This post was originally published June 20, 2017, and extensively updated April 27, 2021
Getting payroll right is essential for small business owners. Each employee is counting on you to run payroll every pay period and ensure that they receive their net pay on time. At the same time, you must deduct Social Security and Medicare taxes and pay federal and state income tax on behalf of your employees.
At Cook Martin Poulson, we know that payroll processing can be complicated, but paying attention to some of the do’s and don’ts of payroll for small businesses can teach you how to avoid the most common payroll mistakes while creating a detailed payroll plan.
How Does Payroll Work for a Small Business?
The payroll process starts with collecting necessary forms from employees and contractors. For example, you will need a W-4 form to tell you how much tax to withhold for each employee. A W-9 form provides information about independent contractors. At the end of the year, you will need to provide W-2 forms to employees so they can file their income taxes.
W-4 forms should be collected from each new hire as part of the onboarding process. The IRS requires these forms. The employee should indicate filing status to ensure accurate withholding.
Managing payroll for small business also requires choosing the right pay schedules, meeting filing and payment deadlines, and paying federal payroll tax and state taxes. You will need to:
- Calculate each employee's gross and net income and hours worked
- Deduct the Medicare, Social Security, Federal and State taxes
- Address wage garnishments
- Make payroll tax payments
- Deposit payroll to each employee's bank account, if desired
The process can be time-consuming, which is why we recommend that you hire an accountant for running payroll.
Can I Run My Payroll for My Small Business?
Running payroll can be a complicated endeavor. If you make mistakes with tax withholding or employee information, you may find that you owe back taxes and penalties to the IRS.
There are software options that make payroll easier, including online payroll tools that can help you calculate everything from gross pay to unemployment taxes. However, if you run the payroll on your own and make mistakes, they can be costly.
Payroll services are not expensive and usually cost less than the time and energy it would take you to run payroll yourself.
Payroll Tips: Do’s & Don’t on How to Do Payroll for Small Business
If you want to know how to manage payroll for a small business, we are here to help. Below are some tips for managing payroll:
- Promptly handle your internal paperwork, including your employer identification number and filing deadlines.
- Have a system to collect and file all necessary forms with the Internal Revenue Service and state taxing agencies.
- Use a reliable time tracking system on your website or internal server to track employee hours and ensure that you comply with overtime pay requirements.
- Provide employees with the tools and information they need to report their hours and track sick time and vacation time.
- Double-check all federal and state tax requirements to ensure that your business complies.
- Offer employees the option of direct deposit to process payroll more quickly.
- Keep the payroll process as simple as possible.
- Contract with a payroll provider or hire an accountant or bookkeeper to run payroll for you and keep accurate records.
- Conduct regular internal audits to catch mistakes and correct them before incurring costly penalties and fees.
You should avoid:
- Submitting payroll without double-checking your timecards
- Putting off calculating overtime
- Misclassifying employees and contractors
- Tracking hours and pay manually
There are automation and payroll tools available that can make your job far easier than it is now and it is a good idea to take advantage of them. Also, as we stated before, hiring a payroll service or Certified Public Accountant to handle your payroll can take the worry of mistakes and tax penalties and fees off your mind.
Collecting and paying payroll taxes needs to be a priority for all small business owners. It can be a challenge, but it is essential to keep accurate records and stay on top of your tax obligations.
Collect employee tax information
Collecting employee tax information is a must because accurate information will help you withhold the proper amount of federal, state, and local tax. Mistakes in tax withholding can affect employees' net pay and lead to errors in your small business payroll and costly penalties.
Some of the forms you may need to collect employee tax information and report it to the IRS include:
- Form W-4
- Form W-9
- Form 941
It is essential to collect information as soon as a new employee is hired to comply with tax laws and pay payroll taxes accurately and on time. That way, you avoid paying unnecessary late fees and penalties that may arise because of payroll errors.
Create a Payroll Budget
The first step in handling your payroll is setting a payroll budget that should cover taxes and wages. Elements that may impact your budget include your sales volume, staff size, and anticipated profit margins.
Use the following steps to create a payroll budget for your business:
- Total the number of employees
- Set pay grades for each category of employee or position
- Determine the median pay grade for each position
- Include estimates for employee attrition
- Determine your budget for yearly salary increases
- Determine the cost of employee benefits
The information you gather will help you set an appropriate budget for payroll.
Don’t Misclassify Your Employees
There are three main employee classifications – salaried, hourly, and independent contractors. A common mistake is categorizing hourly employees as independent contractors, which can lead to missed overtime or insufficient pay.
Employees should be classified as independent contractors only if they fit the description. An independent contractor performs work on an occasional basis and is paid only for the work they complete. They also supply their own materials.
Failing to properly classify your employees could result in problems with the IRS, including liability for back taxes including unemployment taxes and FICA.
Create a Payroll Schedule
Your payroll schedule determines how often you pay employees. The most common pay periods are weekly, biweekly, semi-monthly, and monthly.
Shorter pay periods mean higher costs for you and an increased likelihood of payroll errors. For that reason, many small business owners choose to run payroll monthly. The downside of a monthly schedule is that you may struggle to attract top talent to your business.
Don’t Calculate Overtime Every 2 Weeks
The Department of Labor (DOL) defines the workweek as 40 hours. Any employee that works more than 40 hours in a workweek should receive a rate of no less than 1.5 times their regular pay.
The DOL recently made changes to the overtime rule, which could impact your requirements for paying overtime. According to the Fair Labor Standards Act (FLSA), previously exempt employees may now be considered nonexempt.
With these changes, the salary threshold for requiring overtime pay has changed. Now, workers that earn less than $35,568 per year must be paid overtime for hours worked beyond 40 hours in a workweek.
Determine if You Require an Employer ID Number
Most businesses need an employer identification number (EIN) to file taxes, including payroll taxes. If you don’t have an employer ID number, then you need to obtain one from the IRS.
The application process for obtaining an EIN is simple. Any business located in the US or US territories can apply provided the owner has a valid Social Security number. You can receive your EIN immediately with an online application.
The only situation where you do not need an EIN is if you have a sole proprietorship or an LLC with no employees, in which case you will use your SSN. You may need a new EIN if your business changes its structure. You may also need a state tax identification number.
Keep Payroll Records and Adjust to Fix Mistakes
The best piece of payroll advice for small business owners is to keep accurate payroll records. With accurate records, it is easy to identify mistakes and correct them as quickly as possible.
You should maintain payroll records for a minimum of four years after filing the fourth quarter of a year. You should also retain all payroll information, including timecards, for that period.
Don’t Submit Payroll Without Double-Checking Timecards
If you have hourly employees, you should double-check the timecards when entering data into your payroll system. Employees may occasionally make mistakes such as forgetting to clock in or out at the beginning or end of a shift. These issues can result in payroll errors, including mistakes in the payroll tax.
It is your responsibility to ensure accurate pay for every employee. In addition to checking time cards, you should also check to ensure your small business payroll includes reimbursement for gas and travel.
Use Quality Payroll Software
If you handle payroll, make sure to use quality payroll software. The right software will help you catch mistakes before they create problems down the road.
Quality payroll software simplifies the process of payroll processing for small business owners. Payroll software can usually be integrated with your current time and attendance system.
There are payroll programs that will automatically take care of federal tax as well as state and local taxes. Paying employment taxes on time is a must and using payroll software can help.
Don’t Forget to File Tax Forms on Time
You need to file forms and pay federal and state taxes on time to avoid penalties. In most cases, the deadlines are determined by your business's fiscal year.
Electronic employment tax deposits for federal taxes are required semi-weekly or monthly. If you struggle getting these taxes in on time, then hiring a payroll provider or accountant may be the right move.
Outsource Your Payroll or Bookkeeping
You might think that an in-house payroll could save time and money, but it is actually the opposite and may lead to costly payroll errors. It takes the average small business owner five hours to process payroll. Over a year, that adds up to 21 days if you run payroll every two weeks.
The answer may be to outsource your payroll to a third-party provider such as a Certified Public Accountant (CPA). Working with a CPA or bookkeeping professional can prevent errors and save time.
Outsourcing your payroll simplifies the payroll process and makes it easier to:
- Offer direct deposit to employees
- Keep your payroll software up to date
- Prevent errors
- Reduce penalties
Most importantly, outsourcing your payroll means that you will have the free time you need to focus on running your business and increasing your profits. If you can save the five hours per pay period that the average business owner spends on payroll, you'll be able to focus on things other than calculating payroll taxes and gross pay.
While outsourcing isn’t always necessary, it can be a major help to your growing business. You won’t need to deal with some of the do’s and don’ts we have discussed here. Instead, a qualified accountant or bookkeeper will keep your payroll running smoothly and minimize the risk of mistakes.
Why Payroll Service is Worth It
As a small business owner, it may be tempting to handle payroll yourself with the idea that it saves money to do so. While that line of thinking is understandable, it is also incorrect. In the long run, hiring a professional to handle your payroll can save you time and money. It can prevent costly errors and penalties, not to mention the stress of an IRS audit.
Ultimately, working with a payroll service will ensure that your payroll is accurate and timely and that your employees are appropriately compensated for their work, including overtime.
Cook Martin Poulson can help you run your payroll efficiently. Contact us today to learn about our services and schedule an appointment.