How to Run Your Own Payroll Correctly

Running your own payroll is a manageable process for business owners and individual employers. It requires careful attention to compliance with tax laws and regulations, accurate record-keeping, and timely payments. Understanding the fundamental steps and requirements ensures your business meets its legal obligations and fosters positive employee relations.

Setting Up Your Payroll System

Establishing a solid foundation for your payroll system is essential. This involves securing identification numbers, gathering employee details, deciding on a payroll schedule, and understanding basic labor laws.

A primary step involves obtaining an Employer Identification Number (EIN) from the IRS, your business’s federal tax ID. This nine-digit number is necessary for hiring employees, opening business bank accounts, and filing federal tax returns. The application process is free and can often be completed online, providing immediate access. Many states also require a separate state tax identification number for state-specific tax obligations.

Gathering employee information is another foundational element. Each new employee must complete Form W-4, Employee’s Withholding Certificate, which provides data to calculate federal income tax withholding. This form requires employees to indicate their filing status, account for multiple jobs, and claim dependents or credits for accurate tax deductions. The IRS website is the official source for obtaining the most current version of Form W-4.

All U.S. employers must complete Form I-9, Employment Eligibility Verification, for all new hires. This form verifies identity and legal authorization to work in the United States. Employees complete Section 1 by their first day, attesting to employment authorization. They then present acceptable documents, such as a U.S. passport or a driver’s license and Social Security card, for the employer to review and record in Section 2 within three business days of the employee’s start date. Official Form I-9 and its instructions are available on the U.S. Citizenship and Immigration Services (USCIS) website.

Establishing a consistent payroll schedule is a key decision that impacts both administrative effort and employee satisfaction. Common frequencies include weekly (52 paychecks per year), bi-weekly (26 paychecks per year), semi-monthly (24 paychecks per year), and monthly (12 paychecks per year). Bi-weekly is the most common payroll frequency in the U.S. Choosing a schedule involves considering the nature of your workforce.

Understanding basic federal payroll laws is another component. The Fair Labor Standards Act (FLSA) sets federal minimum wage and overtime pay requirements for most employees. Covered non-exempt employees must receive at least the federal minimum wage. The FLSA also mandates overtime pay at one and one-half times an employee’s regular rate for hours worked over 40 in a workweek. Employers must adhere to the higher of federal or state minimum wage and overtime laws.

Having separate business bank accounts for payroll and tax payments simplifies financial tracking and ensures funds are properly segregated. This practice helps maintain clear financial records and facilitates accurate reporting.

Calculating Employee Pay and Deductions

Accurately calculating each employee’s gross pay and applying necessary deductions determines their net pay. This process requires a precise understanding of various compensation structures and tax withholding rules.

Gross pay varies based on an employee’s compensation type. For hourly employees, gross pay is their hourly rate multiplied by hours worked, with overtime for hours exceeding 40 in a workweek. Salaried employees generally receive a fixed amount per pay period, if exempt from overtime rules. For those earning commissions, gross pay is based on a percentage of sales.

Certain pre-tax deductions reduce an employee’s taxable income before taxes are calculated. Examples include contributions to traditional 401(k) plans, health insurance premiums, Flexible Spending Accounts (FSAs), or Health Savings Accounts (HSAs). These deductions effectively lower the amount of income subject to taxes.

Federal Income Tax (FIT) is withheld from an employee’s wages based on their Form W-4 and IRS tax tables. The accuracy of this withholding relies directly on the employee’s correct completion of their W-4.

Federal Insurance Contributions Act (FICA) taxes, funding Social Security and Medicare, are withheld from employee wages. The Social Security tax rate is 6.2% for both employee and employer, applied to wages up to an annual limit of $176,100. Medicare tax is 1.45% for both employee and employer on all covered wages, with no wage base limit. An Additional Medicare Tax of 0.9% applies to employee wages exceeding $200,000. Employers must match the employee’s portion of Social Security and Medicare taxes.

State and local income taxes must also be calculated and withheld where applicable, based on specific tax laws and withholding tables. These calculations vary significantly by jurisdiction, requiring employers to be familiar with the rules in each location where their employees work. Some states may also have their own unemployment insurance taxes that require employee contributions.

Post-tax deductions are subtracted from an employee’s pay after taxes. Examples include contributions to Roth 401(k) plans, wage garnishments, and union dues. The remaining amount is the employee’s net pay, which is the amount they receive.

Remitting Taxes and Paying Employees

After calculating employee pay and deductions, the next stage involves timely payment of employees and remittance of withheld taxes to government agencies. This procedural phase requires strict adherence to established schedules and methods to avoid penalties.

Paying employees can be accomplished through various methods, with direct deposit being a common and efficient choice. Alternatively, paper checks can be issued, though often more administrative effort. Ensuring employees receive their correct net pay on their scheduled payday is important.

Federal tax remittances, including federal income tax and FICA taxes, are typically made through the Electronic Federal Tax Payment System (EFTPS). The IRS determines deposit frequency based on the employer’s total tax liability. Monthly depositors must remit taxes by the 15th day of the following month. Semi-weekly depositors have more frequent obligations. If a tax liability reaches $100,000 on any day, the deposit must be made by the next business day.

State and local tax remittances are managed through state-specific online portals or payment systems. This includes state income tax, state unemployment insurance contributions, and other local taxes that apply. Each state and locality has its own set of rules and deadlines for reporting and remitting these funds.

Adhering to all federal, state, and local payment deadlines is paramount. Failure to remit taxes on time can result in significant penalties and interest charges. Establishing a reliable system for tracking due dates is a core aspect of compliant payroll management.

Maintaining Records and Filing Reports

Payroll management encompasses diligent record-keeping and timely filing of required reports. Maintaining accurate records is crucial for compliance, auditing, and resolving any future discrepancies.

Employers must keep essential payroll records for specified periods. These include payroll registers, timekeeping records, and copies of tax forms like W-4 and I-9. Employment tax records, including Forms W-4, W-2, and 941, must be kept for at least four years. Form I-9 records must be retained for three years after hire or one year after termination, whichever is later.

Federal reporting requirements involve several key forms submitted to the IRS. Form 941, Employer’s Quarterly Federal Tax Return, reports federal income tax, Social Security tax, and Medicare tax withheld from employee wages, plus the employer’s share. This form is filed quarterly, with deadlines on April 30, July 31, October 31, and January 31 of the following year.

Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, reports the federal unemployment tax liability. This tax helps fund unemployment compensation for eligible workers and is paid solely by the employer. Form 940 is filed annually, generally by January 31 of the year following the tax year.

At the end of each year, employers must issue Forms W-2, Wage and Tax Statement, to each employee, detailing annual wages and taxes withheld. A copy of Form W-2 must also be sent to the Social Security Administration (SSA). Form W-3, Transmittal of Wage and Tax Statements, is a summary form accompanying the W-2s submitted to the SSA. Both Forms W-2 and W-3 are due to employees and the SSA by January 31 of the following year.

State and local reporting requirements often mirror federal obligations but have distinct forms and deadlines, including state unemployment tax reports, state wage reports, and any other specific local tax filings.

For businesses that engage independent contractors, Form 1099-NEC, Nonemployee Compensation, reports payments of $600 or more for services. These forms are generally due to the contractor and the IRS by January 31 of the following year. Maintaining organized records and adhering to these reporting schedules ensures regulatory compliance and provides a clear audit trail.