How to Set Up Payroll for a Small Business
Learn how to set up payroll for a small business effortlessly with this step-by-step guide.
1. Apply for an EIN
The first step when setting up your payroll is applying for an EIN (Employee Identification Number) from the IRS. An EIN is a tax identifier for your business. Think of it as a social security number but for businesses as opposed to individuals.
Applying for an EIN is free and relatively simple. You can visit the IRS website and apply for one electronically. Assuming you meet the basic criteria, these numbers are generally provided instantly.
Alternatively, you can also mail or fax a completed SS-4 IRS form to the IRS service center in your state. Faxed applications take about two weeks to receive an EIN, while a mailed application will take about four weeks to process.
Once your EIN is secured, you can proceed with setting up payroll for a small business.
Depending on your state and local government, you will likely need to obtain a state or local business ID. This is needed for collecting state and local taxes in areas where income tax is assessed.
The collection process will vary from state to state, so you’ll need to consult the Secretary of State where your business is located for details on what is required.
You will need a written set of policies that are then agreed to by employees. These policies cover how wages and payment schedules will be handled as well as holidays and other special circumstances which affect employee payouts.
These policies must be in accordance with federal and state laws regarding employee rights. Be sure to check with the specific laws for your business location if you are unsure how payment issues are handled.
A few key points to include in any payroll policy are:
- Pay periods
- Paid time off
- Non-mandatory leave
One thing to note is that certain union workers may have rules that determine how often they are paid. These rules may also play a factor in how long after performing work that payments need to be made.
Depending on your payroll service, more frequent pay periods will likely cause an increase in fees, so try to find a payment schedule that works for your employees and keeps extra fees at bay.
4. Create a Separate Bank Account for Payroll and Tax Obligations
Although not necessary, many businesses use a separate bank account that is only used for payroll-related expenses. Doing so can make accounting much easier and creates a clear separation between payroll and other business finances.
To open a payroll account, contact the bank that handles your business’s other accounts and services and ask about setting up a separate payroll account.
Additional fees may be associated with operating a second account for payroll purposes. Be sure to ask about ways to possibly help lower these fees.
Worker’s compensation varies from state to state. That said, many states require businesses to have worker’s compensation insurance. This can be purchased privately or can also be purchased through the state in some cases.
You will need workers' compensation coverage even if only one of your employees lives in a state that requires it.
Details like this are important when learning how to do small business payroll.
Pay attention to your benefits package to attract and keep the best of the best. Consider adding features like health insurance, life insurance, dental insurance, and retirement plans. As employees typically cover the cost of these plans through paycheck deductions, deciding on benefits is an important step.
In the U.S., there are two different types of employment: "employment" and "independent contractor."
Independent contractors are self-employed persons who perform services, have no authority to hire or fire or determine employees' pay and hours, and are not subject to labor employment laws.
Employees are those individuals who enter into an agreement with another person, hereinafter called an "employer," in which the employer agrees to provide them with some type of compensation for a certain amount of work.
Employers must establish whether the person is an independent contractor or an employee.
The distinction between independent contractors and employees is very important because employers must pay Social Security, Unemployment Insurance, and Income Tax for employees but not for independent contractors.
Furthermore, employers must withhold Social Security and FICA (unemployment) taxes only on those considered employees.
8. Choose your payroll schedule
9. Have your employees fill out the correct paperwork
10. Find the right small business payroll system for you
11. Pay your employees effortlessly
Setting Up Your Payroll FAQ
How do I set up a payroll for one employee?
Setting up payroll for a small business includes the following steps:
- Obtain an EIN
- Request a state business ID
- Set pay wages and payroll policies
- Collect tax documents for the employee
- Open a separate bank account, if needed
Calculating payroll manually is possible, but it can be rather tedious and prone to errors.
To start, you will want to have followed all the guidelines above to prepare for calculating your employee’s paychecks.
Next, you will want to calculate gross wages. This is all wages paid before any deductions, including hourly pay, salary, and tips. Other types of fringe benefits may also need to be added if they have cash value and are taxable.
After that, you need to deduct the pre-tax amount from each payment. This includes money taken out pre-tax such as 401(k) and health benefit premiums.
Then comes the most challenging task, calculating each employee's withholding. This amount will vary for each employee as it correlates directly to how they filled out their IRS W-4 form. It is one of the more challenging components to master when learning how to set up payroll for a small business.
It will also be dependent on your state and local tax laws. For federal taxes, you can consult with the IRS 15-T supplemental guide, which shows you the withholdings based on certain criteria.
You will also need to calculate FICA taxes, which include Medicare and Social Security. Keep in mind employers are required to pay half of FICA, federal unemployment tax, and state unemployment tax. The employer contribution is separate from the employee contribution for these taxes. Check with your state or local government for the exact withholdings.
Finally, deduct the employee withholding amounts from the gross earnings to determine the final amount of the employee’s net pay.
Double-check all information before remitting payments.
As you can see, this method can be extremely detailed, and mistakes or omissions are very easy to make. This is why it is often wise to use payroll software, even for small businesses with only a few employees.
The time it takes to complete payrolls manually is determined by how much manual data entry is involved in compiling the payroll. This time can range from hours to days, depending on the complexity of your payroll process.
What if this time could be reduced to less than a minute? With Roll by ADP, it can be. This innovative payroll and HR software solution, part of ADP's integrated suite of apps, is specifically designed for small businesses. With it, small business owners can streamline the way they manage payroll.
Roll by ADP simplifies the payroll process by providing an online portal to update employee information, make edits, and enter changes. In addition, it can be set up to connect with bookkeeping, accounting, and payroll providers, making it easy to shift information back and forth.
As a small business, you need to handle all of the intricacies of a big business while still working within the confines of your budget. Payroll management is one area that can cause significant challenges for small businesses, as they don’t have the money or time to hire a high-level HR professional who can accurately manage and maintain payroll records.
The most common mistakes during the payroll process are:
- Paying the wrong person
- Employers not paying taxes on time
- Paying too much or too little in Social Security, Medicare and federal withholding taxes
- Forgoing annuities when they may be beneficial
- Paying your employees too much money when it is not due to be paid
- Not taking care of workers' compensation claims and other types
- Failing to correctly classify employees as exempt or non-exempt
- Failing to offer required paid sick leave, vacation and holiday time
Several factors will determine the answer to this question. The first is whether you have the skill set to manage payroll.
Learning how to do payroll for a small business takes dedication. After all, understanding how to comply with all federal, state, and local laws isn’t easy.
Next, you need to decide if it’s cost-effective for you to do it yourself. You’re likely already busy with management tasks and day-to-day operations if you run a business. Dealing with how to set up payroll may not be something you have time to take on.
Whether to outsource payroll or do it yourself will ultimately depend on what setup best suits your business operations.