How to Do Payroll Yourself: A Step-by-Step Process

Doing payroll yourself involves managing employee compensation, withholding taxes, and reporting these activities to government agencies. It requires understanding federal and state regulations to ensure compliance. This process includes paying employees accurately, calculating and remitting correct tax amounts, and maintaining thorough records.

Essential Payroll Setup

Businesses must complete foundational setup steps before processing payroll to ensure legal compliance. A primary step is obtaining an Employer Identification Number (EIN) from the IRS. This unique federal tax ID is needed for all federal tax filings.

Businesses must also register with state agencies, including the state’s tax department for income tax withholding and the state labor department for unemployment insurance purposes.

Gathering employee information is another preparatory step. Employees must complete IRS Form W-4, the Employee’s Withholding Certificate, which provides employers with the necessary details to calculate federal income tax withholding from paychecks. New hires must also complete Form I-9, Employment Eligibility Verification, to confirm identity and legal eligibility to work in the United States.

Establishing a consistent payroll schedule, such as weekly, bi-weekly, semi-monthly, or monthly, is necessary. This fixed schedule dictates when employees will be paid and helps in planning tax deposits and reporting. Setting up individual payroll records for each employee, documenting their pay rate, deductions, and other relevant information, is a component of organized payroll management. Understanding the different types of pay, like hourly wages, fixed salaries, and overtime rules, is also part of this phase.

Calculating Employee Pay and Deductions

Payroll processing involves accurately calculating each employee’s gross wages and then applying various deductions to arrive at their net pay. Gross pay for hourly employees is determined by multiplying their hourly rate by the number of regular hours worked, while salaried employees receive a fixed amount per pay period. For non-exempt employees, the Fair Labor Standards Act (FLSA) mandates overtime pay at a rate of at least one and a half times their regular rate for all hours worked over 40 in a workweek.

Once gross wages are determined, pre-tax deductions are applied, which reduce an employee’s taxable income. Common examples include contributions to health insurance premiums or qualified retirement plans like a 401(k). These deductions lower the amount of income subject to federal and, often, state income taxes.

After pre-tax deductions, various taxes are withheld from an employee’s pay. Federal income tax (FIT) withholding is calculated using the information provided on the employee’s Form W-4 and applying the appropriate IRS tax tables or wage bracket methods. Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare, are also withheld. For 2025, the Social Security tax rate is 6.2% for both the employee and employer, applied to wages up to a certain annual wage base limit, which is $176,100 for 2025. The Medicare tax rate is 1.45% for both the employee and employer, with no wage base limit. An additional Medicare tax of 0.9% applies to employee wages exceeding $200,000 in a calendar year, for which there is no employer match.

State income tax (SIT) withholding is calculated based on state-specific rules and forms, similar to federal income tax, and is then deducted. Some localities may also impose local income taxes, which require additional calculations and withholding. Post-tax deductions are applied; these are taken from an employee’s pay after all taxes have been calculated and withheld. Examples include wage garnishments, certain charitable contributions, or Roth 401(k) contributions. After all these calculations and deductions, the remaining amount is the employee’s net pay.

Remitting Taxes and Filing Reports

After calculating and withholding taxes, employers must accurately remit these funds to the appropriate federal and state authorities and file required reports. Federal tax deposits for withheld federal income tax, Social Security, and Medicare taxes are typically made using the Electronic Federal Tax Payment System (EFTPS). The deposit schedule for these taxes can be either monthly or semi-weekly, depending on the employer’s total tax liability during a specified lookback period. Employers with $50,000 or less in tax liability during the lookback period generally follow a monthly deposit schedule, with taxes due by the 15th of the month following the payroll payment. Those with more than $50,000 in tax liability typically adhere to a semi-weekly schedule, with specific due dates based on the day wages were paid.

Employers must also file several federal payroll reports. IRS Form 941, the Employer’s Quarterly Federal Tax Return, is used to report income taxes, Social Security, and Medicare taxes withheld from employee wages, along with the employer’s share of FICA taxes. This form is due quarterly, on April 30, July 31, October 31, and January 31, for the preceding quarter. Another annual report is IRS Form 940, the Employer’s Annual Federal Unemployment (FUTA) Tax Return, which reports federal unemployment taxes. This form is generally due by January 31 of the year following the reported year.

Year-end reporting to employees and the Social Security Administration (SSA) involves Forms W-2, Wage and Tax Statement, and Form W-3, Transmittal of Wage and Tax Statements. Employers must furnish Form W-2 to each employee by January 31 of the following year, detailing their wages and withheld taxes. Form W-3 is a summary document that accompanies Copy A of all W-2 forms when submitted to the SSA, also by January 31. State income tax and unemployment insurance tax deposits and reports also have their own specific requirements and deadlines, which vary by state.

Paying Employees and Maintaining Records

The final procedural step in payroll involves distributing wages to employees and diligently maintaining comprehensive records. Common methods for paying employees include direct deposit, which electronically transfers funds directly into an employee’s bank account, and issuing paper checks. Regardless of the payment method, providing employees with detailed pay stubs for each pay period is essential. These stubs should clearly outline gross pay, all deductions (pre-tax, taxes, and post-tax), and the final net pay.

Accurate and organized record keeping is fundamental for payroll compliance and operational efficiency. Employers are required to retain various types of records, including time sheets, payroll registers, copies of tax forms (such as W-4s, I-9s, 941s, 940s, and W-2s), and detailed pay stubs.

The IRS generally mandates keeping employment tax records for at least four years after the tax return due date or the date the taxes were paid, whichever is later. The Department of Labor (DOL) requires retention of payroll records, including hours worked, wages paid, and deductions, for at least three years, with supporting records like time cards kept for two years. These records are crucial for demonstrating compliance during potential audits by federal or state agencies and for resolving any discrepancies or disputes with employees regarding their pay.