What Does Running Payroll Mean for Your Business?
Understand the full scope of running payroll for your business, ensuring accurate employee compensation, tax compliance, and essential record keeping.
Running payroll involves managing employee compensation, handling deductions, and fulfilling tax obligations. This process ensures employees are paid accurately and on time, while maintaining compliance with governmental regulations. Managing payroll impacts a business’s financial health and adherence to federal and state laws.
Essential Preparations for Payroll
Businesses must establish foundational elements for their payroll system. A first step involves securing an Employer Identification Number (EIN) from the Internal Revenue Service (IRS), a unique federal tax ID for businesses. This number is mandatory for reporting taxes.
Collecting employee information is also required, including names, addresses, Social Security numbers, and completed federal Form W-4, Employee’s Withholding Certificate, for income tax withholding. Businesses must also complete Form I-9, Employment Eligibility Verification, to confirm an individual’s legal authorization to work in the United States.
Employers must also understand and comply with specific state and local requirements. This often involves registering with the relevant state tax agencies to manage state income tax withholding, state unemployment insurance, and any other local payroll taxes. The chosen payroll processing method—manual, software, or outsourcing—represents a significant preparatory decision impacting efficiency and compliance.
Calculating and Paying Employee Wages
Calculating and paying employee wages begins with determining an employee’s gross wages, which is the total amount earned before any deductions, based on their hourly rate and hours worked, or their predetermined salary. Accurate tracking of work hours, especially for non-exempt employees, ensures compliance with federal and state wage and hour laws, including overtime regulations.
From the gross wages, various deductions are then calculated. Mandatory deductions include federal income tax withholding, Social Security tax, and Medicare tax, known as Federal Insurance Contributions Act (FICA) taxes. The employee’s share of Social Security tax is 6.2% on earnings up to an annual limit, while Medicare tax is 1.45% of all earnings, with no wage limit.
Voluntary deductions, such as contributions to health insurance premiums, retirement plans like 401(k)s, or other benefits, are also subtracted from gross pay. After all mandatory and voluntary deductions are applied, the remaining amount is the employee’s net pay.
Businesses then disburse these net wages through direct deposit, paper checks, or pay cards.
Employers are required to provide employees with a pay stub or statement detailing their gross wages, all deductions taken, and their net pay for the pay period. This transparency helps employees understand their compensation breakdown.
Handling Payroll Tax Obligations
Businesses have distinct obligations to remit payroll taxes to various government authorities. Employers are responsible for their own share of FICA taxes, matching the employee’s contribution of 6.2% for Social Security and 1.45% for Medicare. This employer portion contributes to federal social insurance programs.
Businesses also contribute to unemployment insurance programs, including the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). FUTA is a federal tax that helps fund unemployment benefits, typically at a rate of 6% on the first $7,000 of an employee’s wages, though most employers receive a credit that significantly reduces this to 0.6% if they pay their state unemployment taxes on time. SUTA rates vary by state and are typically experience-rated, meaning they can fluctuate based on a company’s history of unemployment claims.
The employer is also responsible for remitting all taxes withheld from employee paychecks, including federal income tax and the employee’s share of FICA taxes. These funds are held in trust by the employer until they are paid to the appropriate tax agencies.
The frequency of these tax payments, whether weekly, bi-weekly, monthly, or quarterly, is determined by the employer’s total tax liability, with larger liabilities typically requiring more frequent deposits.
Federal tax payments are commonly made through the Electronic Federal Tax Payment System (EFTPS). State and local tax payments similarly have electronic submission requirements.
Required Reporting and Record Keeping
Running payroll requires ongoing reporting and meticulous record keeping to ensure compliance and provide transparency to both employees and tax authorities. Employers are required to file periodic tax forms that summarize wages paid and taxes withheld or due. A primary federal form is Form 941, Employer’s Quarterly Federal Tax Return, which reports federal income tax, Social Security, and Medicare taxes withheld from employee wages and the employer’s share of FICA taxes for each calendar quarter.
Annually, businesses must provide each employee with Form W-2, Wage and Tax Statement, by January 31 of the following year. This form details the employee’s annual wages, tips, other compensation, and the amounts withheld for federal, state, and local taxes. Employers also submit Form W-3, Transmittal of Wage and Tax Statements, to the Social Security Administration, which serves as a summary of all W-2 forms issued.
Maintaining accurate and detailed payroll records is important for compliance, audits, and dispute resolution. These records should include information such as hours worked, pay rates, gross wages, all deductions, net pay, and dates of payment.
Federal law generally requires employers to keep payroll records for at least three to four years, although some state laws may require longer retention periods.