How to Do Employee Payroll for a Small Business
Gain clarity on managing employee payroll for your small business. Navigate the complete process from initial setup to accurate tax reporting and compliance.
Employee payroll processing involves calculating employee wages, managing tax withholdings, and ensuring compliance with various federal and state regulations. This process is fundamental for businesses to operate smoothly and maintain legal standing. Understanding payroll allows employers to accurately compensate their workforce while fulfilling financial obligations. It encompasses steps from initial setup to regular tax remittances and form filings. Efficient payroll management contributes to employee satisfaction and helps avoid potential penalties for non-compliance.
Setting Up Your Payroll System
Establishing a payroll system begins with obtaining an Employer Identification Number (EIN) from the Internal Revenue Service (IRS). This unique nine-digit number acts as a federal tax ID for businesses and is required for hiring employees and tax filings. Businesses can apply for an EIN online through the IRS website for immediate issuance, or by mail or fax.
Beyond federal registration, businesses must also register with relevant state agencies. This registration is necessary for state income tax withholding, state unemployment insurance, and other state-specific payroll taxes. Before processing payroll, gathering essential employee information is also necessary, including Federal Form W-4 and Form I-9.
Form W-4 provides employers with details about an employee’s tax situation, guiding the employer on how much federal income tax to withhold. Employees complete this form to indicate their marital status and claim any adjustments. Form I-9 verifies the identity and employment authorization of individuals hired in the United States, ensuring they are legally permitted to work. Employers must complete Form I-9 within three days of an employee’s first day of employment.
Determining a consistent payroll schedule is another step, with common options including weekly, bi-weekly, semi-monthly, or monthly. The chosen schedule impacts how frequently payroll calculations are performed and when employees receive their pay. Establishing a method for accurately tracking employee hours is also important for calculating gross pay. This setup ensures all necessary registrations are complete and required employee data is collected before the first payroll run.
Calculating Employee Pay and Withholding Taxes
Calculating employee pay begins with determining gross wages, the total amount earned before any deductions. For hourly employees, this involves multiplying hours worked by their hourly rate. If an employee works more than 40 hours in a workweek, the Fair Labor Standards Act (FLSA) requires overtime pay at least one and a half times their regular rate for those additional hours. Salaried employees receive a fixed amount per pay period, regardless of hours worked.
After calculating gross pay, various deductions are applied, starting with pre-tax deductions. These deductions reduce an employee’s taxable income, which can lower their federal and state income tax liability, and sometimes FICA taxes. Common pre-tax deductions include contributions to health insurance premiums, Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs), and qualified retirement plans. Contributions to a traditional 401(k) are deducted before federal income taxes are calculated.
Tax withholding is a substantial part of payroll calculation, starting with federal income tax (FIT). The amount of FIT to withhold is determined by information provided on the employee’s Form W-4 and the IRS’s withholding tables or percentage method, detailed in IRS Publication 15-T. Employers use these tables, which factor in filing status and other adjustments, to accurately subtract the appropriate amount from each paycheck.
Federal Insurance Contributions Act (FICA) taxes, comprising Social Security and Medicare taxes, are also withheld from employee wages. For 2025, the Social Security tax rate is 6.2% for both the employee and the employer, applied to wages up to an annual wage base limit of $176,100. The Medicare tax rate is 1.45% for both the employee and the employer, applied to all wages without a wage base limit. An Additional Medicare Tax of 0.9% applies to employee wages exceeding certain thresholds ($200,000 for single filers, $250,000 for married filing jointly), though employers do not match this additional amount.
State and local income taxes also require withholding, with specific rates and regulations varying by jurisdiction. These are calculated based on state-specific withholding tables or percentages. Post-tax deductions are then applied, subtracted from an employee’s pay after all taxes have been withheld. Common post-tax deductions include wage garnishments, Roth 401(k) contributions, or union dues. After all calculations and deductions, the remaining amount is the employee’s net pay.
Remitting Taxes and Filing Payroll Forms
After payroll calculations are complete, remitting withheld taxes to the appropriate government agencies is the next step. Federal income tax and FICA taxes must be deposited using the Electronic Federal Tax Payment System (EFTPS). Employers are assigned either a monthly or semi-weekly deposit schedule based on their total tax liability during a lookback period.
State and local tax remittance procedures vary by jurisdiction, often involving online portals, and follow monthly or quarterly schedules. These tax payments ensure that the withheld amounts reach the government agencies in a timely manner. Failure to adhere to these deposit schedules can result in penalties.
Beyond remittances, employers must file various federal and state payroll forms to report wages paid and taxes withheld. The primary federal form is Form 941, which reports federal income tax, Social Security, and Medicare taxes withheld from employee paychecks, along with the employer’s share of FICA taxes. Form 941 must be filed quarterly, with specific due dates.
At year-end, employers issue Form W-2 to each employee, detailing their annual wages and taxes withheld. A summary of all W-2s, Form W-3, is then sent to the Social Security Administration. These forms are important for employees to file their individual income tax returns and for the government to reconcile reported wages and taxes. State governments also require quarterly and annual payroll reports, which parallel federal reporting requirements but are specific to each state’s regulations.