How to Process Payroll for Your Small Business

Knowing how to process payroll correctly is essential for new business owners. Processing payroll yourself or with the help of payroll software solutions gives you access to all your business's employee payment data and gives you the power to set up payroll exactly as you want.

There are many potential stumbling blocks when setting up payroll and paying your employees. For that reason, many small business owners outsource payroll to professional bookkeepers or automate the process using software-based payroll solutions.

Step 1: Obtain an Employer Identification Number (EIN)

The first step is to set up an employer identification number (EIN). The IRS will use this number to identify your business. Any business that pays employees must have an EIN.

New businesses can read about applying for an EIN on the IRS website. Be sure to find out if your business needs multiple employer identification numbers if you operate in more than one state, county, or city.

Step 2: Gather Relevant Employee Tax Information

Gathering relevant employee tax information is the next step once you have your EIN. Ask your employees to fill out a W-4 and an I-9 form to collect their tax information. If you employ contract or freelance workers, you will need to issue a Form 1099. These payroll forms ask employees for information about their employment status, eligibility to work in the United States, and TIN where appropriate. The W-4 also gives employees choices about tax credits, deductions, and additional tax withholding.

1099 contractors are subject to different rules than employees regarding taxation. However, since most of the work will be done by the employee, your role will be limited to distributing the forms, collecting them, and submitting them to the IRS.

Also ask each employee for:

• Their payment details

• Any relevant paperwork related to the employee’s health insurance or retirement savings accounts

• Approved reimbursement requests on a month-by-month basis, as applicable

This step is just one of many small business bookkeeping tasks your business must complete before processing payroll. At this point, a small business accounting professional can provide you with the current FICA and FUTA tax rates as well as the relevant tax withholding tables for local, state, and federal governments.

Step 3: Choose Your Payroll Schedule

There are four possible pay schedules for processing payroll: weekly, biweekly, semiweekly, and monthly. Each one of these options has advantages and disadvantages for the business and the employee. 

Be sure to review state laws regarding payroll schedules to guarantee compliance in your state. For example, businesses in Florida do not have a pre-specified payment schedule to follow. However, employers in some other states need to pay their employees on a specific schedule.

Step 4: Calculate Gross Pay

Calculating an employee's gross pay will differ if they're salaried employees or they're paid by the hour.

• Salaried employees: Divide the employee’s annual salary by the number of pay periods in the year. For example, an employee who earns a salary of $60,000 per year and is paid monthly will have a gross pay of $5,000 per pay period ($60,000/12).

• Hourly rate: Calculating gross pay based on an hourly rate is simply a matter of multiplying the number of hours an employee has worked by their hourly rate. For example:

An employee has worked 86 hours in a biweekly pay period. Their hourly rate is $15 per hour and $20 for overtime. In a pay period of 80 hours:

80 hours x $15/hour = $1,200

6 hours x $20/hour = $120

Gross pay = $1,320

Many small business owners learn how to do payroll in QuickBooks. Payroll solutions like QuickBooks automate the calculations required for the payroll process, reduce the risk of data loss, and reduce the scope for human error. It can be particularly useful in businesses with a team of workers as it can save you a significant amount of time.

If you choose to process payroll manually, check timesheets carefully and take overtime into account. You must also factor in commissions, bonuses, profit shares, incentives, and merit pay when calculating remuneration for your employees.

Step 5: Work Out Payroll Taxes and Other Deductions

Working out employees’ payroll deductions, allowances, and withholdings is one of the most important steps when processing payroll.

• Federal taxes: Employers need to withhold federal income tax, FICA taxes, and FUTA taxes (when applicable) from their employees’ wages.

• Federal income tax: Use the current year’s income tax bracket table to calculate the amount of federal income tax due.

• FICA tax: The current FICA tax rate is 15.3% of the employee’s gross pay. This covers the 12.4% tax for Social Security taxes and 2.9% for Medicare taxes. Half is paid by the employer and half by the employee.FUTA tax: You may need to pay federal unemployment tax on behalf of some employees. Employers need to pay federal unemployment taxes if they've paid an employee $1,500 or more in any quarter of a calendar year and if they had an employee at least one day a week during 20 weeks in a calendar year.

• State and local taxes: Check with your local authorities or ask your accounting team about how local and state rules affect you.

• Voluntary deductions: Some employees may request that you withhold additional deductions such as retirement plan contributions, and life or dental insurance.

• Wage garnishments: Wage garnishment is when part of an employee's paycheck is withheld and sent to another party. Common examples include spousal or child support and student loans.

Working out withholdings can be time-consuming if done by hand because deductions will vary from employee to employee. Payroll processing software (when implemented by an expert) can streamline this process. 

Step 6: Calculate Employees' Net Pay and Pay Your Employees

Once you have calculated the total deductions and taxes that must be withheld from each employee’s pay, you must then subtract this amount from the gross figure to arrive at the employee’s net pay. Calculate net pay using the following formula: Gross pay – deductions = net pay.

It's vital to get this step right as mistakes can be costly and cause conflict between the company and its employees. A 2022 study observed that each mistake in payroll costs companies an average of $291 to fix (page 3 of the linked PDF). The amount can quickly add up if you have frequent errors in your calculations.

Net pay—or take-home pay—is the amount employees receive at the end of each pay period. You can pay employees directly in cash, check, or direct deposit, or outsource the task to a third-party payroll service provider. 

You must then create a pay stub for each employee. You can print pay stubs in QuickBooks online quickly and easily every month or on-demand if an employee needs a recent pay stub for any other reason.

Finally, you will need to submit the amounts withheld to the relevant agencies. This may include:

• The Internal Revenue Service

• Your state’s department of revenue

• Your employees’ retirement and insurance providers

Step 7: Keep Thorough Payroll Records

Keeping methodical, honest, and organized payroll records is essential for your business. Having clear records protects your business if there's ever a discrepancy between an employee's net pay and what they expect to receive. Up-to-date and accurate records will also provide you with backup if you are ever audited by the IRS.

Get the Payroll Support You Need

Processing payroll is a time-consuming process and one that must be done right. Because payroll is only one of the many bookkeeping processes necessary to keep your business ticking over, many business owners turn to professionals for support.

Getting help from a professional either to take over the payroll process or to set up payroll software in your company can streamline payroll and reduce the chances of costly errors. Best of all, you'll feel supported at every stage and free to concentrate on the aspects of your business you love most.