How to Do Your Own Payroll for a Small Business

Managing payroll for a small business involves precise calculations, strict adherence to tax regulations, and meticulous record-keeping. Understanding these processes is fundamental for ensuring compliance, avoiding penalties, and maintaining accurate financial records. This guide provides a clear path for business owners to manage their own payroll effectively.

Core Payroll Components

Payroll calculations start with an employee’s gross pay, the total earnings before deductions. Deductions are categorized as either pre-tax or post-tax.

Pre-tax deductions, such as traditional 401(k) contributions or health insurance premiums, reduce an employee’s taxable gross pay. These are subtracted before federal and most state income taxes are calculated, lowering the income subject to tax. Taxable gross pay determines federal income tax, state income tax, and FICA taxes (Social Security and Medicare).

Tax withholdings are mandatory deductions. Federal and state income taxes are withheld based on the employee’s Form W-4 and state withholding forms. FICA taxes, comprising Social Security and Medicare, are split between the employee and employer. Post-tax deductions, like Roth 401(k) contributions or wage garnishments, are subtracted after all taxes. The remaining amount is the employee’s net pay.

Essential Information Collection

Before processing payroll, gather specific information for both the employer and each employee. For the business, this includes the Employer Identification Number (EIN), a unique nine-digit federal tax ID issued by the IRS for tax and legal purposes. The business name, address, and any applicable state tax identification numbers are also required.

For each employee, collect their full legal name, address, Social Security number, date of birth, and start date. The pay rate (hourly or salaried) and established pay frequency (e.g., weekly, bi-weekly, semi-monthly, or monthly) are also needed.

An employee’s Form W-4 (Employee’s Withholding Certificate) provides information for calculating federal income tax withholding. This form indicates marital status, allowances, and any additional withholding amounts, directly impacting federal tax deductions. Similar state-specific forms are used for state income tax withholding. Information for deductions, such as health insurance premiums or retirement contributions, is obtained from benefit enrollment forms or court orders for garnishments. Bank account information is needed for direct deposit of wages and electronic payment of taxes.

Wage and Deduction Calculation

Calculating an employee’s pay begins with gross pay. For hourly employees, gross pay is hours worked multiplied by their hourly rate. Overtime, typically 1.5 times the regular rate for hours exceeding 40 in a workweek under the Fair Labor Standards Act (FLSA), must be factored in. Salaried employees receive a fixed amount per pay period.

Once gross pay is established, pre-tax deductions are applied. These deductions, such as health insurance premiums or traditional 401(k) contributions, are subtracted from gross pay before taxes are calculated. This results in the taxable gross pay, the amount subject to federal, state, and FICA taxes.

After calculating all tax withholdings, any post-tax deductions are subtracted. These deductions, including Roth 401(k) contributions, charitable donations, or wage garnishments, are taken from the remaining amount after taxes. The final step involves subtracting all calculated deductions and withholdings from the gross pay to arrive at the net pay, which is the actual amount the employee receives.

Payroll Tax Obligations

Employers are responsible for calculating, withholding, and paying payroll taxes. Federal income tax withholding is determined using IRS tax tables or the wage bracket method, based on the employee’s Form W-4. FICA taxes, funding Social Security and Medicare, involve both employee and employer contributions. For 2025, the Social Security tax rate is 6.2% for both the employee and employer, applied to wages up to an annual limit. The Medicare tax rate is 1.45% for both the employee and employer, with no wage limit. An Additional Medicare Tax of 0.9% applies to employee wages exceeding $200,000, with no employer match.

State and local withholding taxes vary by jurisdiction. Employers must calculate state income tax, state unemployment insurance (SUTA), and any applicable local taxes based on specific rules. The Federal Unemployment Tax Act (FUTA) imposes an employer-paid tax on the first $7,000 of each employee’s annual wages. Employers can receive a credit for timely state unemployment tax payments, reducing the effective federal rate.

Depositing federal payroll taxes, including withheld income tax, FICA taxes, and FUTA taxes, is generally done through the Electronic Federal Tax Payment System (EFTPS). The deposit schedule (monthly or semi-weekly) is determined by the employer’s tax liability. For example, if tax liability is low, monthly deposits are required; higher liability may require semi-weekly deposits. State and local tax payment methods also have their own specific requirements, often involving electronic transfers.

Reporting and Documentation

Employers must file Form 941, Employer’s Quarterly Federal Tax Return, each quarter. This form reports wages paid, federal income tax withheld, and both employee and employer portions of Social Security and Medicare taxes. Quarterly filing deadlines are April 30, July 31, October 31, and January 31 of the following year.

Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, is filed annually by January 31 of the year following the tax year. Employers also prepare and distribute Form W-2, Wage and Tax Statement, to each employee by January 31 annually. This form reports an employee’s total wages and taxes withheld. Form W-3, Transmittal of Wage and Tax Statements, is a summary form submitted to the Social Security Administration with all W-2s.

Businesses must also comply with state and local payroll tax and unemployment insurance reports, with varying deadlines and forms. Retain detailed payroll records, including timesheets, pay rates, payroll registers, tax deposit records, and copies of all filed forms, for compliance. The IRS generally requires employment tax records to be kept for at least four years.