How to Run Payroll: The Ultimate Guide to Doing Payroll
Running payroll is an essential part of operating any business that has employees. But it doesn’t come without its challenges. And the more employees you have, generally the more complicated the process can become. So how are businesses handling this essential process? A recent Paychex poll* of payroll users found that 39% of businesses do payroll manually, and just 17% of respondents would consider changing from a manual to an outsourced solution.
These and other professionals may not realize that if and when things go wrong, they often come at a high price. To prevent this from happening at your company, read this overview on how to run payroll, as well as your options for completing the process accurately and efficiently.
How does payroll work?
Once you have employees, you need to pay them and handle applicable taxes each pay period. There are many steps involved to complete these tasks, which we will cover in detail. These and other responsibilities make up the payroll process, which you or another staff member such as a bookkeeper can do, or you can find an accountant or payroll provider to handle these tasks for you.
Can you do payroll yourself?
Running payroll is an essential part of operating any business, no matter the size or type of industry. Business owners can do payroll themselves, though they must become familiar with the terminology, options, and basics of running payroll, as well as payroll tax laws to avoid making mistakes. Approximately 33% of all employers make payroll errors, and those mistakes can be costly. Unpaid taxes can result in hefty penalties, and mistakes on employee paychecks can erode worker morale and be a detriment to your business reputation.
Business owners have several options when it comes to running payroll, including outsourcing the process. Depending on the method you choose, consider actors such as how much control or oversight you want to have, cost considerations, and time commitments, among others.
Business information for payroll
Before getting acclimated with payroll basics or getting started, the following business items must first be in place:
- Apply for a Federal Employer Identification Number (FEIN): This is assigned by the IRS and is used to identify a business entity. You need this nine-digit number to pay federal taxes, hire employees, open bank accounts, and apply for business licenses and permits. You can do this online on the IRS website.
- Register with your state and local government: Depending on your business structure and location, you’ll need to register for a state ID number to pay your business’s state taxes. Tax obligations and steps to get an ID number both differ at the state and local levels, so check with your state and local agencies.
- Look into workers’ compensation coverage: This insurance is mandatory in most states, although rules vary from state to state as to how many people a business can employ before it is required. Nonetheless, it’s strongly recommended that you have workers’ compensation coverage if you have employees.
- Report new hires: State and federal laws require employers to report information on new and rehired employees to the appropriate agency within 20 days of beginning employment. Some states require reporting this data sooner. This information is used to locate parents who owe child support.
Employee payroll information
There are also specific pieces of employee information you’ll need to gather before getting payroll started. They include:
- Worker classification (exempt vs. non-exempt, employee vs. independent contractor): It’s important that any worker you bring on board is classified correctly, since each classification falls under different rules. This will determine the appropriate wage and net pay amounts.
- New-hire documents: (Form W-4, Form I-9, etc.): Although certain forms are completed by nearly all new hires, they may vary from company to company due to industry-specific regulations, company benefits, and policies. In addition, for employers with more than one location, different state and local laws may require that employees at only one worksite complete certain documents. It’s your responsibility to ensure that all required new hire forms are completed as part of the onboarding process.
- Payment method: Depending on the options you offer, you will have various tasks to complete to successfully deliver paychecks via direct deposit, paper checks, or paycard. Learn more about employee pay options that may be available to your business.
Payroll Service As a Home Business
Certain types of business are easier to operate as a home business, and running a payroll service as a home business is a viable option. A payroll service handles calculating taxes, withholding taxes from employee paychecks, filing employer tax returns, making tax payments and cutting the payroll checks for the businesses that are your clients (and/or making the direct deposits). Since you can handle most of the transactions between you and your clients by phone, email and online, it is possible to offer payroll services to clients anywhere in the country.
Experience
While it is not a necessity, it is helpful to have an accounting or financial background to run a payroll service from your home office. You also need to have, or gain, a full understanding on employer taxes, such as withholding taxes from employee paychecks like Medicare and Social Security taxes. Your job is to make the life of your clients easier. They don’t want to take the time or effort to do payroll or learn the wage laws on their own. So, the more experience you have, the better. At the very least, enroll in a tax and wage withholding class or seminar before starting your business.
Licenses
Running a payroll service from a home office may require you to carry an occupational license with the county or city where you operate your business. Some counties also require you to have a home-based office license from the county zoning board. To run a payroll service, you do not have to be federally licensed, but you do have to register your business with the state in which you operate the business. Contact your Secretary of the State for the state where your business operates (where your home office is) to obtain the paperwork you need to register your business entity name as a sole proprietor, partnership, corporation or limited liability company (LLC).
Considerations
Consider how you wish to interact with your payroll clients so you can transmit payroll information back and forth. Clients need to submit the hours employees work, wage rates and withholding information to you so you can calculate the correct paycheck amounts for each employee. Decide if you want to offer an online option, where clients can upload this information to a self-service Internet platform that they can also use to access their account information with a username and pass code. This is the most technologically advanced option for interacting with payroll clients, but you can also have them submit this information via email, fax or by phone.
Geography
Geographic boundaries do not necessarily apply to a payroll service you run from a home office. You can serve a client in the same city as easily as you can a client clear across the country, since offering the service does not require face-to-face interaction. If you do offer payroll services out of state, you need to be aware of any state laws that apply to client that operates the business in the state. For example, Texas does not have state taxes, but Virginia does, so you need to be aware of how to deduct Virginia taxes from employee paychecks and how employers pay these taxes to the state.
Time Frame
Generally, you work on the clients’ payroll schedule. Most paycheck schedules run weekly, every two weeks or once a month. You also need to be aware of and adhere to tax payment deadlines for employers, which is once a quarter. Being prompt and providing the services on time each pay period is imperative for a payroll service to be successful.
Equipment
Starting and running a home-based payroll service does not require a huge cash investment or the purchase of a lot of fancy equipment. You can start and run your business with a computer, payroll/accounting software, a phone and Internet service. If you want to offer your clients a self-service online platform, where they can submit and access their personal account information, you need to work with a service that can provide this type of interface, so your costs will increase.
Do Payroll Calculations
Once you know how much an employee has worked for the pay period, you can start figuring the important payroll calculations. That includes gross pay, taxes due, deductions for insurance premiums and other benefits, and final net pay.
Gross Pay
Calculating gross pay is as simple as adding up the straight time hours (up to 40 hours within a week) and multiplying by the employee’s hourly rate. Then, add up the overtime hours worked in the pay period and apply the employees’ overtime pay rate to those hours. Straight time is paid at the employee’s regular pay rate, while overtime is calculated at 1.5 times the regular rate of pay.
Payroll Deductions and Taxes
Doing payroll requires you to know in advance what payroll deductions you’re going to make. Deductions include federal and state payroll taxes (be sure you know the tax rates), benefits you might offer, and things like unemployment insurance or Social Security.
Here’s a list of potential deductions with links to more information such as determining what to deduct for each employee. If you use payroll software like Gusto, deductions are processed automatically.
Examples are:
- Social Security and Medicare (FICA)
- Federal unemployment tax (FUTA)
- Deductions based on benefits you offer employees, like health insurance
- Tax deductions based on employee tips
- Miscellaneous deductions such as a uniform expense
To process those deductions, add up all the deductions for each employee to get a total, then subtract that total from the employee’s gross pay. Alternately, you can list each deduction as a line item and subtract them one by one from the employee’s gross pay until you come up with a net pay amount.
The Pros & Cons Of Manual Payroll
Some small business owners choose to do their own payroll manually. It saves money but it is not necessarily the best option for everyone.
Pros Of DIY Payroll
- It’s Cheaper: When you outsource payroll, you incur an extra cost. That cost will depend on the kind of business you are running and the number of people on your payroll, but when you are running a small business, every penny counts. If you just can’t justify the expense of outsourcing Payroll, you can do it yourself using free resources available.
- You Stay In Control: Small business owners often fear losing control of their business. A third-party payroll provider may not do things the way you want them done. Doing it yourself allows you to maintain total control of your business operations.
- You Know What’s Going On: Doing it yourself provides a good opportunity to understand everything about your payroll process and payroll taxes.
Cons Of DIY Payroll
- It Takes Dedication: Successful DIY payroll depends directly on the effort of an individual. If you can’t take care of it for some reason that month, it won’t be taken care of.
- There’s A Significant Time Commitment: Doing your own payroll means sacrificing your own time. Time is the only resource that is even scarcer than money in the small business landscape, and there is an automatic cost to doing payroll yourself.
- Lots Of Room For Error: You might get it wrong or incur too much stress. If you are not a naturally detail-oriented person, doing your own payroll might cause more stress than its worth — and put you in a position of liability when you get things wrong.