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

Manually managing payroll involves calculating employee compensation, deducting appropriate amounts, and fulfilling tax obligations. This approach benefits small businesses or individuals seeking to understand payroll functions. It encompasses gathering employee information, calculating gross and net pay, and ensuring compliance with tax requirements and record-keeping.

Setting Up for Manual Payroll

Before calculations begin, a business must establish its payroll framework. This starts with obtaining an Employer Identification Number (EIN) from the IRS, a unique nine-digit number used for tax purposes and required for reporting payroll taxes.

Collecting comprehensive employee information is the next step, including personal details and tax-related forms. Each new employee must complete Form W-4, Employee’s Withholding Certificate, to determine federal income tax withholding. This form provides crucial information like marital status and adjustments, influencing tax withheld.

Understanding pay rates and schedules is essential for accurate payroll processing. Businesses typically operate on weekly, bi-weekly, semi-monthly, or monthly pay cycles, dictating how often gross pay and deductions are calculated. Additionally, identify state or local tax requirements, as these vary by jurisdiction and may necessitate additional withholding forms or specific local tax calculations.

Beyond income taxes, businesses must account for pre-tax and post-tax deductions. Pre-tax deductions, such as health insurance premiums or retirement plans, reduce an employee’s taxable wages before taxes are calculated. Post-tax deductions, like wage garnishments or loan repayments, are withheld after all applicable taxes have been determined.

Calculating Employee Pay and Deductions

Manual payroll involves calculating each employee’s gross pay, applying deductions, and arriving at their net take-home pay. Gross pay is the total compensation an employee earns before any deductions. For hourly employees, this is hours worked multiplied by their hourly rate; salaried employees receive a fixed amount per pay period.

Once gross pay is determined, pre-tax deductions are subtracted to arrive at the taxable wage base for certain taxes. For example, pre-tax health insurance premiums reduce income subject to federal income tax, Social Security, and Medicare taxes. Determining these taxable wages is a step before calculating tax withholdings.

Federal Income Tax (FIT) withholding is calculated using the employee’s Form W-4 and methods in IRS Publication 15-T, Federal Income Tax Withholding Methods. This publication includes wage bracket tables and percentage methods to help employers determine the correct federal income tax to withhold from each paycheck. Employers must use the correct tables based on the employee’s filing status and pay period.

Next, FICA taxes, including Social Security and Medicare, are calculated. For 2024, the employee’s Social Security tax is 6.2% on wages up to $168,600. The Medicare tax rate is 1.45% on all wages, with no wage base limit. An additional Medicare tax of 0.9% applies to wages exceeding $200,000, which employers must also withhold.

State and local income tax withholdings are necessary in many jurisdictions. These taxes vary significantly by location, requiring employers to consult state and local tax authorities for specific rates, wage bases, and withholding methods. Calculation principles are similar to federal taxes, but percentages and thresholds are unique to each state and locality. Finally, post-tax deductions, such as wage garnishments or loan repayments, are subtracted. After all deductions and withholdings, the remaining amount is the employee’s net pay.

Employer Payroll Costs and Tax Filings

Beyond employee deductions, employers incur their own payroll-related costs and tax filing responsibilities. Employers must match employee contributions for Social Security and Medicare taxes. This means employers contribute 6.2% for Social Security on wages up to $168,600 and 1.45% for Medicare on all wages.

Federal Unemployment Tax Act (FUTA) imposes a tax on employers to fund unemployment benefits. For 2024, the FUTA tax rate is 6.0% on the first $7,000 of each employee’s wages. Employers typically receive a credit of up to 5.4% for timely contributions to state unemployment tax programs, effectively reducing the federal rate to 0.6% in most cases.

State Unemployment Tax Act (SUTA) taxes are state-specific obligations that work with FUTA. SUTA rates and wage bases vary widely by state and often depend on an employer’s experience rating, which can increase or decrease based on unemployment claims filed by former employees. These state-level taxes are generally paid solely by the employer.

Employers must deposit withheld employee taxes and their matching contributions to the appropriate government agencies. For federal taxes, this is commonly done through the Electronic Federal Tax Payment System (EFTPS). Deposits must be made regularly, either monthly or semi-weekly, depending on total tax liability. State and local tax deposits follow similar schedules and procedures, typically through state-specific electronic payment systems.

Regular payroll tax forms must be filed with federal and state authorities. Form 941, Employer’s Quarterly Federal Tax Return, is filed every quarter to report withheld income, Social Security, and Medicare taxes. Form 940, Employer’s Annual Federal Unemployment Tax Return, reports FUTA taxes annually. State equivalents of these forms must also be filed according to state-specific requirements.

Maintaining Payroll Records

Maintaining accurate payroll records is essential for manual payroll management. A payroll register serves as a central record, tracking each employee’s gross pay, deductions, and net pay for every pay period. This register should include details such as hours worked, pay rates, and year-to-date totals for earnings and deductions.

Employers are legally obligated to provide employees with a detailed pay stub or statement each payday. This document must clearly itemize gross wages, specific amounts and types of all deductions (e.g., federal income tax, Social Security, Medicare, health insurance premiums, retirement contributions), and the final net pay. Year-to-date totals for earnings and deductions on pay stubs are also valuable.

Payroll transactions must be recorded in the company’s general ledger to ensure financial accuracy. This involves debiting payroll expense accounts and crediting various liability accounts, such as federal tax withholding payable, state tax withholding payable, and health insurance premiums payable, before crediting the cash account when payments are made. These entries ensure financial statements accurately reflect payroll costs and obligations.

At the end of each calendar year, employers must prepare and distribute W-2 forms, Wage and Tax Statements, to all employees. These forms summarize an employee’s annual wages and total taxes withheld for federal, state, and local purposes. For payments to independent contractors, businesses issue Form 1099-NEC, Nonemployee Compensation, if payments exceed a certain threshold.

Payroll records must be retained for specific periods. The IRS generally requires employers to keep employment tax records, including Forms 941, W-2s, and W-4s, for at least four years after the tax becomes due or is paid. Other regulations, such as the Fair Labor Standards Act (FLSA), may require retention of certain records for at least three years, including basic employee information and payroll data. It is common practice for businesses to keep payroll records for at least seven years for compliance and potential audits.