Small business owners usually juggle multiple aspects of their business: developing the company, working with clients, hiring and supervising employees, and managing independent contractors. In between all of those tasks, they need to find time for running payroll as well.
Payroll can be a time consuming and complicated task for any small business owner. To make it easier for you, we created this detailed overview with a specific, step-by-step guide to small business payroll.
Small business payroll: the basics
Contrary to what it sounds like, payroll is not a simple act of paying your employees. It covers many more aspects, such as compliance with federal and state laws and paying taxes. Along the way, there are many decisions about the payroll process that small business owners need to make.
Employer Identification Number (EIN)
Before you take any steps or make any decisions, you will need to register as an employer and obtain an Employer Identification Number - EIN. The IRS assigns a unique nine-digit number known as EIN to each business as a way to identify the company. Think of the EIN as a Social Security Number for employers. The EIN will be required on many payroll documents, so getting it is step zero for all payroll related questions.
You will need an EIN if your company:
- has employees or is operated as a corporation or partnership;
- deals with trusts, estates, farmers' cooperatives, or non-profit organizations;
- withholds taxes on income other than wages for a non-resident alien;
- files the following tax returns: Employment, Tobacco, Alcohol, and Firearms, or Excise;
- has a retirement plan for self-employed persons (a Keogh plan);
Depending on the state you work in, make sure to check whether you need a state EIN on top of your federal EIN as well.
Registering for EFTPS
You can only make tax deposits for businesses using the Electronic Federal Tax Payment System (EFTPS). Before you start paying taxes, it's necessary to enroll in the EFTPS, which you can do on their website. You can pay taxes either by direct deposit for free or via credit card, with some fees attached.
The essential step in defining the status of your employees is worker classification. If you are working with independent contractors and have employees, it is crucial to classify them correctly. To avoid misclassification penalties, make sure to report your employees to the IRS.
Next up is the salary status of your employees, as well as their exemption status. It would be best to determine which of your employees will have a fixed salary and which ones will have a wage.
Generally speaking, those who have wages are non-exempt, which means you need to pay them minimum wage and overtime. Exempt employees are not eligible for overtime pay, and they hold exempt positions, such as executives. To be exempt, these employees need to earn at least $455 a week or $23,660 a year.
Pay period and payment methods
There are several ways to structure the pay period and payment methods for your employees. The frequency usually varies from weekly or bi-weekly to monthly payments. Although every employee prefers a specific pay frequency, make sure to base this decision on your cash flow and other factors that make payroll easier for you as an employer.
The usual payment methods are either a paycheck, a direct deposit into the employee's bank account, payroll card, or cash.
Employee information collection
Before you can start managing your payroll, there are some final forms and information about employees you need to collect. All your employees need to fill out Form W-4, which is known as Employee's Withholding Certificate. This form is used to estimate the amount that will be withheld in payroll taxes for the employee.
In addition to the W-4, all your new hires need to fill out Form I-9, or Employment Eligibility Verification. After the new employee affirms their employment verification, the employer needs to check all the provided documents and confirm the verification on Form I-9. In short, the I-9 needs to be filled out by both parties.
Finally, make sure to gather information such as deduction amounts for health insurance and retirement plans since they will be crucial for running payroll.
Workers' compensation insurance
Workers' compensation is an insurance type covering the medical bills and expenses arising from an injury on the job. In most US states, this insurance is mandatory and paid by the employer, but its rate can vary between states. Nationwide, the average workers' comp rate is 1.85% of the employee pay.
As an employer, you pay several employment taxes when you run payroll. We advise all business owners to create and keep a tax calendar for their different tax deposits, for it will make tracking your obligations easier. Now let's break down the payroll taxes:
Federal Insurance Contributions Act (FICA) is the tax that funds Social Security and Medicare benefits. The employer pays FICA, but the costs are split between the employer and the employee. When paying FICA, you deduct the employee's half from their paycheck. The FICA tax rate is 15.3% of the employee's pay - 12.4% for Social Security and 2.9% for Medicare.
This calculation means employers pay 6.2% for Social Security and 1.45% for Medicare for their employees. However, both the salary or wages you pay your employees and your portion of the FICA tax are deductible expenses for the business. You can claim this deductible on the annual tax return.
Federal Income Tax
Employers need to withhold income tax from their employees' paycheck and then pay that tax to the IRS. You can calculate the withholding amount by checking their Form W-4 and choosing between the percentage method and the wage bracket method.
Nither method is simple, but the wage bracket method is more prevalent among small business owners. It would be best if you used IRS's Publication 15-T and the wage bracket method table. Find the values corresponding to the wage of each of your employees. Then, check their W-4 form to see if they file taxes as married or single, separate or jointly, and the number of claimed allowances they entered on the form. Use the instructions from Publication 15-T to calculate the exact amount to withhold from each employee's paycheck.
Federal Unemployment Tax Act (FUTA) is an employer-paid tax that helps fund unemployment insurance and state employment agencies. It is sometimes known as the Social Security tax or the Medicare Tax. This tax is not withheld from employees' paychecks and is the expense of the employers.
If you paid more than $1,500 during one quarter to employees or had one or more employees for 20 weeks in a calendar year (whether full-time or part-time), you will need to pay FUTA. The FUTA tax rate is 6% before the state tax credits; this sounds like a significant amount, but after state tax credits, you can end up paying as little as 0.6%. FUTA also only applies to the first $7,000 of the employee pay for one quarter.
However, some US states cannot claim the full state credit due to their outstanding loan balances. Make sure to check the tax credit of your state here. FUTA is paid quarterly, but only if you owe more than $500 in unemployment taxes. If you owe less, you leave the payment for the next quarter and then submit it using Form 940.
Apart from FUTA, there is also the State Unemployment Tax Act - SUTA. These are the state unemployment taxes, and their rate, payments, and bases vary depending on the state. Make sure to keep up to date with paying SUTA tax according to your state legislation.
State and local taxes
Each state and local administration have their own taxes, including state income tax. Every small business owner should check their state and local tax authorities' website to check which taxes they collect and how much they amount to.
*Important note: Due to the Covid-19 pandemic, the United States President released an executive order that contains a payroll tax deferral for the period between September 1, 2020, and December 31, 2020. Find out more about the deferral here.
Challenges of international payroll
For big and small businesses alike, the modern age has brought endless possibilities for recruiting and hiring talent worldwide. Small businesses, particularly startups, can opt to have international employees who work remotely or hire international independent contractors.
However, there are some challenges of international payroll (most of which can be overcome) that prevent small business owners from hiring globally:
- Achieving global compliance
The biggest issue by far is making sure to comply with international labor and employment laws. Each country has its own legislative system, currency, and language, and keeping track can be difficult, especially if you employ people in multiple countries. Try finding payroll software that ensures you are globally compliant.
- Streamlining the process
If you use different local payroll solutions for each country, we can only assume your human resources department is on the ride of their life. We cannot emphasize enough the importance of global payroll systems and their influence on payroll processing ease. Consider using a global payroll provider that enables you to run payroll for all the countries you work with.
Integrating an international payroll system is a good idea. Still, it can be challenging to adapt and replace the solutions you were using before. Make sure to have a clear plan laid out to minimize confusion and errors and keep everything running smoothly.
Choosing a payroll system for small businesses
Once you have registered with the IRS and the relevant state agencies, it is time to choose the model of running payroll for your business. There are three models to choose from:
Manual payroll essentially means managing payroll yourself. It is undoubtedly the most cost-effective method of the three, but it's also the most time consuming one. Most business owners have enough on their plate without the taxes, documents, and procedures related to payroll. And even those who make time for these tasks eventually find out they are just too complicated. Mistakes can always happen, and that can lead to IRS penalties. Time is money, so unless you are a small business owner who happens to be a payroll expert, we don't recommend managing payroll yourself. Of course, if your business is growing, you can always hire a payroll manager or an in-house accountant to run payroll.
Payroll software is an increasingly popular option for small business payroll. There is a multitude of software options ranging from desktop apps to online payroll solutions. The benefits of using payroll software are plenty, but one of the most important is versatility. These solutions can be used either in-house or by professionals, so business owners can always keep up to date with their payroll.
When choosing your payroll software, make sure to consider the nature of your business, the number of employees, and your budget for this expense. Features, plans, and pricing come in ranges, so make sure to think carefully about your needs. Investing in payroll software can seem hefty at first, but the peace of mind that comes with neat payroll is worth every penny.
Here are some of the most popular options:
Deel offers contracts, onboarding, and payments for companies hiring independent contractors or international employees. Features on Deel include contracts compliant with local labor laws, payments in 150+ countries, and automated tax forms collection.
Gusto is a platform offering full-service online payroll and beyond. The platform has solutions for onboarding new hires, time tracking and employee benefits tools, and access to HR experts for questions and advice.
Quickbooks is an accounting software often used by businesses in the US. Its features are diverse and cover accounting, tax filing, tax deduction, cash flow management, and payroll. Some plans even calculate income tax withholding and offer tax penalty protection.