How to Process Payroll Manually Step by Step

Manual payroll processing provides insight into employee compensation and tax obligations. While automated software is common, understanding the manual process helps small business owners comprehend calculations and compliance. It involves gathering employee data, calculating wages, withholding taxes, and ensuring timely payments and reporting.

Gathering Essential Payroll Information

Accurate employee information must be collected before calculations. This includes each employee’s full name, current address, and Social Security Number for tax and reporting.

The Form W-4, Employee’s Withholding Certificate, is used for federal income tax withholding. Employees complete it to indicate marital status, dependents, and other income or deductions, which affects federal tax withholding. Many states and local jurisdictions also require similar withholding forms for state and local income tax deductions.

Establish the employee’s pay rate, whether hourly, salary, or commission. The defined pay period (weekly, bi-weekly, semi-monthly, or monthly) sets payroll frequency. Document agreements for bonuses, commissions, or other compensation.

Deductions from gross pay are pre-tax or post-tax. Pre-tax deductions, like health insurance or 401(k) contributions, reduce taxable income before taxes. Post-tax deductions, such as wage garnishments or union dues, are withheld after taxes. Employers must obtain documentation, like court orders for garnishments, for compliance.

Calculating Gross and Net Pay

Determining an employee’s take-home pay begins with gross pay. For hourly employees, gross pay is hours worked multiplied by their hourly rate, including overtime at one-and-a-half times the regular rate for hours over 40 in a workweek. Salaried employees receive a fixed amount per pay period, with adjustments for partial periods or leave. Bonuses or commissions are added to regular earnings for total gross pay.

After gross pay, pre-tax deductions are subtracted to determine taxable gross pay. These deductions, like retirement plan contributions or health insurance premiums, reduce income subject to federal, state, and local income taxes.

Federal Income Tax (FIT) withholding is calculated using the employee’s Form W-4 and IRS Publication 15-T. This publication provides methods for calculating withholding based on filing status, adjustments, and pay period.

FICA taxes, including Social Security and Medicare, are withheld. For 2025, Social Security tax is 6.2% for employee and employer, up to $176,100. Medicare tax is 1.45% for both, with no wage base limit. An additional 0.9% Medicare tax applies to employee wages over $200,000, with no employer match.

State and local income tax withholding varies by jurisdiction, often requiring specific tax tables or formulas. These calculations follow a similar process to federal withholding, using employee information and tax rates. After pre-tax deductions and mandatory tax withholdings, post-tax deductions like wage garnishments or union dues are subtracted. The final result is the employee’s net pay.

Recording Payroll and Paying Employees

After calculations, create accurate pay stubs. A pay stub must detail gross pay, itemized deductions, and net pay for the current period. It should also include year-to-date totals for gross pay and each deduction.

Maintain a payroll register or ledger for record-keeping. This register should track each employee’s gross pay, all pre-tax and post-tax deductions, employee and employer FICA taxes, federal income tax withheld, and any state or local taxes withheld for every pay period. These records support financial management, audits, and reporting compliance.

Employees must be paid the net amount. Common methods include physical paychecks or direct deposit. Direct deposit electronically transfers net pay into the employee’s bank account. Employers initiate an Automated Clearing House (ACH) transfer through their bank for direct deposit.

Meeting Payroll Tax Obligations

After processing payroll and paying employees, employers must deposit withheld taxes and file reports. Federal income tax, Social Security, and Medicare taxes (employee and employer portions) must be deposited with the U.S. Treasury via the Electronic Federal Tax Payment System (EFTPS). The deposit schedule (monthly or semi-weekly) depends on the employer’s total tax liability during a lookback period. Monthly depositors remit by the 15th of the following month; semi-weekly depositors have specific deadlines. If tax liability reaches $100,000 or more on any day, taxes must be deposited by the next business day.

Similar deposit requirements exist for state and local income taxes, varying by jurisdiction. Employers must consult their state and local tax authorities for deposit methods and schedules.

Employers file quarterly tax forms, such as Form 941, Employer’s Quarterly Federal Tax Return, with the IRS. This form summarizes total wages, federal income tax withheld, and employee and employer shares of Social Security and Medicare taxes for the quarter. Form 941 is due by the last day of the month following each calendar quarter (April 30, July 31, October 31, and January 31 of the following year).

Annually, employers file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. The FUTA tax rate is 6% on the first $7,000 of each employee’s wages. Form 940 is due by January 31 of the following year. Employers must also prepare and distribute Form W-2, Wage and Tax Statement, to each employee by January 31 of the following year. A copy of each W-2, along with Form W-3, Transmittal of Wage and Tax Statements, must be filed with the Social Security Administration by the same January 31 deadline.