How to Do Payroll for Your Employees

Payroll involves compensating employees, managing taxes, and fulfilling regulatory obligations. It impacts financial stability and employee well-being. Accurate processing ensures labor law adherence, prevents penalties. It fosters morale and trust. Effective payroll management is integral to success.

Setting Up Your Payroll Foundation

Payroll setup requires preliminary steps. Businesses must obtain an Employer Identification Number (EIN) from IRS. This nine-digit number is essential for federal tax filings. Apply for an EIN online through the IRS for immediate results.

Beyond the federal EIN, businesses need state and local tax identification numbers. These include State Unemployment Insurance (SUI) and state income tax withholding IDs. Requirements vary by jurisdiction; consult state revenue and labor departments. Some localities may require additional payroll tax registrations.

Accurate employee information is essential. The federal Form W-4, Employee’s Withholding Certificate, determines federal income tax withholding. It provides details like filing status, dependents, and other withholding adjustments. Employers must retain a completed Form W-4 for each employee.

The federal Form I-9, Employment Eligibility Verification, confirms an employee’s identity and work authorization. Employees must present documents. Employers must examine documents and complete Form I-9 within three business days of the first day.

For direct deposit, gather bank account and routing numbers. Essential employee data includes name, address, Social Security Number, hire date, job title, and pay rate. Accurate information ensures correct payment and compliance.

Clear payroll policies ensure consistent operations. Businesses must decide on pay periods: weekly, bi-weekly, semi-monthly, or monthly. Each impacts calculation and payment schedules. Overtime policies must align with the Fair Labor Standards Act (FLSA), mandating 1.5 times regular pay for hours over 40 weekly.

Benefit deduction decisions are part of policy. If offering benefits (e.g., health insurance, 401(k)), set up mechanisms for employee contributions. Policies dictate pre-tax or post-tax deductions, impacting taxable income. Communicate these policies to employees.

Choosing a payroll system is important. Manual processing is complex and error-prone as a business grows. Payroll software automates calculations and includes compliance features. Outsourcing payroll offloads the process, including tax filings, allowing businesses to focus on core operations.

Calculating Employee Pay and Deductions

Payroll calculates gross pay and applies deductions to reach net pay. For hourly employees, gross pay is hours worked multiplied by hourly rate. Hours over 40 in a workweek are compensated at 1.5 times their regular rate. Salaried employees receive a fixed gross amount per pay period, their annual salary divided by pay periods.

Gross pay includes commissions, bonuses, or tips. These are added to base wages before deductions. Accurate tracking ensures correct gross pay and tax withholding.

After gross pay, pre-tax deductions are applied. These reduce taxable income. Examples include traditional 401(k) contributions, health insurance premiums, or FSA/HSA contributions. Rules for pre-tax deductions outlined in Internal Revenue Code Section 125.

Federal tax withholdings are calculated next. Federal income tax (FIT) withholding uses employee Form W-4 information and IRS tax tables. Employers use filing status, dependents, and requests to determine income tax to deduct. Use current IRS withholding tables for accurate calculations.

FICA taxes (Social Security and Medicare) are withheld from wages. For Social Security, both employee and employer contribute 6.2% of wages, up to an annual wage base. For 2025, the Social Security wage base is projected at $174,900. Medicare tax is 1.45% for both employee and employer, applied to all wages without a limit.

An additional Medicare tax of 0.9% applies to individual wages exceeding thresholds ($200,000 single, $250,000 married filing jointly, $125,000 married filing separately). This additional tax is withheld only from employee wages, with no employer contribution. These FICA taxes are mandatory federal payroll taxes.

State and local tax withholdings are calculated based on residency and work location. These taxes vary by jurisdiction; some states have no income tax, others have progressive rates. Consult state and local tax authorities for tables and regulations. Some states may require a state-specific withholding form similar to Form W-4.

Finally, post-tax deductions are applied. These are taken from pay after all taxes are withheld. Examples include Roth 401(k) contributions, wage garnishments, union dues, or charitable contributions. The remaining amount is the employee’s net pay. The calculation sequence is Gross Pay – Pre-Tax Deductions – Tax Withholdings – Post-Tax Deductions.

Processing Payroll and Tax Payments

After calculations, pay employees and remit collected taxes. Direct deposit preferred for its convenience and security. Employers collect bank account and routing numbers, then use software or a service to transfer funds electronically.

Some businesses still use paper checks, which are printed, signed, and distributed. Regardless of method, employers must provide a detailed pay stub for each pay period. This statement must itemize gross pay, all deductions, and net pay. Pay stubs can be printed or electronic, ensuring transparency.

Remitting federal tax payments is a compliance step. Employers must deposit federal income tax withheld, plus Social Security and Medicare taxes, with the U.S. Treasury. The primary method is the Electronic Federal Tax Payment System (EFTPS), an online system for secure payments.

Federal tax deposit frequency depends on the business’s total tax liability, determined by the IRS. Most employers follow monthly or semi-weekly deposit schedules. Monthly depositors pay by the 15th of the following month; semi-weekly depositors have payroll-based deadlines. The IRS provides deposit schedule guidance; adherence avoids penalties.

State and local tax payments are remitted to their respective tax authorities. These include state income tax withheld and state unemployment insurance contributions. Payment methods include online portals, direct debit, or checks. Payment frequencies vary by jurisdiction, from weekly to quarterly, depending on tax volume.

Payroll Reporting and Compliance

Payroll reporting and compliance ongoing. Employers submit forms to federal, state, and local agencies to report wages and taxes. Form 941, Employer’s Quarterly Federal Tax Return, reports federal income, Social Security, and Medicare taxes quarterly. It is due on the last day of the month following each calendar quarter: April 30, July 31, October 31, and January 31.

Annually, businesses must file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. This form reports FUTA tax liability, funding unemployment benefits. The FUTA tax rate is 6.0% on the first $7,000 of wages; most employers receive a credit for timely state unemployment tax payments, reducing the federal rate to 0.6%. Form 940 is due by January 31 of the following year.

Form W-2, Wage and Tax Statement, is an annual reporting obligation. Employers must issue a Form W-2 to each employee by January 31 of the year following wage payment. This form reports an employee’s total wages, tips, compensation, and all withheld taxes. A copy of each W-2 must also be filed with the Social Security Administration (SSA) by January 31.

State and local reporting requirements mirror federal obligations but vary by jurisdiction. Employers typically file quarterly state unemployment insurance (SUI) wage reports for unemployment benefits. State income tax withholding reports are common, with varying forms and frequencies. Some localities may also require specific payroll tax reports.

Maintaining payroll records is necessary for compliance and audits. Businesses should retain all payroll documentation: timesheets, payroll journals, federal tax forms (W-4, I-9), and submitted tax returns (941, 940). These records prove compliance with wage and hour laws, tax regulations, and employment eligibility.

Payroll record retention periods vary. Federal payroll tax records must be kept for at least four years after tax due or paid. Form I-9 documents must be retained for three years after hire or one year after employment ends (whichever is later). FLSA records (e.g., hours worked, wages paid) must be kept for three years. Proper record-keeping ensures businesses can respond to tax or labor department inquiries.