How to Properly Run Payroll Yourself

Managing payroll internally ensures accurate and timely employee compensation while adhering to regulatory obligations. For businesses with employees, payroll is a fundamental operation that impacts financial stability and legal standing. It encompasses calculating wages, withholding taxes, and remitting funds to government agencies, all while maintaining meticulous records. Choosing to manage payroll oneself means taking direct responsibility for these intricate tasks, rather than relying on external services. This decision offers greater control and can reduce outsourcing costs, though it requires diligence. Properly executed, in-house payroll contributes to employee satisfaction and avoids potential penalties from tax authorities. This guide provides a comprehensive understanding for managing payroll operations, detailing necessary steps for compliance and accuracy.

Gathering Essential Information

A federal Employer Identification Number (EIN) is assigned by the Internal Revenue Service (IRS) to identify businesses for tax purposes. This number is mandatory for employers and is used on all federal tax forms. Businesses can obtain an EIN free of charge by applying online, by mail, or fax.

Beyond federal requirements, businesses must register with state and local tax authorities. This includes obtaining state unemployment insurance (SUI) and state income tax withholding numbers. Registration processes vary by jurisdiction, typically involving state labor or revenue agencies. Understanding these requirements ensures compliance.

Collecting accurate employee information is important for payroll processing. This includes their full legal name, current address, and Social Security Number (SSN). Date of birth and start date are also necessary for record-keeping and benefit calculations. Accurate recording of each employee’s pay rate, hourly or salaried, forms the basis of gross pay.

Employees must complete Form W-4, “Employee’s Withholding Certificate.” This form allows employees to indicate federal income tax withholding preferences, which impacts federal income tax deductions. Many states also require state-specific withholding certificates. Businesses must keep these forms on file to calculate tax withholdings.

Establishing a consistent payroll schedule is important. Common frequencies include weekly, bi-weekly, semi-monthly, or monthly. The schedule impacts cash flow and tax remittances. Businesses should select a schedule aligning with operational needs and employee preferences, and communicate it clearly.

Understanding different types of compensation is important for payroll. This includes regular hourly wages or fixed salaries. Businesses must also account for overtime pay, calculated at 1.5 times the regular rate for hours over 40 in a workweek. Other forms of compensation, such as commissions, bonuses, or tips, must be categorized and included in gross pay.

Setting up a system for tracking hours worked and other relevant payroll data is helpful before processing the first payroll. This could involve simple spreadsheets, timekeeping software, or physical time cards. The goal is a reliable method for aggregating raw data for each pay period. This setup ensures inputs are organized and accessible for calculating employee earnings and deductions.

Calculating Employee Pay

Calculating employee pay involves determining gross wages before deductions. For hourly employees, gross pay is calculated by multiplying their hourly rate by regular hours worked. If an employee works overtime, those hours are compensated at 1.5 times their regular hourly wage, added to regular earnings. Salaried employees receive a fixed amount per pay period.

Beyond regular wages, other forms of compensation must be included in gross pay. Commissions are added to an employee’s earnings for the period. Bonuses contribute to gross pay. Businesses must identify and aggregate all compensation for total gross earnings.

Once gross pay is determined, pre-tax deductions are applied, reducing taxable income. Common pre-tax deductions include contributions to qualified retirement plans, such as a 401(k), and premiums for health, dental, or vision insurance plans. Contributions to Flexible Spending Accounts (FSAs) or Health Savings Accounts (HSAs) are also pre-tax. These deductions are subtracted from gross pay before calculating certain taxes, lowering income subject to federal and state income tax.

Calculating federal income tax withholding relies on the employee’s Form W-4 and IRS Publication 15-T, “Federal Income Tax Withholding Methods.” It provides instructions and tables for determining withholding based on the employee’s Form W-4. Employers can use either the wage bracket method or the percentage method. Accurate withholding avoids under- or over-withholding.

Federal Insurance Contributions Act (FICA) taxes are mandatory. For Social Security, both the employee and the employer each contribute 6.2% of wages, up to an annual wage base limit. Medicare tax is 1.45% for both the employee and employer. An employer must also withhold an Additional Medicare Tax of 0.9% from wages exceeding a certain threshold. These FICA taxes are calculated on gross taxable wages before most pre-tax deductions.

Calculating state and local income tax withholding follows a similar process to federal income tax, but rules and rates vary by jurisdiction. Rates vary, with some states having no income tax, others flat rates or progressive brackets. Businesses must consult their state’s revenue department or tax authority for specific withholding tables and instructions. Local taxes, such as city or county income taxes, may also apply.

After pre-tax deductions and tax withholdings, post-tax deductions are applied. These are taken from pay after taxes are calculated and withheld. Common post-tax deductions include wage garnishments, such as for child support or defaulted student loans, and contributions to Roth 401(k) plans. Examples include union dues, repayment of company loans, or certain voluntary insurance premiums.

The final step in calculating employee pay is determining net pay. This is achieved by subtracting all pre-tax, federal, FICA, state, local, and post-tax deductions from gross pay. This is the employee’s take-home pay. Each component must be reviewed for accuracy and compliance.

Paying Employees and Remitting Taxes

After payroll calculations and net pay determination, the next step is fund transfer. Businesses have several common methods for disbursing net pay to their employees. Direct deposit is a common option, transferring funds electronically into the employee’s bank account. This method requires obtaining bank account and routing numbers from employees and setting up an Automated Clearing House (ACH) transfer system.

Alternatively, businesses can issue paper checks. This requires printing and distributing physical checks. Paper checks are less common but remain a viable option. Regardless of the chosen method, timely payment on the established payroll schedule is important for satisfaction and compliance.

Remitting federal taxes to the IRS is a key part of payroll. This includes federal income tax withheld, and both employee and employer portions of Social Security and Medicare taxes. The primary method for making these federal tax deposits is through the Electronic Federal Tax Payment System (EFTPS). Businesses must enroll in EFTPS to make electronic payments.

The frequency of federal tax deposits depends on the business’s total tax liability. Most small businesses are monthly depositors, depositing federal taxes by the 15th of the following month. Larger businesses or those with higher tax liabilities may be semi-weekly depositors, depositing on specific days based on payroll dates. Failing to deposit taxes by the deadline can result in penalties.

Remitting state and local taxes involves a similar process, though methods and deadlines vary by jurisdiction. Many states offer online portals for electronic payments; others accept mail or financial institution payments. Businesses must consult state and local tax authorities for remittance procedures and schedules. Some states may require weekly, monthly, or quarterly deposits for state income tax withholding and unemployment insurance contributions.

Adhering to all payment deadlines, both federal and state, is important to avoid penalties. The IRS outlines specific deposit schedules for federal employment taxes in Publication 15, “Employer’s Tax Guide.” These schedules are determined annually based on total tax liability. Businesses must regularly review their tax liabilities and adjust their deposit schedule if tax liability changes.

Filing Required Payroll Reports

After processing payroll and remitting taxes, businesses must file federal, state, and local payroll reports. These reports summarize wages paid, taxes withheld, and taxes remitted.

For federal reporting, Form 941, “Employer’s Quarterly Federal Tax Return,” is used to report income tax, Social Security tax, and Medicare tax withheld from employee wages, and the employer’s share of Social Security and Medicare taxes. Form 941 must be filed quarterly by the last day of the month following the quarter’s end. It summarizes tax liability and payments.

Another federal report is Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return.” This form is used to report the Federal Unemployment Tax Act (FUTA) tax. The FUTA tax is paid by the employer. Form 940 is an annual return, due by January 31 of the following year, with an extension to February 10 if all FUTA tax is deposited on time.

Annually, businesses must prepare Form W-2, “Wage and Tax Statement,” for each employee. This form reports the employee’s annual wages, tips, and other compensation, and federal, state, and local taxes withheld. Employers must furnish Form W-2 to employees by January 31 of the following year. This deadline also applies to electronic filing with the Social Security Administration (SSA).

Employers must also file Form W-3, “Transmittal of Wage and Tax Statements,” with the SSA. Form W-3 summarizes total earnings, Social Security wages, Medicare wages, and withheld taxes for all employees reported on accompanying W-2 forms. It acts as a cover sheet for W-2s, ensuring totals match. Both forms can be filed electronically through the SSA’s Business Services Online.

State and local payroll reporting requirements parallel federal obligations but vary. Many states require quarterly or annual reports for state income tax withholding and separate reports for state unemployment insurance (SUI) contributions. SUI reports often include employee wage details determining the employer’s unemployment tax rate. Businesses must identify specific forms, filing frequencies, and submission methods mandated by state and local tax authorities. Many jurisdictions provide online portals for electronic filing.

Maintaining Payroll Records

Maintaining organized payroll records is a compliance requirement for businesses. These records serve as documentation for tax filings, demonstrate labor law compliance, and provide information for audits or resolving discrepancies.

Businesses must keep various payroll documents. This includes employee information such as Form W-4s, employment applications, and changes to pay rate or withholding status. Detailed payroll registers, listing gross pay, deductions, and net pay for each period, are also necessary. Time sheets or other records of hours worked are essential for hourly employees, demonstrating wage calculations.

Copies of all filed tax forms, such as Forms 941, 940, W-2s, and W-3s, and proof of tax payments and deposit confirmations, must be retained. Records related to any pre-tax or post-tax deductions, including benefit enrollment forms or garnishment orders, are also required. These documents provide a complete audit trail of payroll activities.

Federal law generally requires employers to keep all employment tax records for at least four years from the later of the tax due date or payment date. This retention period is mandated by IRS regulations for audits and tax compliance verification. State laws may have additional or longer record retention requirements. Businesses should consult state regulations for full compliance.

Secure and organized storage methods for payroll records are essential. This includes physical filing systems, digital storage on secure servers, or cloud-based solutions. Records should be protected from unauthorized access, damage, or loss. Accessibility is key for audits, employee inquiries, or legal purposes. Accurate and accessible records demonstrate compliance and address potential issues.

Gathering Essential Information

Businesses must obtain a federal Employer Identification Number (EIN) from the IRS for tax purposes. This number is mandatory for employers and used on all federal tax forms. Applications are free and can be done online, by mail, or fax.

Beyond federal requirements, businesses must register with state and local tax authorities. This includes obtaining state unemployment insurance (SUI) and state income tax withholding numbers. Registration processes vary by jurisdiction.

Collecting accurate employee information is important for payroll. This includes full legal name, address, Social Security Number (SSN), date of birth, and start date. Accurate pay rate recording forms the basis of gross pay.

Employees must complete Form W-4, “Employee’s Withholding Certificate,” to indicate federal income tax withholding preferences. Many states also require state-specific withholding certificates. Businesses must keep these forms on file.

Establishing a consistent payroll schedule is important. Common frequencies include weekly, bi-weekly, semi-monthly, or monthly. The schedule impacts cash flow and tax remittances, and must be clearly communicated.

Understanding different types of compensation is important for payroll. This includes hourly wages, salaries, and overtime pay. Other forms like commissions, bonuses, or tips must also be included in gross pay.

Setting up a system for tracking hours worked and other payroll data is helpful. This could involve spreadsheets, timekeeping software, or physical time cards. A reliable method ensures inputs are organized and accessible.

Calculating Employee Pay

Calculating employee pay begins with determining gross wages. For hourly employees, this is hourly rate times hours worked, plus overtime. Salaried employees receive a fixed amount per period.

Other forms of compensation, such as commissions and bonuses, must be included in gross pay. All compensation must be identified and aggregated for total gross earnings.

Pre-tax deductions reduce taxable income. Common examples include 401(k) contributions, health insurance premiums, FSAs, and HSAs. These are subtracted before calculating certain taxes.

Federal income tax withholding relies on Form W-4 and IRS Publication 15-T. Employers use wage bracket or percentage methods. Accurate withholding avoids under- or over-withholding.

FICA taxes fund Social Security and Medicare. Both employee and employer contribute 6.2% for Social Security (up to a wage base) and 1.45% for Medicare. An Additional Medicare Tax of 0.9% applies above a threshold.

State and local income tax withholding rules and rates vary by jurisdiction. Businesses must consult their state’s revenue department for specific instructions. Local taxes may also apply.

Post-tax deductions are applied after taxes are calculated. Common examples include wage garnishments, Roth 401(k) contributions, union dues, and company loan repayments.

The final step is determining net pay. This is achieved by subtracting all deductions and taxes from gross pay. This net amount is the employee’s take-home pay.

Paying Employees and Remitting Taxes

After payroll calculations, the next step is transferring funds to employees. Businesses have several common methods for disbursing net pay.

Direct deposit is a common option, transferring funds electronically into the employee’s bank account. This requires obtaining bank account and routing numbers and setting up an ACH transfer system.

Alternatively, businesses can issue paper checks. This requires printing and distributing physical checks. Timely payment on the established payroll schedule is important for satisfaction and compliance.

Remitting federal taxes to the IRS is a key part of payroll. This includes federal income tax withheld, and both employee and employer portions of Social Security and Medicare taxes. The primary method is through EFTPS.

Federal tax deposit frequency depends on the business’s total tax liability. Most small businesses are monthly depositors. Larger businesses may be semi-weekly depositors. Failing to deposit taxes by the deadline can result in penalties.

Remitting state and local taxes involves a similar process, though methods and deadlines vary by jurisdiction. Many states offer online portals for electronic payments; others accept mail or financial institution payments. Businesses must consult state and local tax authorities.

Adhering to all payment deadlines, federal and state, is important to avoid penalties. The IRS outlines specific deposit schedules for federal employment taxes in Publication 15. Businesses must review and adjust their deposit schedule if tax liability changes.

Filing Required Payroll Reports

Businesses must file various federal, state, and local payroll reports. These reports summarize wages paid, taxes withheld, and taxes remitted over specific periods.

For federal reporting, Form 941, “Employer’s Quarterly Federal Tax Return,” reports income tax, Social Security, and Medicare taxes. It must be filed quarterly by the last day of the month following the quarter’s end.

Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” reports FUTA tax, paid by the employer. It is an annual return, due by January 31 of the following year.

Annually, businesses must prepare Form W-2, “Wage and Tax Statement,” for each employee. This form reports annual wages and taxes withheld. Employers must furnish W-2s to employees by January 31 of the following year.

Employers must also file Form W-3, “Transmittal of Wage and Tax Statements,” with the SSA. Form W-3 summarizes total earnings and withheld taxes for all employees. Both forms can be filed electronically.

State and local payroll reporting requirements parallel federal obligations but vary. Many states require quarterly or annual reports for income tax withholding and SUI contributions. Businesses must identify specific forms and filing methods.

Maintaining Payroll Records

Maintaining organized payroll records is a compliance requirement for businesses. These records serve as documentation for tax filings, labor law compliance, and provide information for audits or resolving discrepancies.

Businesses must keep various payroll documents. This includes employee information like Form W-4s, employment applications, and pay rate changes. Detailed payroll registers and time sheets are also necessary.

Copies of all filed tax forms (e.g., 941, 940, W-2s, W-3s) and proof of tax payments must be retained. Records related to pre-tax or post-tax deductions are also required. These documents provide a complete audit trail.

Federal law requires employers to keep employment tax records for at least four years from the later of the tax due date or payment date. State laws may have additional or longer retention requirements. Businesses should consult state regulations.

Secure and organized storage methods for payroll records are essential. This includes physical filing systems, digital storage on secure servers, or cloud-based solutions. Records should be protected and accessible for audits or inquiries.