How to Put Myself on Payroll as a Business Owner

Transitioning from owner’s draws to a formal payroll system means treating the business as a separate entity for tax and administrative purposes. The owner receives a regular salary, like any other employee, with applicable taxes withheld from each paycheck. This differs from owner’s draws or distributions, which are taken from business profits without direct tax withholding. Formal payroll is relevant for business structures that distinguish the owner as an employee.

Determining Eligibility and Tax Implications

The ability for a business owner to be on payroll depends on their business’s legal structure. Corporations, specifically S Corporations and C Corporations, typically treat owners as employees. S Corporations are required by the IRS to pay “reasonable compensation” to any shareholder-employee for services rendered before taking remaining profits as distributions. C Corporations also pay owners as employees, and this salary is a deductible business expense.

Sole proprietorships and partnerships generally do not use a traditional W-2 payroll system. Owners in these structures compensate themselves through owner’s draws or guaranteed payments, which are not subject to income tax withholding or FICA taxes at the time they are taken. Instead, they pay self-employment taxes, covering both employee and employer portions of Social Security and Medicare taxes, when filing individual tax returns. The self-employment tax rate is generally 15.3% on net earnings, comprising 12.4% for Social Security (up to an annual wage base, which is $168,600 for 2024) and 2.9% for Medicare (with no wage limit).

Being on payroll means the owner’s wages are subject to federal income tax withholding, Social Security and Medicare taxes (FICA), and potentially state and local income tax withholding. For 2024, the employee portion of FICA tax is 7.65% (6.2% for Social Security on wages up to $168,600 and 1.45% for Medicare on all wages). The employer also pays a matching 7.65% of FICA taxes. An additional Medicare tax of 0.9% applies to individual wages exceeding $200,000, for which there is no employer match. This structure allows for deducting certain employee benefits, like health insurance premiums, through the business.

For S Corporations, “reasonable compensation” is a significant IRS compliance consideration. This refers to the amount ordinarily paid for similar services by comparable businesses under similar circumstances. Factors include the owner’s training, experience, duties, responsibilities, and time devoted to the business. Underpaying a reasonable salary can lead to IRS reclassification of distributions as wages, resulting in penalties and interest for unpaid payroll taxes.

Setting Up Your Payroll Infrastructure

A fundamental requirement for any employer is obtaining an Employer Identification Number (EIN) from the IRS. The EIN is a unique nine-digit federal tax ID for the business, essential for tax reporting, hiring employees, and opening business bank accounts. The application for an EIN can be completed online through the IRS website, typically providing the number immediately.

Businesses must also register with relevant state and local agencies to comply with state income tax withholding and unemployment insurance laws. Requirements vary by jurisdiction, but generally involve registering with the state’s department of revenue for income tax and the state labor department for unemployment contributions. Completing these state-specific registrations is a prerequisite for legal payroll operations.

Selecting a payroll system determines how payroll will be managed and taxes calculated. Options range from manual processing to utilizing payroll software or engaging a full-service payroll provider. Payroll software, such as QuickBooks Payroll, Gusto, ADP Run, Paychex, SurePayroll, or OnPay, offers automated calculations, direct deposit, and tax form generation. Full-service providers can handle all aspects of payroll, including tax filings and deposits.

Establishing separate business bank accounts is important for financial management and simplifies payroll processing. A dedicated payroll bank account helps track expenses distinctly and can be used for issuing direct deposits or checks. This separation aids in maintaining clear financial records for accounting and tax compliance. Finally, collecting necessary employee information, such as W-4 form details for federal income tax withholding and bank account information for direct deposit, is a preparatory step.

Executing Payroll and Tax Payments

The first step is to establish a consistent payroll schedule, such as weekly, bi-weekly, semi-monthly, or monthly, ensuring regularity in compensation. This fixed schedule provides predictability for financial planning and tax obligations.

Each pay period requires calculating gross wages, the total compensation before deductions. From this, pre-tax contributions are deducted, followed by the calculation and withholding of federal income tax, FICA taxes (Social Security and Medicare), and any applicable state or local income taxes. The remaining amount after all withholdings is the net pay, which the owner receives.

Beyond employee withholdings, the business incurs employer payroll taxes. These include the employer’s matching portion of FICA taxes (6.2% for Social Security on wages up to the annual limit and 1.45% for Medicare on all wages). Employers are also responsible for Federal Unemployment Tax Act (FUTA) taxes, typically 0.6% on the first $7,000 of each employee’s wages annually. These employer-paid taxes are separate from amounts withheld from employee pay.

Timely deposit of federal payroll taxes (withheld income tax and both employee and employer portions of FICA taxes) to the IRS is a strict requirement. Most employers use the Electronic Federal Tax Payment System (EFTPS) for these deposits. Deposit frequency, whether monthly or semi-weekly, depends on the business’s total tax liability from a lookback period. Higher tax liabilities generally necessitate semi-weekly deposits. State and local payroll tax deposits also have their own specific requirements and due dates. Finally, net pay is issued to the owner, typically through direct deposit or a physical check.

Fulfilling Ongoing Reporting Requirements

Maintaining payroll compliance involves consistent reporting and filing obligations throughout the year. For federal payroll taxes, employers must file Form 941, Employer’s Quarterly Federal Tax Return, to report wages, tips, and federal income, Social Security, and Medicare taxes withheld, as well as the employer’s share of FICA taxes. This form is due quarterly: April 30 for the first quarter (January-March), July 31 for the second quarter (April-June), October 31 for the third quarter (July-September), and January 31 for the fourth quarter (October-December).

Annually, businesses must file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to report and pay federal unemployment taxes. The deadline for filing Form 940 is typically January 31 of the year following the tax year. Employers are also required to issue Form W-2, Wage and Tax Statement, to the owner by January 31 of the following tax year. This form reports total annual wages paid and taxes withheld. 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 (SSA) by January 31. Form W-3 summarizes all W-2 forms transmitted.

In addition to federal forms, businesses are typically required to file corresponding state and local payroll tax returns. These often include state income tax withholding returns and state unemployment insurance reports, with their own specific filing frequencies and deadlines. Maintaining accurate payroll records is important for compliance and potential audits. Records should include wage payment details, employee information, tax deposit records, and copies of filed forms. The IRS generally requires employment tax records to be kept for at least four years after the tax due date or payment date.