How Can I Do My Own Payroll for a Small Business?

Payroll for a small business involves setting up accounts, calculating wages, remitting taxes, and filing reports. Managing these responsibilities independently requires attention to detail and adherence to regulatory guidelines. This process ensures employees are paid accurately and on time, while fulfilling federal, state, and local tax obligations.

Establishing Your Payroll System

Before processing paychecks, a small business must establish its payroll system. This involves obtaining an Employer Identification Number (EIN) from the Internal Revenue Service (IRS), a unique federal tax ID. The EIN is used for tax filing, business reporting, and opening bank accounts. You can apply for an EIN online.

Businesses must register with state and local tax agencies, including for state unemployment insurance, state income tax withholding, and any applicable local payroll taxes. States and some localities have specific tax requirements and reporting procedures.

Distinguishing between employees and independent contractors is important, as tax obligations differ. Employees are subject to payroll taxes and withholding, while independent contractors manage their own taxes. Employers must collect essential employee information, including a completed federal Form W-4 for federal income tax withholding.

Employers should also collect state withholding forms, if applicable, and a Form I-9, Employment Eligibility Verification, to confirm authorization to work in the United States. Establishing clear pay periods, such as weekly, bi-weekly, semi-monthly, or monthly, dictates payroll processing frequency.

Calculating and Withholding Employee Pay

Payroll processing involves calculating gross pay and determining withholdings and deductions. Gross pay includes hourly wages, salaries, overtime, and bonuses. For hourly employees, gross pay is calculated by multiplying hours worked by the hourly rate, plus any overtime.

Pre-tax deductions are subtracted from gross pay before taxes are calculated, reducing an employee’s taxable income. Examples include contributions to traditional 401(k) plans and certain health insurance premiums. Pre-tax retirement contributions do not reduce income subject to Social Security and Medicare taxes.

Federal tax withholding includes Federal Income Tax (FIT), calculated using information from the employee’s Form W-4. Federal Insurance Contributions Act (FICA) taxes, comprising Social Security and Medicare taxes, are withheld.

For 2024, the Social Security tax rate is 6.2% for both employee and employer, up to a wage base limit of $168,600. The Medicare tax rate is 1.45% with no wage limit. An additional Medicare tax of 0.9% applies to wages exceeding certain thresholds.

State and local tax withholdings vary by jurisdiction and are calculated based on specific rules and employee-provided forms. After pre-tax deductions and mandatory tax withholdings, post-tax deductions are applied. These might include wage garnishments, Roth 401(k) contributions, or certain insurance premiums. The final amount an employee receives is their net pay.

Paying Employees and Remitting Taxes

After payroll calculations, the next phase involves paying employees and remitting withheld taxes. Businesses typically pay employees through direct deposit or by issuing physical checks. Direct deposit requires collecting employee bank account and routing numbers. For physical checks, businesses must print checks, ensure sufficient funds, and distribute them.

Remitting federal payroll taxes, including federal income tax, Social Security, and Medicare taxes, is primarily done through the Electronic Federal Tax Payment System (EFTPS). EFTPS allows businesses to make federal tax payments online or by phone. To use EFTPS, employers must enroll, a process that can take up to five business days to receive a Personal Identification Number (PIN) by mail.

Deposit schedules for federal taxes are either monthly or semi-weekly, depending on the business’s total tax liability. Employers must make these deposits by specified deadlines to avoid penalties. Remitting state and local payroll taxes involves using state-specific online portals or forms, as procedures and deadlines vary by jurisdiction.

Filing Payroll Reports

After processing payroll and remitting taxes, businesses must file various reports with federal, state, and sometimes local agencies. These reports reconcile amounts withheld and paid. Federal quarterly reporting involves Form 941.

Form 941 reports total wages paid, federal income tax withheld, and both employee and employer shares of Social Security and Medicare taxes for the quarter. This form is generally due by the last day of the month following the end of each calendar quarter. Federal annual reporting includes Form W-2, Wage and Tax Statement, which details annual wages and withheld taxes.

Employers must distribute Form W-2 to employees by January 31 of the following year and submit copies to the Social Security Administration (SSA). Form W-3 accompanies W-2 submissions to the SSA, summarizing total wages and taxes. State and local reporting often mirrors federal requirements, with many jurisdictions requiring their own quarterly and annual reconciliation reports.

Maintaining Payroll Documentation

Businesses should retain records including employee names, addresses, Social Security numbers, and dates of employment. Detailed wage records, such as hours worked, gross pay, and all deductions and withholdings.

Records of tax deposits and copies of filed federal and state reports, like Forms 941, W-2, and W-3, should be kept. Time cards or other wage statements used to compute pay are necessary. The IRS generally requires employers to keep employment tax records for at least four years after the tax becomes due or is paid.

Other regulations, such as the Fair Labor Standards Act (FLSA), require retaining certain payroll records for at least three years. Records used for wage computations must be kept for two years. Form I-9 must be kept for three years after hire or one year after employment termination, whichever is later.