive 26 paychecks each year, and sometimes 27.
A biweekly payroll also means employees will receive three paychecks in some months. Employees might like getting an “extra” check some months. However, biweekly pay periods can make it harder for you to track and plan cash flow compared to less frequent pay periods.
A semimonthly pay period means that employers pay employees twice a month, resulting in 24 paydays a year. On this schedule, the company pays employees on the same dates each month, such as the 1st and 15th. If one or both of those dates fall on a weekend, the pay date is typically the Friday before.
If you pay salaried employees, this schedule is easy to follow. You’ll run payroll on the same dates each month. The check amounts are usually the same for each pay period.
This pay period also reduces how long you’ll need to spend on payroll tax and benefit administration tasks. These pay periods can make it harder to pay hourly and other nonexempt employees because semimonthly pay periods do not align with the workweek used to determine the overtime and other premium pay owed to nonexempt employees.
For a monthly pay period, employees receive one paycheck per month, usually issued on the first or last day of the month. On this schedule, you will process 12 payrolls per calendar year. Running payroll monthly can potentially save you time, money, and resources.
It does, however, present similar challenges as semi-monthly pay periods if you have hourly or other non-exempt employees. Also, many states do not allow a monthly pay schedule for non-exempt workers. Employees also may find it tougher to manage their personal finances on a monthly pay schedule. Monthly pay frequency is the least common pay period according to the U.S. Bureau of Labor Statistics.
Step 5: Calculate Gross Pay and Withhold Taxes
The steps to run payroll depend on industry rules and state or local laws.
Generally, you start by calculating your employee’s gross pay. Gross pay is the income an employee earns before payroll tax and other deductions. Three steps to help you determine gross pay include:
- Identify pay structure (hourly, salaried, etc.)
- Calculate base pay (weekly salary, hourly rate times hours worked, etc.)
- Include additional compensation (bonuses or commissions)
Use our free hourly paycheck calculator. It makes it easy to figure out an employee’s hourly pay.
Mandatory Tax Deductions and Other Deductions
After calculating gross pay, the next step is determining deductions.
After calculating the taxes and deductions from each employee’s gross pay, you will pay them the remaining amount. This is their net pay, which people often call take-home pay.
Other deductions may be voluntary yet important. Agreeing upon these deductions with your employee in advance is vital. Accurate deduction handling is key to a successful payroll process.
- Mandatory deductions include federal taxes, Social Security and Medicare
- State and local taxes, as applicable
- Voluntary deductions include health insurance and retirement.
Step 6: Pay Your Employees
Finally, you’ll pay employees using the method they chose. This could be direct deposit, a paper check, or a pay card. Make sure to follow all legal requirements.
Step 7: File Payroll Taxes and Reports
Next, you must file the payroll taxes with the proper tax agencies. When you file, use the right forms. This helps you report withholding activities to the correct federal, state, and local tax authorities.
- Form 940 to report your annual Federal Unemployment Tax (FUTA) liability.
- Form 941 is the employer's quarterly federal tax return. It reports income taxes and Social Security and Medicare withheld from employees' paychecks. You also use this form to pay the employer’s portion of Social Security or Medicare.
- If your yearly taxes for Social Security, Medicare, and federal income tax are $1,000 or less, use Form 944. You can pay these taxes once a year.
You must deposit federal employment taxes electronically through the IRS Electronic Federal Tax Payment System (EFTPS). Check with your state to determine how to report and deposit state employment taxes.
If you haven’t already, be sure to mark your calendar for key payroll tax deadlines for 2025 and bank holidays.
Manual Payroll vs Payroll Software vs Outsourcing
There are many payroll options for small businesses. Choosing the right one depends on your needs and resources.
Manual Payroll
Some small business owners ask, how can I manually do payroll?
You can do it. But the next question should be, do I really want to?
Processing payroll manually can be cost-effective but it requires significant time investment and a thorough understanding of tax regulations. The pros include complete control and no software costs, but the cons are the risk of errors, and the time required.
Manual payroll requires keen attention to detail. It involves calculating hours worked, earnings, and deductions by hand, which can be time-consuming. It gives you full control over the payroll process. This way, you can understand every part of your business's payroll.
Despite its advantages, manual payroll is prone to human errors. Mistakes in calculations or tax withholdings can lead to discrepancies and compliance issues. Regular training and checking calculations can reduce these risks. However, it needs a steady commitment from those managing payroll.
For those asking, how can I do payroll myself for free, the most likely answer is manual payroll.
Payroll Software
Payroll software automates many tasks, reducing errors and saving time. Depending on the software, the downside can be the cost, especially for small businesses with tight budgets. Service and support can also be an issue with DIY software.
The primary advantage of payroll software is its fingertip availability—download the software on your device and you’re ready to go.
Some software also offers scalable solutions, allowing businesses to expand or reduce features as needed, providing flexibility in managing costs.
Outsourcing Payroll
Many small business owners find outsourcing payroll beneficial and cost-effective. Professional payroll services can help businesses automatically calculate pay, deductions, file payroll taxes, and even manage direct deposits.
Many providers also offer integration with accounting systems, streamlining financial management across the board.
The cost of outsourcing can be a consideration. It's crucial to compare payroll providers, considering not only the cost but also the range of services offered.
Additionally, while outsourcing reduces the direct burden on the business, it also means you won’t have the same visibility into payroll processes as you would if you handled payroll all on your own. To help you get the most out of your services, you can set up clear communication with your service provider.
Common Payroll Mistakes Small Businesses Make
Avoiding common payroll mistakes can save your business from potential fines and employee dissatisfaction.
Misclassifying Employees
Consider consulting with a legal or HR professional for guidance on proper classification. They can help you develop clear and consistent classification processes that focus on documented details related to the work performed by the employee.
Documentation can also help support your classifications in case of audits or legal challenges. Misclassification can have serious financial and legal implications.
Missing Deadlines
Implement a system to track deadlines for federal, state, and local taxes. Missing payroll tax deadlines can lead to costly penalties and interest charges.
Calendar reminders or payroll software can help keep you on schedule and ensure timely filings. In addition to tax deadlines, consider setting reminders for other important payroll tasks, such as issuing W-2 forms or updating employee records.
A regular payroll routine can help you complete all tasks on time, reduce stress, and minimize the risk of errors.
Incorrect Tax Withholdings
Regularly review W-4 forms and keep current on tax law changes to help ensure accurate employee tax withholdings.
Accurate tax withholdings are essential to avoid underpayment or overpayment of taxes. Consider conducting annual reviews to update withholdings based on any changes in employee status or tax regulations.
Providing employees with resources to understand their tax withholdings can also be beneficial. Encourage them to review their W-4 forms and adjust as needed. Transparency and communication can help prevent misunderstandings and ensure that withholdings accurately reflect each employee's tax situation.
Lack of Organization
Efficient payroll management requires keen organizational skills.
Establish a system for tracking employee hours, wages, and deductions to help prevent errors and ensure timely payments. Consider using digital tools or spreadsheets to maintain organized records and facilitate easy updates.
Regular audits of your payroll records can help identify discrepancies and improve accuracy. Conducting these audits on a regular basis can help you catch any errors early and correct them promptly.
Staying organized not only simplifies payroll processing but can also help your business comply with applicable legal requirements.
Overlooking Advantages of Direct Deposit
Implementing direct deposit can help streamline your payroll process and improve employee satisfaction. This method provides employees with fast and reliable access to their earnings, eliminating the need to wait for checks to clear.
Direct deposit is a convenient way to pay employees, reducing the need for paper checks and the risk of lost payments. Encouraging employees to opt for direct deposit can also reduce administrative burdens and costs associated with paper checks.
When setting up direct deposit, be sure to collect all employee banking information securely. Implementing measures to protect this sensitive data can help prevent fraud and enhance trust.
Regularly reviewing your direct deposit processes can help identify areas for improvement and maintain an elevated level of service for your employees.
Neglect Regular Process Reviews
Regularly review internal payroll processes for efficiency and effectiveness. Gathering feedback from employees and other stakeholders can provide valuable insights into areas for improvement.
By regularly updating your processes, you can enhance accuracy, compliance, and employee satisfaction.
Missing Updates
Payroll requirements are subject to change, making it essential to stay informed about new developments. Regularly reviewing your payroll processes can help you ensure that they align with current laws and industry standards. Subscribing to industry newsletters or joining professional organizations can help you stay updated on relevant changes.
How SurePayroll Simplifies Payroll for Small Businesses
Properly setting up payroll sets the stage for efficient business operations. It also helps establish a key component of your workplace culture—trust.
While processing payroll is a fundamental task in any business, it's not your primary focus. If you’d prefer to run payroll on your own, keep in mind that some mistakes are easier to fix than others.
A small business payroll software provider, like SurePayroll® By Paychex, makes paying employees and contractors easier. It automates payment timing and calculates payroll taxes. That means you have more time to stay focused on your business, customers, and employees—and grow your business.
Trusted by small businesses and households for more than 25 years, you can count on SurePayroll® By Paychex to provide you with simple, no-nonsense payroll—with no long-term commitment. The easy-to-use SurePayroll platform helps you accurately pay your employees and file your taxes on time, every time.
Learn More.
