How to Run Payroll: The Ultimate Guide to Doing Payroll
Running payroll is an essential part of operating any business that has employees. But it doesn't come without its challenges. And the more employees you have, generally the more complicated the process can become. So how are businesses handling this essential process? A recent Paychex poll* of payroll users found that 39% of businesses do payroll manually, and just 17% of respondents would consider changing from a manual to an outsourced solution.
These and other professionals may not realize that if and when things go wrong, they often come at a high price. To prevent this from happening at your company, read this overview on how to run payroll, as well as your options for completing the process accurately and efficiently.
How does payroll work?
Once you have employees, you need to pay them and handle applicable taxes each pay period. There are many steps involved to complete these tasks, which we will cover in detail. These and other responsibilities make up the payroll process, which you or another staff member such as a bookkeeper can do, or you can find an accountant or payroll provider to handle these tasks for you.
Can you do payroll yourself?
Running payroll is an essential part of operating any business, no matter the size or type of industry. Business owners can do payroll themselves, though they must become familiar with the terminology, options, and basics of running payroll, as well as payroll tax laws to avoid making mistakes. Approximately 33% of all employers make payroll errors, and those mistakes can be costly. Unpaid taxes can result in hefty penalties, and mistakes on employee paychecks can erode worker morale and be a detriment to your business reputation.
Business owners have several options when it comes to running payroll, including outsourcing the process. Depending on the method you choose, consider actors such as how much control or oversight you want to have, cost considerations, and time commitments, among others.
How can you do payroll manually?
There are standard expectations that need to be met during each pay period when doing your own payroll. Depending on how employees are classified (exempt or non-exempt), you will need to:
- Determine the appropriate wage and net pay amounts.
- Calculate and subtract the state unemployment, FICA, state taxes, garnishments, and any other withholdings.
Print and sign the actual paychecks.
- Make deposits to the appropriate tax agencies according to the calculated or assigned frequencies Handle all the necessary tax reporting ,tracking, third party payments etc. .
In short, when you do payroll yourself, you are in total control of the entire process. But that also means you are responsiblefor accurately processing the payroll, including all required and elected deductions., writing the checks that need to be written, and avoiding errors — otherwise paying penalties.
Business information for payroll
Before getting acclimated with payroll basics or getting started, the following business items must first be in place:
- Apply for a Federal Employer Identification Number (FEIN): This is assigned by the IRS and is used to identify a business entity. You need this nine-digit number to pay federal taxes, hire employees, open bank accounts, and apply for business licenses and permits. You can do this online on the IRS website.
- Register with your state and local government: Depending on your business structure and location, you'll need to register for a state ID number to pay your business's state taxes. Tax obligations and steps to get an ID number both differ at the state and local levels, so check with your state and local agencies.
- Look into workers' compensation coverage: This insurance is mandatory in most states, although rules vary from state to state as to how many people a business can employ before it is required. Nonetheless, it's strongly recommended that you have workers' compensation coverage if you have employees.
- Report new hires: State and federal laws require employers to report information on new and rehired employees to the appropriate agency within 20 days of beginning employment. Some states require reporting this data sooner. This information is used to locate parents who owe child support.
Employee payroll information
There are also specific pieces of employee information you'll need to gather before getting payroll started. They include:
- Worker classification (exempt vs. non-exempt, employee vs. independent contractor): It's important that any worker you bring on board is classified correctly, since each classification falls under different rules. This will determine the appropriate wage and net pay amounts.
- New-hire documents: (Form W-4, Form I-9, etc.): Although certain forms are completed by nearly all new hires, they may vary from company to company due to industry-specific regulations, company benefits, and policies. In addition, for employers with more than one location, different state and local laws may require that employees at only one worksite complete certain documents. It's your responsibility to ensure that all required new hire forms are completed as part of the onboarding process.
- Payment method: Depending on the options you offer, you will have various tasks to complete to successfully deliver paychecks via direct deposit, paper checks, or paycard. Learn more about employee pay options that may be available to your business.
How do you calculate payroll?
Employees depend on and expect timely, accurate delivery of their paychecks. Any disruptions or errors can prevent your process from running smoothly, and could even lead to turnover. When learning how to run payroll, the following factors are key foundational basics with which you must become familiar.
Track worker time
Accurate payroll relies on tracking employee time correctly. There are various methods for tracking hours, including time and attendance software that integrates with payroll or having employees track their time manually. Keep in mind that, like payroll, manual methods can lead to inaccuracies. This is why, when evaluating your payroll process, you may also want to evaluate whether your time and attendance solution is the best fit for your business.
Understanding different types of pay
Before you can calculate your employees' wages, it's important to understand the different types of pay so you don't make any payroll errors. Here are a few examples:
- Gross pay: This is the amount an employer pays on an hourly or annual schedule. Gross pay is the amount that employees receive before deductions.
- Net pay: This is the amount an employee takes home, after deductions.
- Bonus pay: Additional compensation provided as a reward for high performance. Both cash and non-cash bonuses are subject to income tax withholding and other payroll taxes.
Calculate employee wages
There are many calculations and factors that go into determining an employee's wages. One of the key parts of calculating pay is deducting payroll taxes from employee paychecks. In addition, you will need to do the following:
Determine your business's payroll schedule
A payroll schedule establishes employee pay dates, tax payment due dates, and tax return filing deadlines, etc. You'll also want to account for scheduling special payrolls, such as for seasonal or annual bonuses.
Calculate gross wages
To calculate wages manually for a non-exempt employee who has not worked more than 40 hours in a workweek, multiply the employee's hourly rate by the number of hours worked in the pay period to calculate gross regular pay.
If you've determined that a different, salaried employee is exempt from overtime compensation, calculate their gross wages by dividing their annual salary by the total number of pay periods in a year. For example, an employee with a salary of $75,000 who is paid biweekly receives 26 paychecks a year (but may receive 27 in some years). Divide $75,000 by 26 to calculate their biweekly salary of $2,884.
Account for overtime pay
If an employee worked more than 40 hours in a single workweek and is classified as non-exempt, they are eligible for overtime. If there is no additional remuneration such as non-discretionary bonuses or commissions, multiply the employee's hourly rate by 1.5, and then apply that rate to the overtime hours worked.
Handle wage garnishments
A wage garnishment is any legal or equitable procedure where some portion of a person's earnings is withheld by an employer for the payment of a debt such as alimony, child support, student loan default, or other circumstance. Once notified, employers should alert the employee and immediately start the wage garnishment process and ensure that payments are sent to the appropriate agency or creditor. This protects the business from any legal repercussions for failing to respond to the order.
Factor in benefits contributions
Account for benefits contributions such as workplace-sponsored retirement plans, health, life, or disability coverage, and flexible spending accounts. In such cases, you'll need to calculate and deduct each employee's individual contributions from each paycheck.
Deduct payroll taxes
Employers generally have to withhold federal and state income tax from all employees' taxable wages, based on what employees enter on their Form W-4. Here's a brief explanation of a few mandatory payroll taxes:
Federal income tax
This is withheld from an employee's wages or salary, reported to the federal government, and applied to the employee's calculated tax liability at the end of the year.
Social Security and Medicare taxes
This tax is generally paid equally by the employer and employee to fund these entitlement programs.
Federal employment tax
This is paid to provide funds for paying unemployment compensation to workers who lost their jobs.
There is also the state unemployment (SUI) tax that subject employers must pay. Except for a few states, state unemployment taxes are not deducted from an employee's wages.
How can I print my own payroll checks?
If you prefer to pay employees via traditional paycheck, consider using a service that can laser encode your signature and put the paycheck into an envelope, so they're ready to deliver to your team. This can help ensure checks look professional and minimize the time you need to spend on the process.
Can payroll checks be handwritten?
Paychecks can be handwritten, but there are some things to keep in mind. Employees may find it challenging to cash their checks, depending on where they go to get their earned wages. There's also potential that they can be stolen and signatures can be forged.
Payroll processing basics
Paying mandated taxes on a regular schedule through your payroll is one key to avoiding penalties. And remember: on-time, accurate paychecks are directly correlated to worker morale and a solid business reputation. Some basics to keep in mind when processing payroll include:
- Collecting and tallying the hours worked by each employee
- Paying the right amount, including double-checking all employee information, tax withholding amounts, and payment information
- Processing payroll on time every pay period
- Paying attention to bank holidays, which are holidays when your bank closes, and your payroll processing timelines have to be adjusted
- Depositing and reporting employment taxes correctly to all federal, state, and local tax authorities
- Printing and signing paychecks, as well as administering direct deposit for employees who opt for this payment method
- Classifying employees correctly
Is doing payroll yourself worth it?
Given its complex nature, processing payroll on your own can cost more in the long run than what you may save initially. A 2017 Paychex survey found that one-third of small businesses spend around $1,001 to $5,000 each year on annual administrative costs by doing payroll themselves. Another third of companies spend more than $5,000 a year, with some companies reaching expenses as high as $40,000 or more.
Time is an additional factor when considering whether to do payroll yourself. Another Paychex survey found that HR professionals spent an average of 11 hours each week on payroll – equating to a full day and a half every week with an office that has a typical eight-hour workday. Recognizing this, 30% said that processing payroll was the top function for which respondents wished they had better systems and technology in place.
Benefits of outsourcing payroll
There's too much at stake for business owners to commit time-consuming (and potentially expensive) payroll processing errors. Consider the benefits of using payroll services from a professional provider:
- Time saved: No need to input data and double-check for errors every pay period.
- Greater efficiency: Look for a provider that allows you to import multiple files at one time, from one location, so you don't need to wait for each file to complete before processing a new one.
- Money saved: Costs saved on printing and distributing paychecks, generating reports for in-house and accountant use.
- Greater security: Protection against identity theft, embezzlement of funds, and tampering with records for personal gain.
- Professional know-how: Payroll providers with expertise on how to do payroll can help at any point in the process.
Keeping up with the complexities of employee withholdings, minimum wage legislation, and IRS forms can be daunting. Outsourcing payroll can also alleviate the burden that often comes with payroll tax compliance, including mitigating your business's risk of penalties for late or inaccurate payments.
Ease the burden of payroll with Paychex
Among the many items on small business owners' to-do lists, payroll tasks can be particularly important and complex ones. However, there any many risks and costs to handling these administrative responsibilities on your own, not to mention the time they can take away from your already-busy workday. If you think the time is right to reexamine how your business handles payroll, learn more about how to get started with a third-party provider. You may also want to compare payroll services to see what can work best for your business.
*Paychex conducted four separate online surveys of 300 principals of U.S.-based businesses with 2 to 500 employees. Wave 1 was fielded April 17-20, 2020; Wave 2, April 24-27; Wave 3, May 1-4; Wave 4, May 15-17. Each survey has a +/-5.66% margin of error.