Payroll for Small Businesses Guide

Payroll for Small Businesses Guide
Article by Zarah Ariola
Last Updated: December 02, 2023

As the needs of your small business accounting grow, you must figure out how to do payroll. The payroll process is one of the most crucial activities for a business — you can do the payroll manually, use online software, or hire an expert.

Doing the payroll yourself is a good idea for small business owners. This article will show how to do payroll for small businesses in detail.

Nine Steps for Doing Payroll for Small Businesses

  1. Step #1: Gather the Preliminary Information Needed to Process Payroll
  2. Step #2: Find the State's Business Requirements
  3. Step #3: Know the Difference Between Employees and Independent Contractors
  4. Step #4: Determine the Payroll Schedule
  5. Step #5: Create an Employee Handbook
  6. Step #6: Choose a Payroll System and Decide Who Manages It
  7. Step #7: Process the Payroll Manually
  8. Step #8: Make Sure New Employees Complete the Required Paperwork
  9. Step #9: Execute the Follow-up Tasks After Each Pay Period

Setting up a payroll system for your small business can be broken down into small steps.

Step #1: Gather the Preliminary Information Needed to Process Payroll

The Employer Identification Number is crucial; hence, this is the first step in the process. The federal EIN is a number issued by the IRS for tax administration. It is used in your business fillings to identify your company.

Getting one is easy and quick as you can apply for it on the IRS website and get yours immediately.

  • Find the Employer Identification Number through IRS
  • Establish the local and state tax ID numbers
  • Collect employee financial information like the 1099 and W-4 forms

Step #2: Find the State's Business Requirements

Apart from a federal EIN, you must register your business in a state and get a state ID number. This number is used when paying taxes for income and employment. You can check the Small Business Administration's state-by-state resource to check whether you need a state ID.

At the same time, you can consult an attorney about whether you need to apply for state withholding and unemployment insurance accounts.

Step #3: Know the Difference Between Employees and Independent Contractors

As a company owner, you need to determine if the people you are hiring should be employees or contractors. This is necessary to file the proper paperwork and withhold taxes for any employees.

The IRS has a guide to help classify the workers as employees or independent contractors. If you are unsure, you can file a form and seek the help of the IRS to decide for you.

Step #4: Determine the Payroll Schedule

Business owners can choose to pay their employees weekly, semi-monthly, or monthly, depending on the business's cash flow. Biweekly payments are the most common.

There are also state-wise requirements about the minimum pay frequency for employees. You can confirm this with your attorney by checking the state's department of labor website.

Step #5: Create an Employee Handbook

An employee handbook is a compilation of the company's policies and processes. It lists down the rules employees should follow along with their legal rights.

This handbook is unique to the business, and you can take the help of resources available online to shape it. Websites like the National Federation of Independent Business guide you on what to include in the handbook.

One of the vital policies to design should be about how your company manages paid time off, overtime, and other types of non-mandatory leave.

Step #6: Choose a Payroll System and Decide Who Manages It

This is a significant step. Business owners must decide if they will run payroll with software or hire a company's payroll management system. Many software options enable you to automate payroll entries and quarterly file forms and stay compliant with state and federal laws. Payroll services take complete responsibility for handling payroll from start to finish.

If you choose payroll software, you must also decide who will manage it in the future. If your business is small, however, you can run the payroll yourself.

Step #7: Process the Payroll Manually

To complete this step, you need to:

  • Calculate employee schedules and overtime pay
  • Calculate the gross revenue for each employee
  • Calculate the deductions and subtract them from the gross pay
  • Calculate the net income and issue payment

Step #8: Make Sure New Employees Complete the Required Paperwork

Once you are ready to hire the first employee, you need two forms to be filled in by each employee:

  • W-4: The employee withholding certificate gives you the information you need to withhold the correct tax amounts from the employee's paycheck. A W-9 is used for independent contractors, but you don't need to withhold taxes for them.
  • I-9: This form verifies that the employee is eligible to work in the United States.

As an employer, you also need to verify the employee's Social Security number and name, which you can do on the Social Security Administration's website. You must also file a new hire report to your state within 20 days.

Step #9: Execute the Follow-up Tasks After Each Pay Period

  • Document and store payroll records
  • Report new hires to the IRS
  • Stay updated on mistakes or miscalculations and document them for reporting to the IRS later

This is a general road map for setting up a payroll system and processing payroll for your small business. Some of these points will be discussed in detail when we speak about the steps involved in payroll processing for small businesses.

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Things You Need to Process Payroll

Here is a checklist to provide an overview of the information businesses should gather before processing each pay period's payroll.

  • Employee information
  • Hours worked
  • Hourly wage
  • Overtime hours worked
  • Preferred payment delivery method (if applicable)
  • Tax information
  • Employer identification number
  • State tax ID information
  • I-9 for each employee
  • W-4 for each employee
  • 1099 for each contractor or freelancer (if applicable)
  • Recordkeeping system
  • Trusted storage for pay stubs and tax information

Importance of a Payroll System for Small Businesses

The most obvious reason is that you need to pay the people who work for your company. Paying employees once a job is done is easy, but having a proper system improves business operations and mitigates possible risks.

Also, payroll is not about paying the employees only. Payroll processing is an elaborate documentation system tracking who is working for your business, how long they are working, and how much you are investing in labor.

If you outsource payroll, your system is automatically set up through the provider. However, if you manage payroll independently, you must set up your system and gather all the required information before starting the process.

How To Do a Payroll for Small Business: Takeaways

Payroll processing can sometimes be tedious when you run a small or large business. You can use some of the best payroll software available if you want to do it yourself.

Businesses can also hire professional accountants to manage tax deadlines and compliance responsibilities as the company expands. Such professional guidance can also add value to your organization's culture and help exceed industry goals while achieving the overall objectives.

Another way to go about it is to look for a specialized payroll agency that can help you with all your payroll and accounting efforts.

Our team ranks agencies worldwide to help you find a qualified agency partner. Visit our Agency Directory for the top Payroll Agencies, as well as:

How to Do Payroll for Small Businesses FAQ

1. How do small businesses keep track of payroll?

Small businesses can keep track of payroll in several ways:

  • Manually. Small businesses can use manual spreadsheets to track payroll. This method is low-cost and suitable for startups and small businesses.
  • Using payroll software. Payroll software solutions automate payroll processes, help with compliance, and streamline the entire payroll process.
  • Outsourcing payroll. Small businesses can outsource their payroll to specialized payroll agencies and focus on core business activities.
  • Hiring professional accountants. Professionals can ensure accurate payroll processing, provide financial advice and assist in creating a payroll strategy that aligns with the business's goals.
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