In 12th century France, providing compensation on a daily basis was less difficult to administer. If laborers were present at work, they were paid. As labor and compensation became more complicated, workers were paid weekly, bi-weekly, or monthly. Workers were occasionally given paper documents that could be exchanged for money. Eventually, a system of management had to be formed to handle the complexities of exchanging labor for money. That system is now called payroll.
While historical payroll systems have definitely changed over time, modern American payroll is a complex and multilayered process, complete with mountains of forms and specific state and federal laws. New business owners are often overwhelmed or confused by the prospect of organizing a payroll system to compensate employees.
Of course, compensating employees incorrectly is also a fear. IRS audits and government regulations require strong attention to detail for this important aspect of our economy. Mistakes can be costly, both in terms of penalties and fines, back taxes, or even loss in employee morale if paychecks are delivered late or with incorrect amounts.
If you’re just beginning to explore your options for implementing a payroll system, there are quite a few considerations to keep in mind as you embark on that journey. We’ve put together a comprehensive guide to efficient payroll management to help you feel confident each step of the way. We’ve compiled the most common questions, concerns, and issues we see when business owners establish a payroll system for the first time. We’re experts, and we want to help you prepare for the unexpected with all the wisdom we’ve gained over the years.
The Five Steps to Preparing Payroll
Step 1. Apply For An Employer ID Number (EIN)
Before you can hire and pay employees for work completed, you must first register your business as a financial entity with the IRS. This number functions similarly to a social security number for identification purposes. In this case, though, the identification is of an organization instead of a person. You can apply for this designation online, through the IRS directly, or send an application via fax or mail. EIN is sometimes referred to as a Form SS-4 or a Tax ID Number.
It’s important to be aware that some states require a state employer ID number in addition to the federal EIN. While many states accept the EIN as the identifying number for a company, this is not always the case. Be sure to check your state regulations to see if a separate ID number is required on your part.
Step 2. Gather All Relevant Governmental and IRS Forms (State and Federal)
Even though this may sound like a straightforward step of collecting materials, the reality is a little more complicated. There are quite a few forms to print and organize before payroll implementation can begin. Don’t worry, though. We’ve got your back on this one. First, check out our quick-start guide to payroll taxes, then refer back to this guide. Listed below are all the forms you might need, along with a short explanation of each one and its purpose in the payroll process. Let’s begin!
A Form W-4 is completed by each employee at a company in order to determine how taxes are withheld from an employee’s salary. Depending on how an employee prefers to withhold taxes and depending on the amount of deductions they typically take, this will radically change how their individual payroll is processed. Giving a Form W-4 to an employee is one of the first things an employer must do with a new hire. (In fact, many organizations consider it a non-negotiable first-day onboarding task.) Without a Form W-4, a new hire can never be paid, so it’s a top priority for both employee and employer. In previous years, all Form W-4 documents were required to be submitted to the IRS. That’s no longer the case, but employers must keep them on file at all times.
If you’re an employer, it’s likely you’ve been an employee at some point in your life. If that’s the case, you probably recognize the name of this commonly used federal form, and you likely know a little bit about how it works. Just in case you need a recap, a Form W-2 is the federal document that shows the amount of taxes withheld from an employee’s paycheck for the entire year. At the beginning of the fiscal year, you may not be thinking about Form W-2. But, by the end of the year, it becomes a necessity. You’ll use this form to summarize the wages and tax withholding summaries. There are no exceptions—every employer must file a Form W-2 for each employee. This is where using payroll software or a payroll company becomes incredibly helpful. When wages and withheld taxes are tallied through each pay period, summarizing this information becomes much easier.
Copy A of the Form W-2 goes with form W-3 to the Social Security Administration. Copy 1 is sent to your state or local tax department. Again, these forms can now be filed online, as well as through more traditional methods. If you are filing for the first time as a business, you must verify each employee’s social security number through the Consent-Based Social Security Number Verification Service (CBSV). This verification carries with it a one-time, non-refundable $5,000 fee, so it’s important to set that money aside as you prepare to file for the first time.
Speaking of employee identification, one form that many employers occasionally forget to get completed is Form I-9. This document verifies the identification of each employee and their employment eligibility. This form must be completed for all employees, both citizens and noncitizens. Employees are asked to affirm their employment authorization. To support this claim, employees must present their employer with a number of documents certifying their identity and employment eligibility. A Form I-9 must be kept on file for a designated period and be available for inspection by the government.
The I-9 form must be completed within three days of the employee’s start date. It should be a standard component of any onboarding process. Potential employees may need advance notice or time in order to gather the components they need, such as birth certificates, visas, passports, or Social Security cards. Completing this form as soon as an employee joins your organization is a non-negotiable. It should be one of the very first forms new employees interact with.
If you employ any temporary, seasonal workers, freelancers, or contractors, you’ll need to provide them with a Form 1099-MISC by January 31. This form is needed if you pay a non-employee $600 or more over one calendar year. It’s the equivalent of a Form W-2 for full employees, and it’s just as important to send one both to the contractor and to the IRS by February 28. You also have the option of using the IRS FIRE system to file electronically. If you chose to file this form online, it can be completed by March 31 instead of February 28. Unlike the Form W-2 for full employees, you aren’t required to withhold wages for tax purposes. Freelancers withhold this amount themselves for their own tax purposes since they are considered both employers and employees.
Form 941: Quarterly Tax Report
Any business is required to file a Form 941 at the end of each quarter in order to report on the withholding amounts deducted from employees and the withholding amounts of the business itself. This form reports the total number of employees, total amount of wages paid, total taxes withheld from employees, as well as information on Social Security and Medicare wages and taxes. Finally, the form asks businesses to submit the total amount of taxes due for the quarter. This includes the total deposits already made to the IRS and to a separate withholding account, as well as other taxes still due to the government. Form 941 due dates are April 30, July 31, October 31, and January 31.
Form 944: Small Business Annual Employer Tax
If you’re running a business that has combined taxes of $1,000 per year or less, you’ll pay your total taxes annually, instead of monthly or semi-monthly using this form. However, most businesses end up with a larger total tax load, and so Form 941 works for most businesses, even smaller organizations.
Step 3. Strongly Consider Purchasing Business Insurance
Depending on your state or locale, some types of business insurance may be necessary in order for you to legally operate a business. Most states require any business with employees to pay for workers’ compensation insurance, unemployment insurance, and state disability insurance. How you pay for these policies will affect your payroll process, so it’s important to determine what policies you have and how they are paid for. Many business experts suggest liability insurance. Liability insurance can provide some coverage for your business if you end up making a payroll mistake. It can protect business assets and property in the event of a miscalculation.
Step 4. Determine What Taxes Need to Be Withheld or Paid In Advance
Once you have all the necessary forms and insurance to protect your assets, it’s time to determine how withholding taxes will affect your payroll.
This is one of the most complex parts of payroll administration, and the necessary payments may differ widely depending on state regulations. One of the best ways to determine that you’re calculating withholding and fees correctly is to get advice from a tax professional, HR expert, or outsourced payroll provider. These experts can help prevent common missteps when setting up payroll for the first time.
To get you started, we’ll list a few commonly occurring taxes most small businesses have to account for, but the best way to calculate these important numbers is alongside a professional.
Federal Income Tax
The federal income tax is the basis of the tax system, and it’s essential for employers to withhold their employees’ federal income taxes in order to ensure that the business has sufficient funds to cover taxes for all employees. Taxes taken out of each employee paycheck must be held in a separate account created solely for tax purposes. Failure to collect sufficient funds or to separate these funds from the larger revenue of the company is grounds for an audit, which could end up costing a small business a huge portion of its earnings.
State and Local Income Taxes
State and local taxes are also withheld from an employee’s paycheck in order to comply with state regulations and requirements. Since each state varies widely in the types of tax they levy, it’s important to carefully research any and all taxes that may apply to your business. The process of withholding these taxes is similar to the federal income tax withholding. These monies must be held in a separate account to ensure they’re never mixed with other earnings or assets.
Social Security Tax and Medicare Tax (FICA)
Social Security and Medicare taxes, also known as the FICA (Federal Income Contributions Act) are required contributions to provide post-retirement supplemental income and healthcare for all American citizens. Currently, this tax rate is 6.2% on the earnings below a certain wage base. This wage base can change from year to year, so you’ll need to check and see what it is for the current filing year. The wage base for Social Security in 2019 will increase to $132,900, and the maximum contribution will be $8,239.80 ($132,900 x 6.2%). When an employee earns about $132,900, an employer should stop withholding and paying the Social Security tax.
Medicare Tax Specifics
Unlike the Social Security tax, the Medicare tax does not have a wage base. In 2018, the Medicare tax rate was 1.45% for the first 200,000 in wages and 2.35% for wages over $200,000. Employees contribute 1.45% (plus 2.35% for anything over $200,000) and employers match their contribution with an additional 1.45% (plus 2.35% for anything over $200,000) totaling 2.9% (or more) paid.
Again, remember that tax rates do change. It’s important to check the rate each year to track any differences in withholding you may have to calculate for payroll.
Federal and State Unemployment Taxes (FUTA and SUTA)
In order to provide government assistance to unemployed workers, employers are responsible for covering all unemployment tax responsibilities. In other words, nothing is withheld from an employee paycheck to cover these taxes. Some states also have an unemployment tax, so check your local laws to see if you’ll need to set aside money to pay that as well. Federal unemployment taxes are submitted using IRS Form 940.
If your company’s FUTA is less than $500 per year, you may pay annually. If it is more than that, you must pay quarterly at the end of the month following the end of each quarter. Currently, the FUTA tax rate is 6% of each employee’s wages. If state unemployment taxes (SUTA) are collected in your location, you may be able to reduce the percentage amount of federal unemployment taxes (FUTA) you pay. The federal government may allow you to subtract the SUTA percentage from the FUTA percentage. It’s best to check with the IRS or a tax professional to see if this applies in your geographic region.
Other Possible Deductions From a Pay Period
Depending on an employee’s particular situation or any benefits you may offer, you may withhold additional funds from an employee paycheck, which will change how your payroll works. We’ll list the most common possibilities for additional deductions that might apply to your business, along with a short explanation of each one.
A. Health Insurance or Life Insurance Premiums
If you provide employer-sponsored health insurance or other types of insurance for your employees, it’s likely you’ll deduct a certain amount from each paycheck to pay for a portion of the insurance premium. Remember, if you have several healthcare plans for employees to choose from, the amount deducted for each employee may differ based on which plan they’ve elected to join.
B. 401(k) or Other Retirement Fund Contributions
401(k) or other retirement funds are built by employees contributing a certain amount of their earnings to the fund. Many employers match or even exceed this contribution as a common employer benefit. Depending on the amount of money an employee contributes to a retirement fund, the employer match will vary. Make sure you’re deducting the correct amount from each paycheck and that you’re coordinating with the retirement fund to match or exceed the contribution each employee makes.
C. Union Dues
Some unions authorize businesses to pay union dues through an automatic withdrawal from an employee’s paycheck. When preparing payroll, this means that monthly or bi-monthly checks may have a certain percentage deducted and sent to a union organization.
D. Unpaid Vacation or Sick Days
Employees who have taken unpaid vacation or unpaid sick days in the past pay period must have those missing hours of work deducted from the total payroll amount. It’s essential to have a system in place to keep track of these missed days in order to pay employees properly for the work they completed over a particular pay period.
E. Other Government, State, or Institutional Deductions
Finally, there are a variety of other deductions that might need to be applied to an employee’s paycheck. An employee may have his or her wages partially garnished in order to pay back a delinquent loan, pay off back taxes, or for child support payments. In each of these three cases, the correct amount of money due to an institution, individual, or governmental agency must be withheld from an employee paycheck and delivered to the party that is garnishing the wages.
Step 5. Answer These Two Essential Questions About Payroll
Congratulations! You’ve now completed several steps towards executing payroll for the first time. You’ve familiarized yourself with the laws and regulations of each state. You’ve also reviewed the tax responsibilities you have as a business owner. You’ve looked into purchasing business insurance to protect you in case of payroll mistakes, and you’ve collected all the essential information you need on each employee’s salary and deductions.
Now, you’re finally ready to pay employees. There are a few questions you should ask first as you begin to prepare your first payroll.
Question 1: When Will Your Employees Be Paid?
Usually, employers in the U.S. pay employees weekly, biweekly, or semi-monthly. Each state dictates how often an employee must pay employees. There are some guidelines regarding how taxes will be filed. The IRS has what’s called a “lookback period” to help new businesses determine when to pay taxes. If taxes withholding totaled less than $50,000 over one calendar year (or, if you’re establishing a brand new business), you should make tax deposits monthly.
If your total taxes withholding were more than $50,000 over the last calendar year, you should make tax deposits every two weeks. Despite how you pay taxes, you still have discretion over when employees are paid within the guidelines set by state law.
When it comes to depositing taxes, employers that pay on a monthly basis pay on the 15th day of the following month. Employers that pay twice monthly submit tax payment based on when employees are paid. If employees are paid Saturday, Sunday, Monday, or Tuesday, tax payments are due the following Friday. If employees are paid Wednesday, Thursday, or Friday, tax payments are due the following Wednesday.
Question 2: Do You Want to Use Payroll Software or Work With a Payroll Provider?
Your response to this question really depends on what you’re looking for when it comes to payroll services. Choosing between an internal and outsourced solution requires you to weigh a few options. Our introductory article on the topic should help jumpstart your thinking, but the two primary options are using a software solution or working with an established payroll provider.
Option 1: Payroll Software
Software can be a helpful and flexible option, but it does require a dedicated HR professional or business owner to execute each part of the payroll process. In many businesses, that type of attention to detail can be overwhelming to an already-stressed executive or too costly to hire an additional team member to ensure payroll is done correctly.
“Outsourcing payroll allows you to focus on your product, which is what will make you successful. You want to outsource with a company that has your best interest in mind.” ~Dr. Malcolm Sewell, Belmont Animal Hospital
Option 2: Payroll Provider
For most businesses, this option ends up saving money, time, and stress as a business continues to grow. Executives who engage with a payroll provider find that their time is freed up to work on higher-order concerns affecting their company and their bottom line. Working with a payroll provider may also make things easier for your employees.
Many payroll providers also have online portals where employees can sign in to view pay stubs and tax information, request time off, or read resources related to their employment. Giving employees direct access to these HR documents saves time by empowering employees to handle small requests or questions that would normally be directed towards an HR employee.
“After learning everything LBMC Employment Partners could do for us, we realized that having our employee benefits managed by our HR and payroll service provider made a lot of sense.” ~Lamar Schuler, President of World Travel Services
Outsourced payroll providers can also provide a variety of services in addition to payroll that can dovetail nicely with the types of needs businesses often have. Bundling these services with your payroll needs can save your business money and time if you have other HR, billing, and tax needs. Depending on the outsourced payroll provider, they may provide some or all of the following services:
HR and Payroll Services Your Business May Need
- ACA Compliance Consulting and Tracking
- Employee Benefits
- Outsourced HR (HRO)
- Payroll Tax Deposits
- Social Security Expertise and Services
Congrats—You’re Ready to Prepare Payroll!
That’s it! Once you’ve decided how you’ll implement payroll, you’re ready to pay your employees. It’s a complicated process, but the right professionals and resources can demystify the components. Soon, it will become an integral and fully-integrated part of your daily business operations.
At the beginning of this article, we introduced you to Jacques, the French peasant helping to build Notre Dame. The process of payroll certainly has changed over time and will continue to change. If Jacques’ foreman was preparing a paycheck in 2019, it would be a much more complicated endeavor than just handing over francs on a daily basis.
Luckily, you’re not Jacques’ foreman. Instead, you have access to a variety of tools and organizations that will assist you as you prepare payroll and ensure correct tax compliance. LBMC Employment Partners is a full-service payroll provider that can guide new and experienced business owners through the payroll process. We do our work with integrity, and we’re proud of the legacy we’ve built. With LMBC EP, you choose the services that are right for your company, and we partner with you to deliver those services. When we do this, we make a good business better. To help make your business even better, contact us today.