What is payroll?
Payroll can refer to either your list of paid employees (the people “on your payroll”) or the total amount of money you pay to that list of individuals. The act of processing those salary or wage payments, along with benefits and taxes, is typically called “running payroll.”
To be successful at all things payroll, you’ll need to:
- keep accurate records
- figure out who to pay and how much to pay them
- calculate the taxes to withhold
- pay everyone accurately and on time
- submit withheld taxes to the government
Keeping payroll records
If you outsource your payroll, you’ll reduce your payroll workload significantly. We recommend Gusto, a software application that guides you through the payroll process. Even better, it automatically files and pays your payroll taxes, so you don’t have to worry. Gusto is to payroll as Bench is to bookkeeping, and thanks to its user-friendly interface and automation features, it also received an Editor’s Choice recommendation from PCMag.com.
If you’re a Bench customer, you can take advantage of our Gusto API integration. Using this integration, business owners can automate the flow of information and get real-time categorization of payroll expenses for the bookkeeping process. Using Gusto and Bench together also ensures the accuracy of the information shared between payroll and bookkeeping, so you’re making as few last-minute adjustments as possible come tax time.
If you’re not ready to outsource payroll yet, here are the steps you’ll need to take.
First, you need to keep an individual record for each employee. You should record the amount they were paid each pay period, along with any withheld income—for example, taxes or pension contributions.
Further reading: The Small Business Guide to Recordkeeping
Different rules apply to overtime pay, depending on if your employee is salaried or paid an hourly wage. Hourly employees are entitled to time-and-a-half pay (1.5 times their regular hourly rate) for all hours worked over the standard 40-hour week. Salaried employees do not have this entitlement but tend to receive other benefits, like a 401(k).
Key information to track for each employee includes:
- Current pay rate
- Total hours worked during the pay period (for hourly employees)
- Time-off taken (including paid and unpaid vacation, sickness, and parental leave)
- Time off owed (not used)
- Overtime, double-time, or other variations in pay rate
- Tips, gratuities, commissions, or bonuses
You’ll also need to make sure your paperwork is in order for each employee. When you bring someone on board, have them fill in the following forms:
- An I-9 (proving their eligibility to work in the States)
- A W-4 (this lets you know how much to withhold in taxes each pay period)
You’ll need to ensure that your employees get both these forms, whether or not you’re using a payroll provider.
Further reading: New Employee Forms: What You’ll Need for New Hires
Recurring tax forms
You should also familiarize yourself with Form 941 (which employers must submit quarterly to the IRS to record the amount of income, Social Security, and Medicare taxes withheld from pay), and the W-2, a combined wage and tax statement you provide to your employees once a year.
Calculating payroll taxes
Before you start payroll, make sure you’ve set up an EIN (Employer Identification Number) for your business. It only takes a few minutes to apply online or by phone, and you’ll need it to process payroll taxes.
Some taxes are paid by both the employer and the employee, and some aren’t. The tax rates are updated each year by the IRS and published under the title Publication 15 (Circular E) — The Employer’s Tax Guide. Rates are described as a percentage of the employee’s gross (pre-tax) pay.
Employees typically pay these five payroll taxes:
Employers typically pay these four payroll taxes:
Remitting payroll taxes
As the employer, you are responsible for calculating each tax, withholding it from your employee’s paycheck, and remitting it to the appropriate place. To calculate what you should withhold, follow our guide to payroll tax calculations.
Your payment schedule for payroll taxes will depend on your history as an employer and how much you are collecting in total payroll taxes.
Now that you’ve calculated your payroll taxes, set aside the correct amount, and determined what your remitting and reporting deadlines are, you are all set up to pay your employees.
What about contractors?
Unlike an employee, an independent contractor has the freedom to work the hours and jobs they choose, as determined at the beginning of the contract. Usually, they will work for several clients, supply their own work resources and equipment, do not receive employee benefits (like vacation pay), and invoice for payment, rather than receiving pay on a regular payroll schedule. They are also responsible for the entirety of their taxes.
It’s important to be certain if the person working for you is an employee or an independent contractor; if you’re not sure, check out our post on the difference, or file form SS-8 for an IRS judgment on the situation.
How to pay your contractor
Instead of a W-4, have independent contractors fill in a W-9 at the start of their contract—this will give you all the details you need to report on their earnings later. Although they aren’t employees, and you are not responsible for withholding tax, you will need to file a 1099 to let the IRS know how much you paid them. There are around 20 different variations of this form, so be sure to talk to a professional to make sure you’re using the right one.
The 1099, and its most common variation, the 1099-MISC, are submitted annually, detailing all payments made to the contractor. You’ll need to provide a copy to the contractor, retain one for your records, and submit one to the IRS. Some states also require a separate state-level 1099 filing, so check your state’s legislation, or ask your accountant for details.
If you have several independent contractors, you’ll submit multiple 1099s, which means you also have to file a 1096 (a form that summarizes all the 1099s you submitted).
Common payroll mistakes
Your payroll might be incorrect if you miscalculate the wages you owe your employees or if you miscalculate the amount of tax you need to withhold. The IRS is pretty serious about the tax part, and more than a third of small business owners are fined each year for mistakes made on their payroll taxes. As an employer, you are legally on the hook for all payroll taxes, even if you’ve outsourced your payroll to another company—so read on from some common payroll tips to avoid:
Reporting an employee as an independent contractor
It’s vital to classify your employees and contractors accurately: you might be paying someone as a contractor, but if IRS sees them as an employee, you’ll have to pay taxes on their behalf. This can be a major expense if you haven’t been setting tax remittances aside. Make sure you’re clear on their status when you hire them—if you need help figuring this out, check out our guide on the differences between an employee and an independent contractor.
Mixing up “exempt” and “nonexempt” employees
There are two different types of employees, and the distinction is important for payroll purposes: you do not pay overtime wages to exempt employees, but you do to nonexempt employees. An employee is exempt if they meet all three of the following requirements:
- They earn a salary
- They earn at least $24,600 a year ($455 per week)
- They’re high up in the company, and their job responsibilities directly affect the company’s operations
You’ll also need to check in with your particular state restrictions, as they can sometimes be even more stringent.
Employers often assume that their employees are exempt because they earn a salary, but that’s not always the case. Make sure you’re clear on your employee’s status because otherwise, you could be on the hook to pay overtime wages—and that could be a big expense if you haven’t accounted for it.
Miscalculating overtime pay
Overtime wages are different than regular wages. Typically, you must pay your employees 1.5 times their regular pay rate (time and a half) for anything more than 40 hours a week, but the rules can vary from state to state, and even city to city, so make sure you double-check. If you fail to pay the correct overtime rate, you are responsible for back wages, and you could incur penalties and interest.
Miscalculating taxable income
If you’re paying out unused vacation pay or overtime hours, it can be easy to forget the vital step of factoring in applicable payroll taxes. Vacation, sick pay, and overtime are all taxable. To remit the correct payroll taxes, you need to calculate it based on all taxable income—even the extras—factoring in any minimum or maximum caps that apply.
Missing the deadline
Deadlines can vary on the state and federal level. Make yourself aware of them, and always file on time. Otherwise, you’ll have to pay penalties between two and ten percent, depending on how late you are.
Paying the wrong tax rates
Tax rates are reassessed every year. If you pay the wrong rate, you won’t just be liable for the missing tax—you’ll also have to pay interest and a fine. Stay on top of the current tax rates by checking Publication 15 (Circular E) — The Employer’s Tax Guide.
Paying the wrong state taxes
If your employee lives in a different state from the one they work in, you might be paying the wrong state taxes. You should be paying according to the state they live in, not the one they work in (if different).
Paying your employees
After you’ve figured out your tax obligations, you have to pay your employees. What you actually end up paying them is their net pay (gross pay minus everything else)—the amount that’s left over after deductions such as:
- Tax withholdings
- Employer contributions, such as 401(k)
- Employee contributions, such as a health insurance policy;
You should pay your employees according to an agreed-upon schedule. The actual pay period will depend on what works best for your business, but you should keep it consistent.
How you pay them will vary: some employers still rely on paper cheques, but direct deposit is commonly the best practice for efficiency on all sides. If an employee doesn’t have a bank account, some employers may pay their wages directly to a prepaid card—the employee can use the card to make purchases or pull cash from an ATM.
Using payroll software
If you’re doing payroll yourself, you’ll need a payroll system. We’ve outlined the top five payroll solutions here.
Payroll software will give you the ability to:
- Run payroll (and produce pay stubs) on the cadence you need (usually biweekly)
- Calculate how much each employee gets
- Make payroll tax payments
- Facilitate paychecks and direct deposits
- Fill out w-4 forms
- Onboard new hires
- Manage workers’ compensation
Can I make this easier?
If this is all sounding a bit complicated, you’ll be relieved to know there are easier options than the DIY route. You can hire a payroll provider to take care of the bulk of the work for you.
We recommend Gusto, a software application that guides you through the payroll process. Even better, it automatically files and pays your payroll taxes, so you don’t have to worry. Gusto is to payroll as Bench is to bookkeeping, and thanks to its user-friendly interface and automation features, it also received an Editor’s Choice recommendation from PCMag.com.
By outsourcing your payroll, you can be free to focus on what your business does best, and enjoy the peace of mind that comes with accurate tax filings.