Doing your employees’ payroll consists of many moving parts that need equal attention.

Wages, working hours, benefits, tax deductions, garnishments, complying with regulations...you need to take all these into account when setting up a process that works smoothly in the long run.

Also, filing payroll taxes incorrectly, incompletely or untimely, could lead to costly penalties.

In this article, we will take a look into how payroll works and establish how to do payroll for any business, either on your own or with the help of a professional payroll company.

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How Does Payroll Work?

Payroll is detailed documentation on how your employees work, for how long and how much of your budget you are spending on them.

It entails various steps from gathering employee information, to calculating taxes and deductions, allotting benefits and sending paychecks. The whole process can be automated or executed manually.

As an employer, you need to make sure you have the following information to be able to process payroll:

  • Employer Identification Number
  • Local tax ID
  • Employees’ Form W-4
  • Payroll frequency
  • Established payroll system
  • Employee banking details

How to Do Payroll In-House

If your company has a small number of employees and you have a dedicated payroll specialist or an HR department, doing payroll on your own could be a cost-effective option.

In order to avoid issues that may affect your business performance and bottom line, you need a well-defined process that will help you maintain payroll records and meet tax filing deadlines.

These 5 steps are essential if you want to do the payroll yourself and keep your business on good terms with tax authorities.

Step #1: Calculate Hours and Gross Pay

When processing your employees’ payrolls manually, the first thing you need to do is calculate every employee’s number of hours during the given payment period (most commonly, this would be the duration of a month from one payroll to the next).

You then need to multiply the total hours of their work with every worker’s pay rate in order to establish the gross pay amount.

Also, remember to take into account any overtime hours. In accordance with the Fair Labor Standard Act, you should multiply each hour that an employee has worked over the standard 40 weekly hours by at least 1.5x the regular pay rate.

The workweeks in this case must consist of seven consecutive 24-hour periods. You should also be aware of the fact that different US states have different overtime pay requirements, so be sure to get to know yours.

Step #2: Process Payroll Deductions

After the gross pay is established, it’s time to process payroll deductions.

When making your pre-tax deductions, withhold contributions such as health benefits, 401(k) retirement plan or life insurance. You then need to calculate the statutory deductions such as federal and state income tax and Federal Insurance Contributions Act (FICA) taxes for social security and Medicare.

As an employer, you need to match the portion of every employee’s paycheck that goes to FICA taxes.

Finally, you need to subtract the post-tax deductions, such as court-ordered wage garnishments from certain employees, IRA retirement plans and so on.

Some states and jurisdictions have other taxes as well that you should withhold from employees and pay, so be sure to know your state’s tax regulations.

Step #3: Define Your Net Pay and Pay Your Employees

The net pay is what’s left once you subtract all pre-tax and post-tax deductions from the employee’s paycheck. This is the money each employee receives and takes home.

There are numerous ways in which you can process payments and distribute paychecks to your employees, as long as you comply with laws that govern salary payments.

In this case, make sure you are familiar with specific electronic delivery requirements for a jurisdiction where you have employees. Flexibility, cost and compliance are payment processing priorities because employers are abandoning traditional checks as paper and postage materials boost payroll operating expenses.

Direct deposits, paycards, eWallets and similar payment methods are more convenient and less costly.

Step #4: File Tax Report

Taxes deducted from your employees’ wages should be filed with the federal government. To pay your FICA taxes and report income tax, Social Security tax and others that you have withheld, you can use Form 941, also called the Employer’s Quarterly Federal Tax Return.

Employers also pay Federal Unemployment Tax Act (FUTA) and state unemployment tax (which shouldn’t be deducted from employee wages). You should file these in compliance with your local guidelines.

Step #5: Document Your Payroll Records

Taking recordkeeping seriously is crucial to ensure everything is accounted for, avoiding any compliance issues and ensuring accurate payrolls each month.

Payroll records for each employee should include:

  • Name and occupation
  • Address
  • Social Security number
  • Day and time when an employee's workweek began
  • Number of hours worked each day and workweek
  • The basis on which the employee’s wages were paid
  • Regular hourly pay rate
  • Total daily or weekly straight-time earnings
  • Overtime earnings for each workweek
  • Gross wages
  • Payroll deductions
  • Allowances claimed
  • Net wages
  • Date of each payment and the pay period that it covered
  • Taxes withheld
  • Form W-4

Bear in mind that you should keep the tax purposes record on file for a minimum of four years, in compliance with federal or jurisdictional requirements.

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How to Set Up Payroll Using a Payroll Service Provider

If you prefer to leave the payroll processing in the hands of dedicated professionals, hiring a business payroll provider is a reliable and, in the long run, a more cost-effective option.

Payroll companies make it possible for decision-makers and managers to focus on their core business processes and goals while ensuring employees get paid timely and adequately.

These companies calculate compensation and taxes automatically and file them directly to IRS and state tax departments on your behalf. They even keep track of total hours worked and pay employees via direct deposit methods.

Step #1: Choose Your Payroll Provider

Numerous specialized companies have the expertise and resources such as payroll software to process payments and reduce the risk of fines.

When faced with numerous options of companies you can hire, it is important to single out the one that befits your company size and industry. They should also have a proven track record of providing satisfactory services and being timely and responsible with filing their clients’ taxes.

Step #2: Add Your Employees

Before processing payrolls, you need to submit your employees’ info to the payroll service provider.

In case you are switching to a new payroll provider, you will also need to add the current employees’ payroll information such as names, addresses, social security numbers, tax withholding info, etc.

Step #3: Track Working Hours and Import Them

Employers must keep track of wage records for up to two years, as required by the US Department of Labor and make sure you know your state’s specific requirements. In that regard, track your employees’ work hours and provide their timecards to your payroll service provider.

Step #4: Have Your Payroll Provider Keep Track of Your Tax Payments

The IRS requires tax forms to be kept for three years. Certain states may have longer retention requirements; be sure to check the specific requirements in your state. 

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What You Need to Run Payroll

As mentioned earlier, you should know the entire process and the prerequisites that you must meet in the beginning before you start doing payroll.

Once you set up the payroll processing system, information and documentation will easily flow and this will greatly help your reporting as well.

The essential steps in the payroll processing system include:

  • Gathering the preliminary information needed to process payroll
  • Find your EIN through the IRS.
  • Establish state and local tax ID numbers.
  • Collect employee financial information like W-4 and 1099 forms.
  • Setting up a payroll schedule
  • Choose a weekly, biweekly, semiweekly or monthly payroll system.
  • Establish payroll tax payment dates.
  • Calculating and issuing payment
  • Calculate employee hourly schedules and overtime pay.
  • Calculate gross pay for each employee.
  • Determine deductions and subtract them from gross pay.
  • Calculate net pay and issue payment.
  • Completing follow-up tasks after each pay period:
  • Keep and document payroll records.
  • Report new hires to the IRS.
  • Stay up-to-date on any miscalculations or mistakes, which should be documented and eventually reported to the IRS.

Final Thoughts on How to Do Payroll

When beginning to process payments for your employees, you are faced with two choices – do it in-house or hire a specialized payroll company or an accountant.

Either way, setting up a good payroll management system is important because you need to pay the employees working in your company while making sure you mitigate the risks of pitfalls and improve business operations.

The essential 5-step process of doing payroll consists of:

  • Calculating working hours and gross pay
  • Processing payroll deductions
  • Defining net pay and paying employees
  • Filing tax reports
  • Documenting payroll records

If you opt to hire a payroll service company that can do these for you, begin with establishing the actual process and make sure tax payments and other administrative obligations do not fall through the crack.

Working with a payroll company automatically sets your system up company-wide. These specialists can help you:

  • Track employee hours and wages
  • Track deductions and other withholdings
  • Keep tax documents organized
  • Track direct deposits and payments
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