How to Properly Set Up Payroll in California

Setting up payroll is a complex undertaking, requiring attention to detail for compliance and accurate employee compensation. In California, this process presents unique challenges due to the state’s comprehensive labor laws. Employers must navigate distinct regulations governing wages, taxes, and employee rights, which differ significantly from federal standards and those in other states.

Establishing proper payroll procedures from the outset is important for avoiding penalties, mitigating legal risks, and maintaining positive employee relations. Missteps can lead to substantial fines, back pay claims, and damage to a business’s reputation. Adhering to California’s specific requirements is essential for any employer operating within the state.

Essential Pre-Payroll Registrations

Before hiring employees or processing payroll, several registrations are necessary at both the federal and state levels. These provide the identification numbers required for tax reporting and compliance.

A Federal Employer Identification Number (EIN) is a unique nine-digit number assigned by the Internal Revenue Service (IRS) to identify businesses for tax purposes. It enables employers to hire employees, file tax returns, and open business bank accounts. Employers can apply for an EIN online through the IRS website by providing basic business information.

In California, employers must register with the Employment Development Department (EDD) to obtain a state employer account number. This number is used for reporting and remitting state payroll taxes, including Unemployment Insurance (UI), State Disability Insurance (SDI), Employment Training Tax (ETT), and Personal Income Tax (PIT) withholding. Registration with the EDD can be completed online through the e-Services for Business portal, requiring business details and the date wages were first paid.

Workers’ compensation insurance is mandatory for most employers in California. This insurance provides benefits to employees who suffer job-related injuries or illnesses, covering medical treatment and lost wages. Employers can secure coverage through a licensed insurance carrier or, if unable to find coverage, through the State Compensation Insurance Fund (SCIF). Obtaining this insurance is a prerequisite to hiring.

Some local jurisdictions may also require specific business licenses or permits. These can vary by city or county and might need to be secured before commencing operations or hiring employees in that area. Checking with local business licensing departments ensures all local obligations are met.

Gathering Employee Information

Collecting accurate information from new hires is a necessary step to ensure proper payroll processing and compliance with federal and state regulations. The initial forms an employee completes provide the employer with the data needed to calculate wages, withhold taxes, and report new employment.

The Federal Form W-4, Employee’s Withholding Certificate, informs employers how much federal income tax to withhold from wages. Employees indicate their filing status, whether they have multiple jobs or a spouse who works, and claim any dependents or other credits that affect their withholding. This information directly influences the amount of federal income tax deducted from each paycheck.

The California Form DE 4, Employee’s Withholding Allowance Certificate, serves the same purpose for state personal income tax withholding. This form allows employees to specify their California withholding allowances and any additional amounts to be withheld. Employers rely on the DE 4 to calculate the California Personal Income Tax (PIT) to be deducted from an employee’s gross pay.

The Federal Form I-9, Employment Eligibility Verification, verifies the identity and employment authorization of individuals hired in the United States. Both the employer and the employee must complete designated sections. The employee must present acceptable documents, such as a U.S. passport or a driver’s license combined with a Social Security card, to prove identity and eligibility to work. Employers must examine these documents and retain the completed Form I-9.

Employers often offer direct deposit. To set it up, employees provide their bank name, routing number, and account number. This information facilitates the electronic transfer of wages directly into the employee’s bank account.

Federal and California laws mandate new hire reporting. Employers must report newly hired or rehired employees to the state’s Employment Development Department (EDD) and the federal Office of Child Support Enforcement. This reporting assists in enforcing child support orders and detecting unemployment insurance fraud. Employers must report the employee’s name, address, Social Security number, and the employer’s name, address, and federal EIN within 20 days of the hire date.

Calculating Employee Pay and Withholding Taxes

Calculating employee pay involves determining gross wages, applying deductions, and withholding federal and state taxes.

Gross pay calculation varies depending on the employee’s pay structure. For hourly employees, gross pay is determined by multiplying hours worked by their hourly rate. California requires overtime pay for hours exceeding eight in a workday or 40 in a workweek. Hours worked beyond 12 in a workday, or beyond eight on the seventh consecutive day of work in a workweek, qualify for double the regular rate of pay. Salaried employees receive a fixed amount per pay period, while commission-based employees earn a percentage of sales or revenue, with a guaranteed minimum wage.

Deductions are subtracted from an employee’s gross pay, categorized as either pre-tax or post-tax. Pre-tax deductions, such as contributions to a 401(k) retirement plan or health insurance premiums, reduce the employee’s taxable income. Post-tax deductions, like wage garnishments, Roth 401(k) contributions, or union dues, are taken out after taxes have been calculated and withheld.

Federal tax withholding includes Federal Income Tax (FIT) and FICA taxes. FIT is calculated based on the employee’s Form W-4 and federal tax tables. FICA taxes, which fund Social Security and Medicare, have both an employee and employer share. For Social Security, both contribute 6.2% on wages up to an annual limit. For Medicare, both contribute 1.45% of all wages, with no limit.

California state tax withholding involves Personal Income Tax (PIT), State Disability Insurance (SDI), State Unemployment Insurance (SUI), and Employment Training Tax (ETT). PIT withholding is determined by the employee’s Form DE 4 and the EDD’s withholding schedules. SDI is an employee-paid contribution, a percentage of wages up to an annual limit, funding disability and paid family leave benefits. SUI and ETT are employer-paid contributions, with rates varying based on industry and unemployment claims history, applied to a portion of each employee’s wages up to a limit.

After calculating gross pay and subtracting all pre-tax deductions, federal and state tax withholdings, and post-tax deductions, the remaining amount is the employee’s net pay.

Fulfilling California Payroll Obligations

Beyond calculating pay and withholding taxes, employers must fulfill reporting and remittance obligations to federal and state agencies. This involves submitting tax forms and making timely deposits of withheld funds. California also has other specific payroll requirements, including wage statements and final paychecks.

For federal payroll taxes, employers are required to report total wages and withheld taxes quarterly using Form 941, Employer’s Quarterly Federal Tax Return. This form summarizes federal income tax, Social Security tax, and Medicare tax withheld from employee wages, as well as the employer’s share. Quarterly filing deadlines are April 30, July 31, October 31, and January 31 of the following year. Federal payroll taxes must be remitted electronically through the Electronic Federal Tax Payment System (EFTPS), with deposit schedules determined by the employer’s total tax liability. Annually, employers issue Form W-2, Wage and Tax Statement, to each employee by January 31 of the following year, and submit Form W-3, Transmittal of Wage and Tax Statements, with all W-2s, to the Social Security Administration.

California payroll taxes require similar reporting and remittance. Employers file Form DE 9, Quarterly Contribution Return, and Form DE 9C, Quarterly Contribution Return and Report of Wages, with the EDD. These forms report total wages paid and the amounts due for Unemployment Insurance, State Disability Insurance, Employment Training Tax, and Personal Income Tax withholding. Quarterly filing deadlines align with federal deadlines, on the last day of the month following each calendar quarter. California payroll taxes are remitted through the EDD’s e-Services for Business portal, with payment schedules dependent on tax liability.

California’s paid sick leave law mandates that employees accrue paid sick leave at one hour for every 30 hours worked, usable for health-related reasons. Employers must allow employees to carry over accrued, unused sick leave, although usage can be capped annually.

Wage statements, or pay stubs, must be provided to employees with each paycheck. They must include gross wages, total hours worked (for non-exempt employees), all deductions, net wages, pay period dates, the employer’s name and address, and the employee’s name and the last four digits of their Social Security or employee identification number.

Rules for final paychecks are specific in California. If an employer terminates an employee, the final paycheck, including all accrued and unused vacation time, must be provided immediately on the date of termination. For employees who resign with at least 72 hours’ notice, the final paycheck is due on their last day. If an employee resigns without providing 72 hours’ notice, the final paycheck is due within 72 hours of the notice of resignation.

Employers must maintain payroll records, including wage and hour records, tax forms, and personnel files, for a minimum of three to four years.