How to Set Up Payroll for Small Businesses in 8 Easy Steps

Setting up a payroll system for your small business may seem complicated and daunting but the process may not be as difficult as you imagine, especially if you break it down into manageable steps.

More importantly, knowing how to set up and manage payroll is fundamental to the success of any small business, even if you’re just starting out with a few employees. Payroll systems are put in place to manage everything from pay calculations for employees to tax deductions and generating accurate pay slips. They can even help to calculate bonuses, holiday pay and expenses, and make end-of-year reporting much less of a burden.

In addition, not having a payroll system in place can have a number of potential drawbacks, including tax and legal irregularities, financial penalties, and even employee dissatisfaction. But just how do you set up payroll?

How to set up a payroll

This eight-step guide on how to set up payroll for small business tells you everything you need to know, broken down into convenient and manageable steps.

Step one: Determine employee classification

This is the system used for categorizing employees in terms of the hours they work (e.g., full time or part time) and on what basis (contracted or freelance), including any other benefits or tax circumstances that might be relevant. This needs to be in place for each employee on the payroll system.

Step two: Obtain an employer identification number (EIN)

Before you hire employees, you need to get an employer identification number, or EIN. This is a number issued by the IRS for tax purposes, which will be used to identify your business in any filings. It’s quick and easy to do using the IRS website portal. An EIN is essential for ensuring accurate and compliant tax payments for each employee.

Step three: Choose a payroll system

The first thing to consider when choosing a payroll system is what you need for your business. Larger companies may need HR add-ons but smaller businesses will usually be more suited to a simpler payroll solution. To establish what kind of system you need, think about the size of your business and how many employees you have.

You may choose to outsource your payroll to a dedicated company but there is also a big choice of payroll software if you want to keep things in-house. Payroll software may be cheaper than outsourcing but you have to think about the time constraints managing your own payroll system may place on you. Outsourcing means that most things will be taken care of by professional payroll managers.

Step four: Collect employee information

In order to pay your employees, you will need to gather the relevant information. This will include their basic data such as name, address, and social security number, all of which you should have on file in their employment record. You will also need them to complete a W-4 tax withholding form to document their filing status and monitor personal allowances. This will determine how much money is deducted from their pay in taxes during each payroll payment. All employee details need to be kept up to date in order to meet tax compliance regulations.

Step five: Choose your payroll schedule

The payroll schedule determines when you make payments to your employees. This could be weekly, bi-weekly, semi-monthly, or monthly. You need to determine this payment period before you hire employees. In addition, you need to check your state’s minimum pay frequency laws which may determine your payroll schedule. You can find this by visiting your state’s Department of Labor website.

Step six: Calculate employee payroll

Payroll for each employee is calculated according to whether they work on an hourly rate or are salaried. You will also need to factor in any overtime payments or bonuses. You are required to calculate which federal and state taxes should be withheld from any pay, as well as any social security and Medicare deductions that need to be made.

Step seven: Set up direct deposit or paychecks

There are a number of different ways you can make payroll payments to employees. These include direct deposit, checks, or paycards. Direct deposits are electronic transfers made directly from the business account to the employee’s account, which is an efficient process with low risk of fraud and low fees for employees. However, this can be more costly for employers.

Paycards are offered by employers to function as debit cards, with wages added to the card account during each payroll period. Cardholders can use these to pay for goods and services, withdraw cash, or make balance enquiries. Paycards are paperless and offer a low risk of debt or financial liability. However, there are fees for both employees and employers.

Paper checks can be used to draw money from the employer account for transfer to employees, although this is generally a slow and inefficient method of payment.

Step eight: File payroll taxes

Finally, you will need to calculate and submit your federal and state taxes for all employees on the payroll, usually on a monthly basis. You will also need to make social security and Medicare payments. It is very important you pay these deductions on time or fines/penalties may be levied on the business, which can be steep. If you are not outsourcing your payroll but doing it in-house, then it may be a good idea to consult with a CPA or tax law attorney to ensure you are deducting the correct amount.

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Setting up and correctly managing a payroll system for a small business may seem confusing and arduous, but by breaking down the process into more manageable chunks you’ll find it less daunting. For some small businesses, outsourcing the whole process to a specialist may be the easiest way to do payroll. But with the use of available software, learning payroll procedures can now be easily achievable in-house. However you manage your payroll, it is vital that it is in place and working correctly, ensuring that employees are paid accurately and on time, and that any tax and legal requirements are being met in full and not subject to costly fines.

At its essence, managing payroll is about being efficient and organized, collecting the right data and getting payroll advice and payroll tips for small business from the right people. These PayPal tips for managing employees will help you to achieve goals and build the daily habits for success and good business practices required for an effective payroll system.