How to Set Up Payroll: A Step-by-Step Guide

Payroll is a crucial process for any business working with or relying on employees or contractors. If you’re setting up payroll for the first time the whole process can seem overwhelming, but that doesn’t have to be the case. By working step-by-step, it’s possible to manage the payroll process on your own as an independent business owner.

Before you start, it’s important to become familiar with every aspect of the payroll process. Not only do you develop a deeper understanding of payroll, you’ll ensure your employees or contractors are paid on time and it will help you remain compliant with state and federal laws.

Below, find a step-by-step guide to help you understand and get started setting up your payroll system.

1. Set up an EIN with the IRS.

As a new business, your first step is to obtain an employment identification number (EIN) from the IRS. Your EIN, also known as your Employer Tax ID, is necessary for reporting to the IRS and any state agencies. Applying online is the fastest way to receive your EIN, as approved applications receive a number instantly. However, you can also apply via fax, mail, or by phone.

2. Check whether you need state/local IDs.

In addition to your federal EIN, some state and local governments require businesses to set up ID numbers before processing taxes.

3. Classify employees.

Before you begin collecting information, you need to figure out what type of employees you have. The IRS guidelines offer little ambiguity and failing to follow the guidelines can result in serious legal and financial consequences for your business. Take the time to identify if your workforce is made up of independent contractors, part-time employees, or full-time employees. Worker classification is important because it dictates your tax burden and what, if any, taxes you need to withhold when paying them.

4. Collect employee tax information.

Once you have your EIN and any state or local ID numbers, collect tax information from anyone who works for your company. Employees will need to complete a W-4 and an I-9, while contract or freelance workers will need to fill out 1099 forms.

If you’re collecting employee tax information in person, consider putting copies into a cloud storage service like DropBox, Google Drive, or Evernote to make them easier to share if you choose to work with someone for tax preparation later. If you have employees who will be working for you in a different area, you may want to use a service like DocuSign for documents that require a signature.

5. Choose a payroll schedule.

After obtaining all the necessary tax information, you need to decide your payroll schedule. Most organizations opt for a biweekly (every other week) or a semimonthly pay period (typically the 15th and the last day of the month). However, businesses can also implement a weekly or monthly payroll, depending on their needs. Be sure to consult with your state laws regarding payroll schedules.

6. Choose a payroll system.

Choosing the right payroll system can make the process significantly easier. Services like Bookkeeper360 offer payroll support for small businesses, allowing them to focus on growing their company. Entrepreneurs who want to tackle payroll in-house can use these services to track their financials, while those who want to outsource the process can get full-service accounting on a monthly or weekly basis.

7. Calculate gross pay.

To calculate gross pay, take the number of hours each employee has worked, then multiply it by their hourly rate. While you can do this calculation manually, setting up gross pay calculations in a spreadsheet can save you valuable time in the long run, especially if you have a team of workers.

8. Determine withholdings.

If you have W-2 employees (rather than independent contractors), you will next need to calculate any withholdings, including deductions, allowances, benefits, and any federal or state/local taxes. Since these numbers will vary by employee and category, using a spreadsheet to automate calculations can keep everything well-organized.

9. Run payroll and keep records.

Once you’ve subtracted withholdings from gross pay, you are left with the net pay — in other words, what the employee takes home. Create a pay stub for each employee, then run payroll and keep a record of everything you’ve calculated and submitted. Keeping meticulous records can help you solve any discrepancies that arise.

10. Systemize payroll taxes.

Knowing the deadline for IRS payroll taxes is vital. If you don’t make your payments on time, you can be facing a 10% Failure to Deposit Penalty. Knowing when taxes are due can get complicated fast, as federal taxes are due at wildly different times including semiweekly, monthly, and quarterly. This doesn’t include additional state or local taxes you will need to pay.

To keep track of each deadline, you should identify all of the taxes you need to pay along with the due dates and put reminders on your calendar or in a project management app like Trello, an Outlook calendar, or Asana.

11. Determine how you will track hours.

The Fair Labor Standards Act (FLSA) requires businesses to accurately track the hours their employees work, but how you track hours is up to you. Knowing how much to pay each person is as important as having a system set up to do so.

If you’re using a physical system such as pen and paper or time clocks, it isn’t overly complicated. Likewise, if you have employees on a salary, hours remain fairly simple to track. However, if you are sending employees out as needed — or you need a more detailed tracking method — there are a lot of options available that include GPS monitoring or geofencing.

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