How to Do Your Own Payroll for a Small Business

Managing payroll involves compensating employees and handling required withholdings and contributions. This guide simplifies the process, breaking down the fundamental steps for independent payroll management.

Initial Setup and Registration

Before processing payroll, businesses must complete several setup and registration steps. Obtaining an Employer Identification Number (EIN) from the IRS is required for most businesses with employees. This nine-digit number acts as a federal tax ID. Applying for an EIN is free and can be completed quickly online through the IRS website, typically resulting in immediate issuance.

Businesses must also register with relevant state agencies. These registrations often include setting up accounts for state income tax withholding and state unemployment insurance (SUTA). Requirements vary by state and local jurisdiction, necessitating research to ensure compliance.

Gathering essential employee information is another preliminary step. Upon hiring, each employee must complete Form W-4, “Employee’s Withholding Certificate,” to determine federal income tax withholding. Form I-9, “Employment Eligibility Verification,” verifies an employee’s identity and legal authorization to work in the United States. Employers must ensure Form I-9 is completed and reviewed within three business days of the employee’s first day.

Establishing a system for payroll management is crucial before processing begins. This system could be a simple spreadsheet or basic payroll software. Its purpose is to accurately track employee hours, gross wages, and all deductions, ensuring organized record-keeping.

Calculating and Withholding Payroll Components

Once initial setup is complete, the ongoing process involves calculating and withholding various payroll components. The first step is determining gross pay, an employee’s total earnings before deductions. For hourly employees, gross pay is their hourly wage multiplied by hours worked. Salaried employees receive a fixed amount per pay period.

After calculating gross pay, pre-tax deductions are applied. These deductions reduce an employee’s taxable income. Common examples include contributions to qualified retirement plans, health insurance premiums, flexible spending accounts (FSAs), and health savings accounts (HSAs).

Federal income tax withholding is calculated based on the employee’s Form W-4 and federal tax tables from the IRS. Employers use either the wage bracket method or the percentage method to determine the amount to withhold.

FICA taxes, which fund Social Security and Medicare, are also withheld. For 2025, the Social Security tax rate is 6.2% for both employee and employer, applied to wages up to $176,100. The Medicare tax rate is 1.45% for both, applied to all wages. An employer must also withhold an Additional Medicare Tax of 0.9% from wages exceeding $200,000, with no employer match.

State and local income tax withholding requirements vary significantly by jurisdiction. Businesses must consult their specific state and local tax authorities for correct rates and rules. These often depend on employee earnings and state-specific withholding forms.

Finally, post-tax deductions are subtracted after all taxes are calculated. These deductions do not reduce taxable income. Common examples include Roth 401(k) contributions, certain disability insurance premiums, union dues, and charitable donations. Wage garnishments, court-ordered withholdings for debts, are also mandatory post-tax deductions. The remaining amount is the employee’s net pay.

Paying Employees and Remitting Taxes

After payroll calculations, the next phase involves paying employees and remitting withheld taxes. Employers have options for paying employees, including direct deposit or paper checks. Adhering to a consistent pay frequency, such as weekly or bi-weekly, is important for employee expectations and compliance.

Remitting federal taxes, including federal income tax, Social Security, and Medicare taxes, is primarily done through the Electronic Federal Tax Payment System (EFTPS). This free online system allows businesses to schedule tax payments. Federal tax deposits are generally required electronically.

The frequency of federal tax deposits depends on the employer’s tax liability. If the total tax liability during the lookback period was $50,000 or less, a monthly deposit schedule applies, with payments due by the 15th of the following month. If liability exceeded $50,000, a semi-weekly schedule is required. If an employer accumulates $100,000 or more in tax liability on any single day, the deposit must be made by the next business day, and the employer becomes a semi-weekly depositor.

Remitting state and local taxes requires adherence to specific state and local deadlines and payment methods. These vary widely by jurisdiction. Employer contributions, such as the employer’s share of FICA taxes and Federal Unemployment Tax Act (FUTA) payments, are also remitted. The standard FUTA tax rate is 6% on the first $7,000 of an employee’s annual wages, reduced to 0.6% with timely state unemployment insurance payments. FUTA tax deposits are generally due quarterly if liability exceeds $500.

Payroll Reporting and Record Keeping

After employees are paid and taxes remitted, the final stage involves governmental reporting and internal record keeping. Federal reporting includes several forms filed regularly. Form 941, “Employer’s Quarterly Federal Tax Return,” reports wages, federal income tax withheld, and Social Security and Medicare taxes quarterly. This form is due by the last day of the month following each quarter.

Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” reports annual FUTA tax liability and is filed annually by January 31 of the following year. At year-end, employers must prepare and distribute Forms W-2, “Wage and Tax Statement,” to each employee by January 31 of the following year. Employers must also file Copy A of Form W-2 along with Form W-3, “Transmittal of Wage and Tax Statements,” with the Social Security Administration (SSA) by January 31.

State and local reporting requirements vary, but commonly include state unemployment wage reports and new hire reporting. Businesses must consult their specific state and local labor and tax departments to understand all applicable reporting obligations and deadlines.

Thorough record keeping is important for compliance and potential audits. The IRS requires employers to keep all employment tax records for at least four years after the tax becomes due or is paid. This includes documents such as payroll registers, Forms 941, W-2s, and W-4s. The Fair Labor Standards Act (FLSA) mandates retaining payroll records for at least three years, with supporting calculations kept for two years. Form I-9s must be retained for three years after the date of hire or one year after termination, whichever is later. Maintaining organized records is essential for demonstrating compliance.