Can I Do Payroll Myself? What Small Businesses Need to Know

Many small business owners consider handling payroll themselves. This task involves managing employee compensation, deductions, and tax compliance. While possible in-house, it requires understanding various components and strict regulatory adherence. This guide outlines the necessary steps for small businesses to manage payroll effectively.

Foundational Understanding for Payroll

Payroll involves calculating gross pay and net pay for employees. Gross pay is total earnings before deductions, while net pay is the amount an employee receives after all deductions. Understanding these distinctions is fundamental to accurate payroll processing.

Employee compensation includes different types of wages. Hourly wages are paid based on hours worked, with an increased rate for overtime hours exceeding 40 in a workweek. Salaried employees receive a fixed amount of pay over a period, regardless of hours worked.

Deductions are subtracted from an employee’s gross pay. Pre-tax deductions, such as health insurance premiums or 401(k) contributions, reduce an employee’s taxable income. Post-tax deductions, like wage garnishments or Roth 401(k) contributions, are taken out after taxes are calculated and withheld.

Employers and employees share responsibilities for payroll taxes. Federal Income Tax (FIT) is withheld from employee wages based on Form W-4. Social Security and Medicare taxes, known as FICA taxes, are split between the employee and employer. For 2025, the Social Security tax rate is 6.2% for both parties on wages up to $176,100, and the Medicare tax rate is 1.45% for both parties on all wages.

The Federal Unemployment Tax Act (FUTA) is an employer-paid tax, generally 6.0% on the first $7,000 of each employee’s wages. A credit for state unemployment taxes can reduce this to 0.6%. State Income Tax (SIT) is withheld in states that have it, and State Unemployment Insurance (SUI) is an employer-paid tax. Some states may also require employee contributions for SUI. Some localities also impose their own payroll taxes.

Preparing to Process Payroll Yourself

Before processing payroll, obtain an Employer Identification Number (EIN) from the IRS. An EIN is a unique nine-digit number used for tax identification. Employers can apply for an EIN online, by fax, or by mail using Form SS-4. Online applications typically provide the EIN immediately.

Businesses must register with relevant state agencies, including the state unemployment agency for State Unemployment Insurance (SUI) and the state’s department of revenue for state income tax withholding, if applicable. Checking local government requirements is also important, as some municipalities have their own registration and tax obligations.

Collecting employee information is a preparatory step. Employees must complete Form W-4, which provides details for federal income tax withholding, such as filing status and dependent information. Employers also need to ensure employees complete Form I-9 to confirm their identity and work authorization. Essential personal data like full legal name, address, Social Security number, and bank account details for direct deposit should be gathered.

Establishing a dedicated business bank account for payroll funds helps segregate business finances and simplifies tracking payroll transactions. This separation is important for clear financial record-keeping and compliance.

Determining a consistent pay schedule is part of the preparation. Common pay frequencies include weekly, bi-weekly, semi-monthly, and monthly. Bi-weekly schedules are common for businesses with mixed hourly and salaried employees, while weekly payments are often preferred in industries with significant overtime. The chosen frequency must align with state regulations, as some states mandate minimum pay periods. Businesses can manually calculate payroll using spreadsheets or utilize payroll software or online tools, which can assist with calculations and record-keeping.

Executing Each Payroll Cycle

Processing payroll for each cycle begins with calculating gross pay. For hourly employees, this involves multiplying their hourly rate by regular hours worked, and calculating overtime pay at 1.5 times the regular rate for hours exceeding 40 in a workweek. Salaried employees receive their predetermined salary amount for the pay period.

Pre-tax deductions are subtracted from gross pay to arrive at taxable gross pay. These deductions, such as health insurance premiums or pre-tax 401(k) contributions, reduce income subject to federal and often state income taxes.

After determining taxable gross pay, employee withholdings are calculated. Federal income tax withholding is determined using the employee’s Form W-4 and IRS tax tables. For 2025, employees contribute 6.2% for Social Security on wages up to $176,100 and 1.45% for Medicare on all wages. These FICA tax amounts are withheld from the employee’s paycheck. State and local income tax withholdings are calculated based on specific state and local regulations.

After calculating all tax withholdings, any post-tax deductions are subtracted. These might include wage garnishments, child support payments, or Roth 401(k) contributions. After all deductions, the remaining amount is the employee’s net pay.

Pay stubs must be generated for each employee. These documents must clearly detail gross pay, all itemized deductions, and net pay for the current pay period, along with year-to-date totals. Employers then pay employees either through direct deposit or by issuing physical checks.

Fulfilling Payroll Tax Obligations

Employers have responsibilities for depositing withheld taxes and filing required reports with various government agencies. This process is separate from per-pay-cycle calculations.

Federal payroll taxes, including withheld federal income tax and both employee and employer portions of FICA taxes, must be deposited regularly. The deposit schedule for Form 941 taxes is either monthly or semi-weekly, determined by the total tax liability during a lookback period. These deposits are typically made using the Electronic Federal Tax Payment System (EFTPS). Federal Unemployment Tax Act (FUTA) deposits are generally required annually if the FUTA tax liability exceeds $500, though quarterly deposits are necessary if the liability for any quarter exceeds $500.

State and local payroll taxes have specific deposit schedules and methods, which vary by jurisdiction. Employers generally use online portals or other designated systems to make these deposits.

Regular filing of federal payroll forms is necessary. Form 941 summarizes total wages paid, withheld income tax, and both employee and employer shares of FICA taxes for the quarter and is due quarterly. Form 940 reports the annual FUTA tax liability and is generally due by January 31st of the following year, with an extension to February 10th if all FUTA taxes were deposited on time.

At year-end, employers must issue Form W-2 to each employee by January 31st of the following year. This form reports the employee’s annual wages, tips, and other compensation, along with federal, state, and local taxes withheld. A Form W-3 must also be filed with the Social Security Administration, summarizing data from all W-2 forms. State and local governments have similar quarterly and annual reporting requirements for state income tax withholding and state unemployment insurance, which must be adhered to according to their specific deadlines and procedures.

Maintaining Payroll Records

Maintaining accurate payroll records is an ongoing administrative task. Employers must keep detailed records of all employee information, including completed Forms W-4 and I-9, along with personal data like names, addresses, and Social Security numbers.

Records of each payroll cycle are important. This includes payroll registers or reports detailing gross pay, all deductions, and net pay for each employee per pay period, as well as timekeeping records for hourly employees. Documentation of tax deposits made to federal, state, and local authorities, along with copies of all filed tax forms such as Forms 941, 940, and state-specific reports, should be retained. Copies of all W-2s issued to employees are also necessary.

Federal regulations require employers to retain payroll records for at least three years, and wage computation records for two years. The IRS requires tax records, including employment tax records, to be kept for at least four years after the tax due date or payment date, whichever is later. Form I-9s must be retained for three years after the hire date or one year after the termination date, whichever is later.

Many states have their own record retention requirements that may exceed federal minimums, often ranging from three to seven years for various types of payroll and employment documents.

Accuracy in record-keeping is important for demonstrating compliance during potential audits by tax authorities or labor departments. Proper record maintenance aids in resolving employee disputes and simplifies the preparation of future tax filings and other required reports. These records should be stored securely, whether in physical or digital formats, to protect sensitive employee and business information.