Payroll management can be one of the most daunting human resources tasks for a small business owner to take on. As well as making sure your employees are paid correctly and on time, how well you manage the entire payroll process impacts your long-term business objectives as well as your ability to remain compliant with specific tax rules.
Here, we’ll take you through the importance of well-managed payroll activities and how to manage each step of the small business payroll process.
- One of the most fundamental obligations you have as an employer is paying your employees accurately and on time, your employees deserve to be compensated consistently and correctly and not doing so can have a huge impact on your business.
- Before you can start the payroll process, you need to collect all of the relevant employee information to feed into your payroll software so that it can conduct accurate calculations.
- There are three types of payroll deductions: pretax, tax withholdings, and post-tax, it’s important ― and a requirement in many states ― to issue employees with pay stubs that include details of their pay each pay period.
Why Are Properly Managed Payroll Processes So Important?
Paying your employees accurately and on time is fulfilling one of the most fundamental obligations you have as an employer. Your employees deserve to be compensated consistently and correctly and not doing so can have a huge impact on your business.
For example, after just two paycheck errors, almost half of employees begin to look for a new job, meaning you won’t retain the top talent you’ve hired.
But mismanaged payroll practices go beyond failing to pay employees on time. Many businesses without well-managed payroll fail to classify their employees correctly, calculate and withhold employee taxes, and maintain payroll databases. In 2020 alone, the IRS assessed an estimated $6 billion in employer penalties for miscalculations or missed payments on employment taxes.
From damage to employee morale to the risk of huge financial penalties, a well-managed payroll process isn’t just an HR exercise ― it’s your legal and duty-bound responsibility.
8 Steps To Use To Manage Your Small Business’s Payroll
- Collect accurate payroll information
- Calculate gross wages
- Subtract relevant deductions and calculate net pay
- Calculate your employer payroll taxes
- Reconcile payroll
- Run payroll
- Make tax and benefits payments
- Send and save payroll documents
Managing small business payroll is much easier with a plan. However, when it comes to a task as important as payroll, we highly recommend that you ditch any manual methods you’ve been relying on and use an HR or payroll software solution to support payroll as part of your digital HR strategy.
Below, we go through the steps you need to take to manage payroll for your small business, and how software can facilitate each part of the process.
1. Collect Accurate Payroll Information
Before you can start the payroll process, you need to collect all of the relevant employee information to feed into your payroll software so that it can conduct accurate calculations.
When you onboard a new employee, there’s a standard set of documents that you need to collect:
- Form I-9: This verifies that a person is eligible to work legally in the United States.
- Form W-4: This confirms how much in federal income tax to withhold from each employee’s paycheck.
- State W-4: If the state in which your business is located collects state income tax, your employees need to fill out this withholding certificate.
- Benefits forms: If you offer employee benefits, such as health or disability insurance and retirement plans, your employees need to fill out these forms, even if they don’t want to participate in any benefits program.
- Form W-9: If you hire independent contractors, they don’t need to fill out Form W-4 or a State W-4, but they do need to fill out Form W-9.
You’ll also need to keep on top of any changes to existing employees’ information, such as changes of address, as well as changes that affect deductions and taxes, such as a pay increase or benefit elections. Many HR and payroll software tools offer employee portals so that employees can adjust any information themselves.
Once you’ve made sure that all of your employee information is up to date, double-check that you’ve completed the following tasks:
- Obtain an employer identification number (EIN), used to uses to identify and track your business’s payroll tax payments and forms
- Check your state’s small business registration requirements and obtain a state ID number
- Choose a payroll schedule, such as weekly, biweekly, or monthly payments
- If necessary, activate the employee time-tracking feature in your payroll or HR software solution
- Gather each employee’s direct deposit bank information
2. Calculate Gross Wages
Although your payroll solution can do this for you, it’s a good idea to get a handle on how gross wages are calculated.
Your employees’ gross wages are the total amount they earn before deductions, such as tax withholdings and retirement contributions, and how they’re calculated depends on whether they’re paid hourly or are salaried employees. Remember, gross wages include overtime pay, sick and holiday pay, and bonuses and commissions.
Calculating gross wages is simple. For employees paid hourly, simply multiply the total hours they worked over one pay period by their hourly wage. For example, if Jane is paid $20 an hour and worked 80 hours within a period, her gross wages would be: $20 x 80 = $1,600.
For salaried employees, divide their annual salary by the number of pay periods throughout the year. For example, if John’s yearly salary is $80,000 and you pay him monthly, his gross wage each pay period would be: $60,000 / 12 = $5,000.
3. Subtract Relevant Deductions and Calculate Net Pay
There are three types of payroll deductions: pretax, tax withholdings, and post-tax. Once these have been calculated, they’re then subtracted from employees’ gross wages to constitute their net pay.
Again, it’s best to leave this part to your payroll solution, but here’s an overview of what this process involves.
These reduce taxable income and the amount of money owed to the government and include health insurance, group-term life insurance, and retirement plans.
These are statutory deductions that you withhold as an employer, and include:
- Federal income tax
- Medicare and social security taxes (FICA)
- State income tax
These are taken from an employee’s paycheck after taxes have been withheld and reduce net pay. They include:
- Roth individual retirement account (IRA) plans
- Disability insurance
- Union dues
- Donations to charity
- Wage garnishments
4. Calculate Your Employer Payroll Taxes
As an employer, you must pay taxes based on employee compensation:
- FICA payroll taxes: Employers pay half of FICA payroll taxes
- Federal unemployment tax (FUTA)
- State unemployment tax (SUTA)
- State or local taxes
5. Reconcile Payroll
Even though payroll software calculates and adjusts paychecks and deductions automatically, you must reconcile payroll, too. Payroll reconciliation essentially means double-checking for any errors or miscalculations before each pay period, and before you run payroll.
6. Run Payroll
After all that preparation, it’s finally time to run payroll. Remember, it’s important ― and a requirement in many states ― to issue employees with pay stubs that include details of their pay each pay period.
With payroll software like Gusto, running payroll can be completed in just a few clicks and takes care of all deductions, files payroll taxes automatically, and deposits payments directly to employee bank accounts. Users can even automate employee payroll with Gusto’s AutoPilot feature to make sure employees and taxes are paid on time every pay period.
7. Make Tax and Benefits Payments
This step is an important one: You need to send off the payments from withheld taxes and contributions and employer payroll taxes. Most payroll software solutions calculate and make these payments every payroll cycle automatically.
However, if you’re not using payroll software, you’ll need to use the Electronic Federal Tax Payment System (EFTPS) to deposit federal taxes.
8. Send and Save Payroll Documents
Not only does the IRS require businesses to keep employment tax records for at least four years, but the U.S. Department of Labor requires you to keep payroll tax data for at least three years.
On top of that, at the beginning of every year, you need to send your employees and the IRS the forms, including Form W-2, Form 1099-MISC or 1099-NEC, and Form W-3, about the previous year’s earnings.
Once you’ve sent off these documents, you need to store copies of them. While there are no federal requirements for how you store the copies, there are some state rules that dictate how and where payroll records can be kept.
Fortunately, many payroll solutions offer built-in standard reports that employers can use for their recordkeeping purposes. With Zoho People, for example, it’s easy to store and manage employee documents from within one centralized platform.
Small Business Payroll: What To Do Next
Payroll isn’t an area where you can afford to make mistakes. And without the right technology tools to help payroll management run smoothly and formalize your processes, your focus is taken away from strategic activities that help grow your business.
If you haven’t already, it’s time to get started with your software search. You’ll need to consider which features your small business needs to perform payroll correctly, as well as pricing tiers and customer support options. Luckily, we’ve done the heavy lifting for you and reviewed over 110 of the best HR software tools with payroll functionality to help you make the right choice for your small business.