What Do You Need to Run Payroll for Your Business?

Running payroll for a business requires compliance, accurate calculations, and timely submissions to various governmental bodies. Businesses must navigate federal, state, and local regulations to ensure employees are paid correctly and all tax obligations are met. Establishing a robust payroll process is essential for operational stability, employee satisfaction, and avoiding penalties.

Essential Business Information

Before hiring employees and initiating payroll, a business must establish its identity with federal and state authorities. A Federal Employer Identification Number (EIN) is a unique nine-digit number assigned by the Internal Revenue Service (IRS) and is required for tax filings, including payroll. It identifies the business for tax purposes, opening bank accounts, and applying for licenses. An EIN is obtained online through the IRS website.

Businesses must also register with state tax agencies for payroll obligations. This includes registering for state income tax withholding and state unemployment insurance (SUI). Registration varies by state, but generally involves setting up an account with the state’s department of revenue. Understanding the business’s legal structure (e.g., sole proprietorship, partnership, or corporation) is important as it influences taxation and payroll tax handling. Each structure impacts owner compensation and tax liabilities, affecting payroll setup and compliance.

Required Employee Details

Collecting specific information and forms from each employee is a required step before processing payroll. The Form W-4, Employee’s Withholding Certificate, is a federal document completed by each employee to determine federal tax withholding. It dictates federal income tax withholding based on filing status, dependents, and other adjustments. Employers must have a current Form W-4 on file for every employee.

The Form I-9, Employment Eligibility Verification, verifies an individual’s identity and authorization to work in the United States. Employers must complete and retain this form for each new hire, inspecting original documents to establish identity and employment eligibility. Beyond these federal forms, employers must collect other employee data for accurate pay and compliance. This includes the employee’s legal name, address, and Social Security Number (SSN) for tax reporting and identification. The agreed-upon pay rate (hourly or salaried), pay frequency (e.g., weekly, bi-weekly, semi-monthly), and bank account and routing numbers for direct deposit are also essential.

Calculating Employee Pay and Withholdings

Calculating employee pay involves determining gross wages, applying deductions, and withholding taxes to arrive at net pay. Gross pay includes all earnings before deductions, such as regular wages, overtime, bonuses, or commissions. Overtime is typically 1.5 times the regular rate for hours over 40 in a workweek, and understanding these rules is essential for federal labor law compliance. Some states have additional overtime requirements.

Once gross pay is established, deductions are applied, categorized as pre-tax or post-tax. Pre-tax deductions reduce an employee’s taxable income. Examples include 401(k) contributions or health insurance premiums. Post-tax deductions are withheld after taxes, such as wage garnishments or Roth 401(k) contributions. Each deduction requires careful tracking for accuracy and compliance.

Employers are responsible for withholding taxes from an employee’s paycheck and often paying a matching portion themselves. Federal Income Tax (FIT) is withheld based on the information provided by the employee on their Form W-4. The IRS provides tax tables to determine the amount of federal income tax to be withheld for each pay period. These tables are updated periodically.

Social Security and Medicare taxes, known as Federal Insurance Contributions Act (FICA) taxes, are mandatory withholdings. Social Security tax is 6.2% on wages up to an annual maximum, and Medicare tax is 1.45% on all wages. Employers must also pay a matching 6.2% for Social Security and 1.45% for Medicare. An additional Medicare tax of 0.9% applies to high-income earners, which employers must also withhold.

State Income Tax (SIT) withholding is required in most states. SIT calculation varies by state, often using tax tables or percentage rates based on earnings. Employers must register with the state tax agency for SIT withholding. State Unemployment Insurance (SUI) is an employer-paid tax funding unemployment benefits. The SUI tax rate varies by state based on industry and claims history, with new employers typically assigned a standard rate.

Meeting Tax Deposit and Reporting Deadlines

After calculating and withholding taxes, businesses must deposit these funds with government agencies on schedule. Federal taxes, including withheld federal income tax, Social Security, and Medicare taxes, are deposited via the Electronic Federal Tax Payment System (EFTPS). Deposit frequency (monthly or semi-weekly) is determined by total tax liability during a lookback period, typically based on Form 941. Failure to deposit taxes on time can result in penalties.

State income tax and state unemployment insurance deposits are made to state agencies, often online. Each state establishes its own deposit schedule, which can be weekly, monthly, quarterly, or annually, depending on tax liability. Employers must adhere to these deadlines to avoid penalties and maintain compliance. Confirm deposit methods and frequencies for each jurisdiction.

Beyond deposits, employers are required to file periodic reports. Federally, Form 941, Employer’s Quarterly Federal Tax Return, is filed four times a year to report wages, tips, federal income tax withheld, and FICA taxes for the quarter. Annually, employers must prepare and distribute Form W-2, Wage and Tax Statement, to each employee by January 31st of the following year, summarizing total wages, tips, compensation, and all taxes withheld.

Copies of Form W-2 are transmitted to the Social Security Administration (SSA) with Form W-3. State unemployment and income tax reports are filed periodically with state agencies. These state reports provide information similar to federal forms, ensuring proper reporting of state wages and taxes. Adhering to these filing deadlines is essential for avoiding penalties and maintaining compliant payroll.

Maintaining Payroll Records and Delivering Pay

Maintaining accurate payroll records is a requirement for any business with employees. These records document compliance with federal and state labor and tax laws, and are essential for resolving discrepancies or audits. Employers must retain detailed records of employee earnings, including gross pay, deductions, and net pay for each pay period. This also includes records of tax withholdings, such as federal income tax, FICA, state income tax, and SUI contributions.

Federal regulations, such as the Fair Labor Standards Act (FLSA) and IRS rules, mandate record retention periods. FLSA requires records like employee names, addresses, pay rates, and hours worked to be kept for at least three years. Tax-related records, including Forms W-4, W-2, and payroll tax returns, must be retained for a minimum of four years after the tax due date or payment. State requirements may vary and can exceed federal guidelines, so businesses must comply with the longer period.

Delivering pay to employees involves various methods, direct deposit being the most common. Direct deposit electronically transfers an employee’s net pay into their designated bank account. Setting up direct deposit involves collecting bank account and routing numbers for Automated Clearing House (ACH) transfers. This method offers reduced administrative burden, enhanced security, and quicker access to funds.

While direct deposit is prevalent, some businesses still utilize physical checks for payroll. Regardless of the payment method, providing clear pay stubs to employees is a legal requirement in most jurisdictions. A pay stub itemizes gross pay, deductions, and net pay for the period. It also includes year-to-date totals for earnings and deductions, offering employees a transparent overview of their compensation.