Can You Do Your Own Payroll for a Small Business?

Managing payroll internally for a small business is feasible for owners with dedication. The process involves complex calculations, strict deadlines, and precise record-keeping. Handling payroll in-house offers direct control over a fundamental business operation. It requires understanding federal, state, and local regulations for compliance and to avoid penalties. With preparation, a small business can manage its payroll, ensuring accuracy and fulfilling employer obligations.

Essential Information for Payroll

Before payroll calculations, a business must compile foundational information. This includes securing an Employer Identification Number (EIN) from the Internal Revenue Service (IRS), which is a unique nine-digit number assigned to businesses for tax purposes. Businesses also need state tax identification numbers for state unemployment insurance and income tax withholding from relevant state agencies.

Beyond these, a business needs its legal name, address, and established pay schedule (e.g., weekly, bi-weekly, monthly). Essential employee data includes full legal name, address, Social Security Number (SSN), and banking details for direct deposit.

Employees must complete IRS Form W-4, Employee’s Withholding Certificate, to provide federal income tax withholding information. Many states also require a similar state-specific withholding form. Gather documentation of wage rates (hourly or salaried) and authorized pre-tax or post-tax deductions (e.g., health insurance, retirement, garnishments). Accurate records are paramount for audit readiness and compliance.

Payroll Calculations

After collecting information, calculate each employee’s pay. The process begins with determining gross pay, total earnings before deductions. For hourly employees, gross pay is hours worked multiplied by their hourly rate, including FLSA-mandated overtime (1.5x regular rate for over 40 hours). Salaried employees typically receive a fixed amount per pay period, regardless of hours worked, unless specific agreements for additional pay exist.

Next, apply various deductions. Pre-tax deductions, like health insurance, 401(k)s, or SIMPLE IRAs, are subtracted from gross pay before taxes, reducing taxable income. After pre-tax deductions, determine taxable wages for federal, state, local income taxes, and Federal Insurance Contributions Act (FICA) taxes.

Tax withholding calculations are complex. Federal income tax withholding is determined using IRS Publication 15-T, Federal Income Tax Withholding Methods, and employee Form W-4 information.

FICA taxes comprise Social Security and Medicare taxes. For 2025, Social Security tax is 6.2% for both employee and employer on wages up to $176,100. Medicare tax is 1.45% for both employee and employer on all wages. An additional 0.9% Medicare Tax is withheld from employee wages exceeding $200,000, with no employer match. State and local income tax withholding varies by jurisdiction, requiring consultation of specific tax agency guidelines.

Finally, post-tax deductions are subtracted after all taxes. These do not reduce taxable income and include Roth 401(k) contributions, wage garnishments, and union dues. After all these calculations, the remaining amount is the employee’s net pay, which is their take-home earnings for the pay period.

Paying Employees and Remitting Taxes

After payroll calculations, distribute net pay to employees and remit withheld taxes to government agencies. For employee payments, direct deposit is common and efficient, requiring electronic transfers. Alternatively, businesses can issue paper checks, which involves printing and distributing checks. Providing detailed pay stubs is mandatory, outlining gross pay, deductions, and net pay.

Remitting federal taxes involves using the Electronic Federal Tax Payment System (EFTPS). Businesses are classified as monthly or semiweekly depositors; adhere to the correct schedule to avoid penalties. Federal income, Social Security, and Medicare taxes are deposited through EFTPS. Federal Unemployment Tax (FUTA) is an employer-only tax, generally 0.6% on the first $7,000 of wages, with a maximum 5.4% credit for state unemployment taxes paid. FUTA taxes are also remitted through EFTPS, typically quarterly if liability exceeds a threshold.

State and local tax procedures vary by jurisdiction. Consult specific state revenue or unemployment agency websites for instructions on remitting state income tax withholding and State Unemployment Insurance (SUI) taxes. Local taxes also have remittance requirements. Timely and accurate remittance of all tax obligations is paramount for compliance and to prevent penalties.

Payroll Reporting Requirements

Employers have ongoing reporting obligations to government agencies. Quarterly federal reports include Form 941, Employer’s Quarterly Federal Tax Return. This form reports wages, tips, federal income tax withheld, and Social Security and Medicare taxes (employee and employer shares) for the quarter. Form 941 is due by the last day of the month following each quarter: April 30 (Q1), July 31 (Q2), October 31 (Q3), and January 31 (Q4).

Annually, businesses must file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, reporting FUTA tax liability. Though FUTA tax may be deposited quarterly, Form 940 is an annual filing, generally due by January 31 of the following year.

For employees, Form W-2, Wage and Tax Statement, reports annual wages and taxes withheld. It must be distributed to employees and submitted to the Social Security Administration (SSA) by January 31. Form W-3, Transmittal of Wage and Tax Statements, accompanies W-2 forms to the SSA, summarizing total wages and taxes for all employees. If a business pays independent contractors $600 or more, Form 1099-NEC, Nonemployee Compensation, must be issued to the contractor and filed with the IRS by January 31.

State and local reporting requirements mirror federal obligations with jurisdiction-specific forms and deadlines. These often include state unemployment wage reports and withholding tax reconciliation forms. Consult state and local tax agency websites for instructions. Retain all payroll records, including timesheets, pay stubs, tax forms, and payment confirmations, for a minimum of four years for employment taxes, as mandated by the IRS. The Fair Labor Standards Act (FLSA) requires retaining wage and hour records for three years, and supporting calculations for two years.