How to Manage Payroll for Your Small Business
The complexities of navigating tax regulations, ensuring compliance, and general payroll management can be a lot for new business owners already wearing many hats.
Payroll can be easy to manage when you simplify the process. With tips that can be easily implemented, we’ll identify alternative options to manual payroll management that can save time, reduce errors, and provide a lifeline for new business owners.
Things you need to process payroll
Tax information is needed to ensure both the employee and employer accurately report their income and dedications and comply with tax regulations. The tax documents you need to manage your small business’ payroll are:
- EIN (Employer Identification Number)
- Employee SSN
- TIN (Tax Identification Number) for contractors
- Employee’s Withholding Certification (W-4)
- State and Local Tax Forms
- Direct Deposit Information
- 1099 Form for Vendors
Employee Records: Working hours & wages
Apart from wages and working hours, here are other important employee records you should have on hand:
- Personal details (contact details, address, SSN)
- Employment contract & offer letter
- W-4 or tax withholding forms
- Benefits enrollment forms
- Performance and disciplinary records
- Records of employee resignations or terminations
A record keeping system is a structured way to collect, organize, and store pay stubs, tax information, and other necessary records.
- Cloud-based record keeping systems such as Google Drive or Dropbox are used to store and organize digital documents.
- Payroll software such as ADP helps manage employee compensation, tax withholdings, and compliance.
Steps to process payroll for your small business
Step 1: Find your employer identification number.
The EIN or employer identification number is an important component of the IRS’s system for identifying, tracking, and managing tax-related activities for any business entity. It ensures that your business is reporting accurately and is in compliance with tax laws. EIN can be obtained for free on the IRS website. Some states may require you to register with the state as an employer as well.
Step 2: Collect employee tax information
Employers in the United States are obligated to collect and maintain employee information for tax withholding and reporting purposes. Employees will need to submit the following forms for you to properly manage your payroll:
- Form W-4: The standard U.S. form used for federal income tax withholding providing details about the employees filing status and allowances.
- SSN: Employers must have each employee’s SSN for reporting wages and withholding Social Security and Medicare taxes.
- Form W-9: Independent contractors and freelancers require this form for tax reporting purposes.
- Form I-9: This form is to document the employee’s identity and employment authorization.
- State Withholding Forms: All states do not require this. Depending on the state, employees may need to complete state-specific withholding forms to determine state income tax withholding.
- Benefit Enrollment Forms: Employers must collect enrollment forms specifying employees’ enrollment choices and contribution amounts.
Step 3: Create a payroll schedule
When planning the payroll schedule, it is important to assess your cash flow to determine how often you can afford to pay all your employees. Take into account your state’s paycheck requirements, such as minimum frequency of payments. To ensure smooth and timely compensation, it is best practice to create and maintain a visual payroll calendar to ensure all employees are paid on time. Consider using payroll software that can streamline and store all payroll information in one place.
Step 4: Comply with wage laws
It is essential for businesses to understand and follow federal and state wage laws to avoid fines, audits, and overall damage to their reputation. In extreme cases, intentional wage law violations may result in criminal charges.
In the United States, businesses must be in compliance with various federal and states laws regarding but not limited to:
- Minimum wage
- Overtime pay
- Equal pay
- Child labor laws
- Record keeping
- Payday frequency
- Wage deductions
- Tip regulation for the service industry
- OSHA (Occupancy Safety and Health Administration) regulations
Step 5: Use a time tracking system
Employers use time tracking systems to efficiently manage employee productivity and calculate wages. With a digital timekeeping system, data is stored securely and can be easily analyzed. Other benefits include preventing time theft, improving time management, and reducing payroll errors. Some time-tracking systems may have downloadable apps making it easily accessible to all employees. Many companies also choose to outsource payroll timekeeping to specialized firms which can save hours of work and ensure compliance with labor laws.
Step 6: Calculate gross pay of employees
Calculating gross pay for employees involves different methods depending on whether the employee is hourly or salaried, and it can include other factors like overtime, bonuses, and other compensation. Here’s an overview:
Hourly Paid Employees
- Determine the hourly wage.
- Calculate regular hours worked in the pay period.
- Multiple regular hours by hours wage.
- Calculate overtime hours (usually hours worked beyond 40 in a workweek).
- Determine overtime rate.
- Multiply overtime hours by overtime rate.
- Add base pay and overtime pay to get the gross pay.
Gross Pay = (Regular Hours*Wages) + (Overtime Hours*Overtime Rate)
Salary Paid Employees:
- Divide employee’s annual salary numbers by the pay periods in a year (example: 12 for monthly payments or 24 for bi-weekly payments).
Gross Pay = (Annual Salary/Number of Pay Periods)
Step 7: Calculate tax deductions, allowances, and withholdings
Pre-tax deductions are the amount taken out of the employee’s gross income before calculating payroll taxes. These tax deductions are typically exempt from income tax. Common pre-tax deductions include health insurance, retirement contributions, and disability insurance.
Taxes applied on gross wages include federal tax income, state income tax (only applies if your state has an income tax), and local income tax. These taxes support government programs and services.
Post-tax deductions are subtracted from the net pay and include wage garnishment (court-ordered deductions for debts or child support), life insurance plans, or 401(k) loan repayments.
Step 8: Determine net pay and pay employee salary
Net Pay is the amount an employee receives in their paycheck after all the deductions including taxes and other contributions have been subtracted from their gross pay.
Net Pay = Gross Pay – Deductions
To calculate net pay, deduct the following from the gross pay:
- federal income tax
- state income tax
- social security tax
- Medicare tax
- health insurance contributions
- retirement contributions
- any other deductions like union dues or wage garnishments
Step 9: Keep record of processed payroll to make adjustments
Accurate payroll records are vital for businesses to ensure both smooth operations and compliance with federal and state laws. If mistakes happen with calculating tax deductions, you may have to work with IRS to rectify mistakes.
To maintain accurate payroll records, you should document the following data for each pay period:
- Timecards: Record hours worked, breaks, and overtime. Timecards act as evidence of hours worked, preventing any disputes and ensuring proper compensation.
- Pay Stubs: These should include details like gross pay, net pay, deductions for taxes and benefits.
- Pay Increase: Any salary adjustments, promotions, and bonuses should be documented so that the payroll system is up to date.
Step 10: Report and pay payroll taxes
It is crucial for employers to fulfill their tax obligations to avoid potential fines, penalties, and legal repercussions. Failure to meet the tax obligations can cause financial instability and reputational damage.
Employers are required to withhold federal income tax, state and local taxes, and FICA tax (Social Security and Medicare taxes) from their employees’ wages. To fulfill these requirements, employers must:
- Withhold: Calculate and deduct the correct amount of taxes for each employee’s paycheck based on their W-4 form.
- Tax Deposits: Submit withheld taxes to the respective tax authorities on a regular basis. Federal taxes are deposited electronically using the Electronic Federal Tax System (EPTPS).
- Report: Employers must provide annual tax reports to employees and the relevant tax agencies.
Why do small businesses need a payroll system?
In a fast-paced world, a reliable payroll system is necessary for small businesses to streamline payroll processes, ensure compliance with tax regulations and labor laws, and maintain accurate records of employee wages, deductions, and tax documents. Here’s how it works:
Efficient payroll processes: A payroll system eliminates the headache of manual calculations and ensures your employees receive their paychecks accurately and on time.
Compliance with tax regulations and labor laws: A payroll system automatically applies the latest rules and updates to ensure you stay on the right side of the law, avoiding costly penalties and legal issues.
Accurate recordkeeping: Payroll systems keep meticulous records of employees’ wage, deductions, and tax documents. Payroll systems not only simplify audits but also provide a historical trail for reference.
Benefits of using a payroll system include:
- Efficient cash flow management
- Accurate and timely payments
- Improved employee satisfaction
- Organized records and documents
- Simplified tax season
Alternative options to manage payroll
Managing payroll manually is a challenging, time-consuming task that often leads to errors. Alternative options to managing payrolls on your own include payroll software, hiring a payroll specialist, or outsourcing to a third-party payroll management firm.
Use a Reputed Payroll Software
Payroll software is a time saving powerhouse for business owners. It automatically calculates taxes, ensures timely paychecks, and handles tax filings. This means no more number crunching or manual paperwork. It also ensures employees get paid on time, as it can deposit wages directly into their accounts. In recent years, payroll software has been the go-to for businesses to manage payrolls in-house but want to save time and ensure accurate calculations.
Hire an accountant to process payroll
Hiring an accountant keeps your books up to date, ensuring financial accuracy. Besides payroll management, they handle tax deadlines and take on compliance responsibilities, steering you clear of penalties. By minimizing errors, they save time and money. An accountant can add tremendous value to a small business’s overall financial health and culture, fostering trust and financial stability.
Outsource payroll management to third-party companies
Outsourcing payroll can free you and your employees to focus on core tasks. Here’s how to find and hire the right third-party payroll provider for your industry:
- Research: Look for reputable payroll firms through referrals, online searches, or industry associations.
- Needs assessment: Identify your business’s specific payroll requirements.
- Compare services & prices: Evaluate providers based on their services offered and compare pricing structures.
- Check reputation: Review client testimonials and references.
- Contract review: Carefully read the service agreement including terms, fees and cancellation policies.
How to finance payroll for your small business
Businesses that are struggling with cash flow to manage payroll can leverage small business financing options such as SBA Loans, short-term loans, lines of credit, leveraging business credit cards, or payroll loans from alternative lenders. Each option has its advantages, and the choice depends on your business’s unique needs and financial situation. These financing solutions can help ensure that you meet your payroll obligations, even during cash flow challenges.