The first step to creating a compliant payroll process is easy: Apply for an employer identification number or federal employer identification number. There is no application fee and the form can be completed online. Without an EIN or FEIN, you cannot pay your people.
Next, register with the Electronic Federal Tax Payment System — it too is free. This system lets you pay both federal payroll and unemployment taxes from your computer.
State and local governments also require an ID number. Some states allow you to use your federal number, but many states have their own ID requirements. Additionally, many states require you to have an unemployment ID number, which is used to file state unemployment taxes.
Once you have your ID numbers, familiarize yourself with federal and state laws regarding minimum wage, overtime calculations, pay stub information requirements, payday frequency regulations and
regulations for how quickly employees must be paid. You can define when your workweeks begin and end, but they must consist of seven consecutive 24-hour periods. Your payroll schedule, which may
include more than one workweek, should strike a balance between cost-effectiveness (because there are fees for running payroll) and convenience, but it should always comply with your
jurisdiction's frequency
requirements.
You also need to purchase workers' compensation insurance through a private insurer or, in states where it is offered, the state. Most states allow employers to choose, but a handful require companies to buy through the state.
You may want to offer benefits such as health, dental, life and disability insurances and/or retirement plans. It is not required to offer all or even some of these, but they often aid in recruitment.
Some companies open a bank account specifically for payroll and payroll tax obligations; this aids in keeping accurate records of payroll transactions.
Running payroll
To determine each employee's gross pay, multiply the hours they worked during the pay period by their pay rate. Or divide their annual salary by the number of pay periods each year.
Next, process payroll deductions:
- Federal pretax deductions include but are not limited to insurances, retirement plans and group life benefits. State law may be different.
- Statutory deductions include federal and state income tax withholding. To accurately withhold these taxes, you will need each employee to complete a federal Form W-4 and, in some states, a state withholding allowance certificate.
- Also statutory are Social Security and Medicare taxes (known collectively as Federal Insurance Contribution Act taxes). FICA is split between the employees and employer.
- Additional taxes must be withheld for state and local jurisdictions.
- Post-tax deductions — including but not limited to garnishments, Roth 401(k)s and union dues — are taken from the amount remaining.
Once pre- and post-tax deductions are subtracted from an employee's gross pay, what’s left is the employee’s net, or take-home, pay.
Additional payroll requirements
Employers are responsible for:
- Paying for workers' compensation insurance, which may not be deducted from employees' earnings
- Paying federal unemployment tax, which, like the employer share of FICA, may not be deducted from wages, and is filed on Form 940
- Filing Form 941 to report taxes and FICA withheld from employees
- Distributing W-2s annually
- Filing workers' compensation reports after workers' compensation claims are made
- Reporting new hires to the State Directory of New Hires (these reports are shared with the National Directory of New Hires and matched against child support records at the state and federal levels)
As an employer, be sure to take recordkeeping seriously. Federal regulations require that payroll and tax records be kept for at least four years; local jurisdictions may have their own requirements. Many states have wage theft prevention laws requiring you to provide employees with information about their pay and other benefits, including a requirement to provide a pay statement even with electronic delivery, such as direct deposit and pay cards, of wages.
It's important to file payroll and payroll taxes correctly and on time; if you do not, you might face penalties. If you do make a mistake with payroll, taxes or deadlines, correct the mistake quickly.
Especially if you have just a handful of employees, it can be cost-effective to run payroll yourself. As your business grows, you may consider outsourcing payroll responsibilities. Flexibility and cost are considerations. You can work with a payroll service provider, hire an accountant, outsource your human resources department or work with a professional employer organization.
Whether running payroll manually or working with a service provider, you can get online help with payroll and retirement calculators as well as taxes and forms.