How to Run Payroll Manually for Your Small Business

Running payroll manually involves gathering employee information, calculating wages and taxes, submitting payments, and maintaining records. This method can offer small businesses cost savings and a deeper understanding of their financial operations. This guide outlines the process for managing payroll without automated systems, ensuring accuracy and compliance.

Gathering Necessary Payroll Information

Gathering essential employee and employer information is a foundational step for accurate payroll processing. This ensures all subsequent computations are based on correct and complete details.

Employee data includes full name, address, and Social Security Number. Form W-4, Employee’s Withholding Certificate, informs employers how much federal income tax to withhold. This form details filing status, multiple jobs, dependents, and any additional amount to withhold. Employers must also obtain Form I-9, Employment Eligibility Verification, to confirm legal work authorization. An employee’s pay rate (hourly or salaried) and pay period (weekly, bi-weekly, semi-monthly, or monthly) are necessary for calculating gross wages.

Employer information requires an Employer Identification Number (EIN) issued by the IRS. This nine-digit number acts as a unique identifier for businesses. Businesses also need state and local tax identification numbers, as withholding and unemployment tax requirements vary by jurisdiction.

Information regarding other deductions must be collected. Common deductions include health insurance premiums (pre-tax or post-tax) and contributions to retirement plans like a 401(k). Wage garnishments, legally mandated withholdings for debts, require a court order or agency directive detailing the amount and terms. Federal forms are available from the IRS website, and state forms from state tax agency websites.

Calculating Employee Wages and Deductions

Once all necessary information has been gathered, calculating each employee’s wages and applying deductions is required. This step ensures accurate net pay and compliance with tax obligations.

The first calculation is for gross pay, an employee’s total earnings before any deductions. For hourly employees, gross pay is determined by multiplying hours worked by their hourly rate. Salaried employees receive a fixed amount per pay period, calculated by dividing their annual salary by the number of pay periods in a year.

Federal income tax (FIT) withholding must be calculated based on each employee’s Form W-4. Employers can use methods outlined in IRS Publication 15-T to determine the correct amount. This publication provides detailed instructions, including the percentage method and wage bracket method, which consider filing status, dependents, and any additional withholding amounts.

Federal Insurance Contributions Act (FICA) taxes, comprising Social Security and Medicare taxes, are withheld from employee wages, with employers matching these contributions. For 2024, the Social Security tax rate is 6.2% for both the employee and employer, applied to wages up to an annual wage base limit of $168,600. The Medicare tax rate is 1.45% for both the employee and employer, with no wage base limit. An additional Medicare tax of 0.9% applies to employee wages exceeding $200,000, for which there is no employer match.

State and local income tax calculations vary by jurisdiction. Employers must consult their state’s tax agency for applicable rates and withholding methodologies, which are then applied similarly to federal income tax withholding. These rates and rules are subject to annual changes and can involve different wage bases or calculation methods.

After federal, state, and local taxes, other deductions are applied. These can be classified as pre-tax or post-tax. Pre-tax deductions, such as qualified health insurance premiums or traditional 401(k) contributions, reduce an employee’s taxable gross pay before taxes are calculated. Post-tax deductions, like Roth 401(k) contributions or wage garnishments, are subtracted from gross pay after taxes have been computed.

Net pay is determined by subtracting all federal, state, local, and other applicable deductions from the gross pay. Employers are also responsible for employer-only taxes, such as the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). The FUTA tax rate is 6.0% on the first $7,000 of each employee’s wages, though most employers receive a credit of up to 5.4% for timely state unemployment tax payments, resulting in an effective federal rate of 0.6%. SUTA rates and wage bases are specific to each state and can vary based on an employer’s unemployment claims history.

Submitting Payments and Filing Reports

After all payroll calculations are complete, the next phase involves the timely submission of payments to employees and tax authorities, along with the accurate filing of required reports. This ensures that all financial obligations are met and regulatory requirements are satisfied.

Paying employees can be accomplished through various methods, such as issuing manual checks or setting up direct deposit through a banking institution. Direct deposit is a practical and widely used approach for disbursing net pay efficiently.

Depositing federal payroll taxes is a strict requirement, encompassing withheld federal income tax and both the employee and employer portions of FICA taxes. The primary method for making these deposits is through the Electronic Federal Tax Payment System (EFTPS), a free service provided by the U.S. Department of the Treasury. Enrollment in EFTPS takes several business days, requiring an EIN, banking information, and an IRS-validated identity, after which a Personal Identification Number (PIN) is mailed. Payments must be scheduled by 8:00 p.m. ET at least one day before the due date. Deposit schedules, either monthly or semi-weekly, depend on the total tax liability during a lookback period, with larger liabilities requiring more frequent deposits.

State and local tax deposits follow similar principles but with varying methods and schedules specific to each jurisdiction. Employers must consult their state and local tax agencies for reporting and payment procedures, as these can differ from federal requirements.

Filing federal payroll tax forms is an ongoing responsibility. Form 941, Employer’s Quarterly Federal Tax Return, reports wages paid, tips, federal income tax withheld, and the employer’s and employee’s share of FICA taxes, filed quarterly. Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, reports the employer’s FUTA tax liability, filed annually. These forms summarize calculations, ensuring the IRS has a comprehensive record of employment tax liabilities.

Employers must issue employee tax statements, Form W-2, Wage and Tax Statement, by January 31st each year. This form summarizes an employee’s annual wages, tips, and other compensation, along with federal, state, and local taxes withheld. Employers must also file Form W-3, Transmittal of Wage and Tax Statements, with the Social Security Administration when submitting copies of all W-2 forms. These documents are essential for employees to file their individual income tax returns and for the government to track wage and tax data.

Maintaining Payroll Records

Maintaining accurate and organized payroll records is a fundamental administrative task that supports compliance, facilitates financial review, and provides a clear audit trail. This responsibility ensures that all activities are properly documented.

Employers must keep a variety of specific records:
Employee-specific forms such as W-4s and I-9s, along with personal contact information.
Detailed wage records, such as timesheets or other documents showing hours worked and pay rates.
Payroll registers, which provide a summary of gross pay, all deductions, and net pay for each employee per pay period.
Documentation of tax payments, including EFTPS confirmations and bank statements.
Copies of all filed tax forms, such as Forms 941, 940, and the W-2/W-3 submissions.
Any supporting documents for benefit enrollments or wage garnishment orders.

The IRS generally requires employment tax records to be kept for at least four years after the tax becomes due or is paid, whichever is later. This includes forms like W-4s, W-2s, and 941s. However, other regulations, such as those under the Fair Labor Standards Act (FLSA), may require certain wage and hour records to be kept for three years, with supporting calculations for two years. For Form I-9, employers must retain them for three years after the date of hire or one year after the date of termination, whichever is later. It is prudent for businesses to check both federal and relevant state requirements, as some states may mandate longer retention periods.

Practical methods for organizing these records can include a systematic physical filing system, ensuring documents are clearly labeled and easily retrievable. For enhanced security and accessibility, digital backups are recommended, often involving secure cloud storage or encrypted local drives. Consistent organization ensures that records are readily available for internal review, potential audits by tax authorities, or any inquiries that may arise.