How to Set Up a Payroll for a Small Business: A Complete Guide

Every small business owner must know how to set up payroll policies that suit their operations and employees’ demands. Payroll covers all the processes involved in calculating employee wages and taxes.

That said, these processes entail keen attention to detail to avoid errors in determining net wages and a thorough understanding of the key factors that help ensure full compliance with taxation and labor laws.

So, if you want to learn the ropes and ace setting up a payroll process that’s flawless and efficient, look at this article as your comprehensive guide.

Key Takeaways

• The important aspects of setting up payroll lie in having a thorough background about existing payroll and tax regulations and choosing a pay schedule for your business.
• When preparing payroll for every pay period, remember to keep employee and business data organized and up-to-date and maintain accuracy in calculating taxes and wages.
• Using pay stub generators and online HR tools, as well as hiring accounting and tax professionals, are some of the best practices for setting up payroll for startups.

What is Payroll & How Does it Work?

Payroll is defined as the different steps and processes needed to manage, prepare, and disseminate employees’ gross and net earnings, taxes owed, voluntary deductions, and benefits.

It entails a systematic approach that allows business owners to promptly disburse payments to their staff while meeting the different tax filing deadlines set by the IRS. At the same time, it requires an in-depth understanding of the various tax regulations, statepay stub requirements, and labor policies.

Business owners must also know that learning how to set up payroll for self-employed individuals differs from the steps involved in setting up payroll for an LLC or larger enterprise.

Specifically, self-employed individuals are subject to self-employment taxes, while single and multi-member LLCs pay taxes on their profit shares through their personal income tax returns.

5 Best Practices to Set Up Payroll for Your Small Business Easily

Setting up payroll for your small business can be intimidating at first. However, with the five best practices for preparing payroll discussed below, you’ll be able to get started with establishing your payroll policies hassle-free—take a look:

#1. Get Acquainted with Employment Laws

An integral aspect of learning how to do payroll involves gaining familiarity with existing employment laws, such as:

• Equal Pay Act. It mandates equal compensation or payment for men and women in similar positions in a company or workforce.

• Fair Labor Standards Act (FLSA). The FLSA enforces minimum wage and overtime compensation for non-exempt employees, which include contractors, laborers, maintenance staff, and non-administrative workers who earn hourly wages.

• Family and Medical Leave Act (FMLA). Under this act, eligible employees must be allowed to take unpaid leave from work to provide medical care to concerned family members. The FMLA also ensures job security for eligible workers while they attend to their medical needs.

• Migrant and Seasonal Worker Protection Act (MSPA). The MSPA protects the rights of migrant workers in the US.

#2. Register for an Employer Identification Number (EIN)

Registering for an Employer Identification Number (EIN) is necessary if you have employees and withhold taxes on earned income.

Your EIN establishes your business identity and helps you file taxes, apply for loans, and acquire licenses and insurance for your business operations. You can register for an EIN through the IRS website.

#3. Pick a Payroll Schedule

Your payroll schedule dictates how frequently you pay your employees. It also keeps you on track regarding regulating your business expenses and planning your monthly, quarterly, and annual budget.

Some of the most common payroll schedules that US-based businesses use include:

• Weekly pay schedule. In this pay schedule, you disburse employees’ wages at the end of each week and 52 times a year. Weekly payments best suit contractual and hourly workers.

• Biweekly pay schedule. A biweekly pay cycle means employees receive their salaries twice a month, specifically every other week. There are 26 pay periods in a year on a biweekly pay schedule.

• Semimonthly pay schedule. Following a semimonthly pay schedule also entails disbursing salaries twice a month. This setup completes a pay period every 11 days, yielding 24 pay periods annually.

• Monthly pay schedule. Monthly pay schedules pay employees once a month or 12 times a year. Monthly salary payments are expected for administrative positions, skilled professionals, and employees earning fixed salaries.

#4. Gather Essential Employee Forms

You cannot set up payroll without first gathering critical information about your employees’ tax situation and eligibility for work. As such, you must ensure that newly hired workers fulfill the following forms with updated and accurate details regarding their taxes and employment status:

• Form W-4, Employee’s Withholding Certificate. This IRS form informs you of the appropriate federal income tax amount to withhold from employee wages and salaries. It also details their filing status and number of dependents, if any.

• Form I-9, Employment Eligibility Verification. You must distribute this form to every newly hired employee to evaluate and certify their identity and employment authority to work in the US.

• Withholding allowance certificates. Collecting withholding allowance certificates only applies in states where the governing authorities levy state income taxes on employee wages.

#5. Understand Different Employment Types

A responsible business owner knows how to differentiate full-time employees from independent contractors or freelancers.

When you hire full-time employees and freelancers, you must set up payroll to accommodate the specific tax treatments and labor regulations imposed on each employment type.

That said, you must distribute Form W-2, Wage, and Tax Statement to salaried workers so they can report their total annual wages and withheld tax amounts for the year. You must also know the difference between a 1099-NEC and a 1099-MISC form and when to use them, respectively.

Form 1099-NEC, Nonemployee Compensation, is used to report nonemployee compensation. Employers distribute 1099-NEC to hired freelancers during tax season.

Meanwhile, Form 1099-MISC, Miscellaneous Information, is used to reports specific types of miscellaneous payments to individuals or organizations.

7-Step Guide on How to Process & Calculate Payroll

Now that we’ve discussed the five proven and best techniques to set up payroll, you might also ask yourself, ‘What specific steps do I need to learn to set up payroll for my business?’

Follow the seven critical steps in processing and calculating payroll seamlessly described below:

#1. Choose a Pay Period

Whether you choose a weekly, biweekly, semimonthly, or monthly pay period, it must adhere to your company’s size and employees’ needs.

You must also note the specific payroll deadlines associated with your pay period, whether they involve reporting income taxes or settling your liabilities and financial obligations to lenders, suppliers, and investors.

#2. Organize Your Employee’s Data

Keep your employee’s data organized and up-to-date to ensure you maintain accuracy when you set up payroll for your small business.

In other words, you must create individual files for each of your staff and ensure that their employment, compensation, and tax information remain accurate throughout their tenure.

#3. Calculate Hourly Gross Wages

To calculate gross wages, you must determine each employee’s hourly rates. Next, check the number of work hours they’ve completed in a pay period.

Remember to note any overtime or extra hours rendered and check whether the employee qualifies for overtime compensation or additional PTO.

#4. Deduct Contributions & Apply Salary Adjustments

After calculating your staff’s gross hourly wages, you must deduct contributions to health and life insurance premiums and retirement plans. If certain employees qualify for bonuses and commissions, implement them in their wages.

Other salary adjustments to watch out for include retroactive payments, which are remunerations given to employees whose paychecks showed discrepancies from the last pay period.

Examples of these discrepancies include missing payments in their salaries or bonuses and pay increases that are not reflected in employees’ salaries. Another type of salary adjustment may be wage garnishments or court-mandated payments for loans, child support, or alimony.

#5. Withhold Taxes

The taxes you must withhold from employees’ gross wages are divided into payroll and income taxes.

Payroll taxes refer to FICA (Social Security and Medicare), FUTA, and SUTA taxes. Under payroll tax, you withhold only a portion of your workers’ earnings for Social Security and Medicare taxes.

Employers only pay FUTA taxes on the first $7,000 worth of wages paid to each employee. SUTA taxes are not imposed across all states. Also, some states levy SUTA taxes on both employers and employees.

Income taxes are federal, state, and local taxes based on each employee’s tax brackets, filing status, and number of dependents.

#6. Calculate Net Wages or Earnings

Net wages and salaries are the resulting amounts after subtracting voluntary deductions, salary adjustments, and taxes from employees' gross wages.

Ensure you correctly calculate all gross wages and deductions to arrive at accurate values for each employee’s net earnings. The resulting net wages are the amount sent to employees’ accounts on the scheduled payday.

#7. Disburse Employee Payments

You can disburse wages and salaries to your employees in different ways. Some standard payment methods that most business owners use include paying workers in cash, issuing checks, pay cards, direct deposit, and mobile payments.

It is up to you to choose a payment method as you set up payroll for your business. Just remember your employees' needs and prepare the required paperwork for your payment method of choice.

For instance, you must prepare direct deposit pay stubs when depositing salaries directly into your employees’ bank accounts.

3 Expert Tips on How to Do Payroll on Your Own

You can also do payroll independently, particularly if you want to save time and resources or need to set up payroll for only one employee. That said, here are a couple of pro tips to use as a guide:

#1. Use Online Tools

If you want to simplify and speed up how you set up payroll for your business, you might want to try online tools in the form of HR software and pay stub generators.

HR or payroll software and online generators for pay stubs and tax forms make it easier for you to fulfill payroll reporting, time tracking, and accounting tasks even with a limited workforce or resources.

Remember to choose payroll service providers whose features and rates align with your business needs and budget.

#2. Employ the Services of Professionals

At times, using payroll or HR software also comes with additional costs, especially if you opt to add more features or switch to a more expensive subscription package.

That said, you can also hire accountants, payroll specialists, or tax professionals instead. Tax professionals can guide you in complying with tax and labor regulations, while accountants help ensure precision in calculating employee wages, including business expenses and revenue.

Payroll specialists, on the other hand, can offer their expertise in preparing and implementing payroll policies for your organization.

#3. Manually Prepare and Manage Your Payroll

Calculating and preparing payroll for every pay period manually is another way to set up your payroll without spending much.

However, you must also be careful if you prefer to do your payroll duties without the help of any software or professionals in the field. The reason is that manual payroll is not only more time-consuming and tedious, but it is also more prone to mistakes.

3 Standout Payroll Tools to Utilize

Here are some notable payroll tools that can help set up payroll for your small business:

• Deel. Deel is a top choice for businesses looking for an all-in-one solution to set up payroll and monitor employee compensation and benefits. Deel is also best known for helping companies that hire remote workforce, thanks to its features that focus on onboarding new personnel, managing freelance contracts, and complying with international payroll regulations.

• OnPay. What makes OnPay another great choice for assisting startups in setting up payroll is its budget-friendly rates for all important payroll management features. Some notable features include regulating life and health insurance contributions, 401(k) plans, and PTO.

• Paystub.org. Paystub.org offers a simpler and more straightforward solution in the form of online generators for pay stubs, W-2 forms, and 1099 forms. The document generators come with pay stub and tax form templates and built-in calculators that effectively reduce the time it takes to process payroll expenses every pay period.

5 Common Payroll Mistakes You Should Avoid

There are five typical payroll mistakes that new business owners often encounter. While these errors may be a common occurrence, it’s best to avoid or resolve them right away.

#1. Wrong Employee Details

Whether the mistake involves a typo on the employee’s name or contact information, inputting the wrong address, or misclassifying your staff, leaving these mistakes unresolved could mean more payroll work for you later on.

For example, if you mistakenly classify a non-exempt worker as exempt, then you are depriving them of their eligibility for overtime pay whenever they exceed their regular work hours.

At the same time, you may end up withholding less or more than the correct tax amount from your staff’s gross earnings.

#2. Missing IRS Deadlines

It is crucial to ensure you meet the due dates set by the IRS for business and employee taxes. Otherwise, you risk incurring penalties or an IRS audit. Also, the more your penalties pile up, the higher the chances of your business ceasing operations.

Make it a point to update your calendar with important tax deadlines when you set up your payroll. In doing so, you can establish a system with your HR or payroll department that ensures you distribute employees’ tax forms and file all your payroll and income taxes on time.

#3. Disorganized Payroll Records

By keeping your payroll records disorganized, you make it difficult to determine accurate and complete employee and company data from inaccurate and incomplete ones.

Find time to check whether your employees’ Form W-4 still contains relevant and updated information about their taxes and dependents.

Some of your staff may qualify for specific tax deductions and government-sponsored assistance programs but forgot to inform your HR personnel properly. Managing your company’s payroll records also aids in enhancing your current payroll processes.

#4. Wrong Gross & Net Wages

According to the UKG Workforce Institute, over 82 million US-based workers have encountered errors in their paychecks. These errors or mistakes include, but are not limited to, miscalculated net wages, late payments, and non-disbursement of their salaries.

By failing to calculate and disburse the correct compensation to your employees, you instantly lose their trust and the integrity of your business. You may also face legal action if you continue to disburse the wrong payment to your workers.

#5. Mismanaged Employee Benefits

Failing to manage and organize your employee’s benefits is the same as robbing them of their right and opportunity to improve their quality of life.

Whether these benefits involve health and life insurance coverage, paid time off, fitness programs, or any other fringe benefit, you must implement your benefits package accordingly. Otherwise, your employees will feel unappreciated and exploited and potentially leave for greener pastures.

Final Thoughts

Establishing payroll policies and processes that underscore your employees’ needs, adhere to labor and tax regulations, and help manage your payroll liabilities is a must, regardless of your business size or type.

Learning how to set up payroll may be time-consuming, but it is also the secret to earning employee trust and securing long-term stability for your business.