How to Process Payroll

How to Do Payroll: A Step-By-Step Guide to Manage Payroll

Processing payroll is a daunting yet essential task for any employer. It involves complex calculations, legal obligations, and resources to get it right. Discover how to do payroll step-by-step.

Jemima Owen-Jones
Written by Jemima Owen-Jones
August 12, 2021
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Key Takeaways

  1. The payroll process involves collecting data, calculating pay, withholding taxes and deductions, and distributing funds accurately and on time.
  2. There are several ways to manage payroll depending on the size of your human resources team, their capacity, and the location of your workforce.
  3. Outsourcing your payroll will save valuable time and ensure you comply with payroll regulations.

How to do payroll in eight steps

Payroll processing is the procedure of paying employees at the end of a payroll period. This process involves multiple steps to ensure you calculate pay accurately and withhold the correct amounts for tax, benefit contributions, and other deductions before you deposit the funds. 

Follow these steps to create a streamlined and legally compliant payroll system:

Step one: Gather all the relevant business information

Before you can process payroll, you need to gather all the necessary data. The data will differ slightly depending on the country where your company is based. 
If you’re based in the US, for example, you will require the following date: 

  • Employer identification number (TIN): The IRS assigns businesses unique, nine-digit identification numbers. It functions as a business’s social security number, and distributing payroll is impossible without it.
  • Local tax ID: Some states require a separate local state tax ID to pay state-specific taxes. The local state government issues this ID.  

Step two: Gather all the relevant employee information

Next, collect your employee’s tax information and accompanying tax forms. Again, the tax information will differ depending on where you’re based. 
If your business is based in the US, you will need the following: 

  • Employee’s Identification Number (EIN)
  • Social Security Number (SSN)
The employer can collect this information by requesting that each new employee completes a W-4 form, also known as an Employee’s Withholding Certificate, at the start of employment.

Step three: Choose a payroll schedule

When it comes to payroll frequency, there are several options. The most common pay schedules include the following: 
  • Monthly
  • Semimonthly
  • Biweekly
  • Weekly
Choose a schedule that works best for your business. Before making a decision, you’ll need to be mindful of your cash flow and other important expenses, such as annual tax filings, utilities, and rent.

Step four: Choose your payment method

Another important decision you have to make is how you will distribute salaries. Direct deposits are the most popular and convenient method as employers can control cash flow better than paper checks, and employees can access their earnings easily from their bank accounts. 
A more modern payment method is via payroll applications. Employers can send funds directly into an employee’s digital wallet, cutting salary payment processing times and providing employees with flexible withdrawal methods.   
Learn about alternative payment methods such as cryptocurrency payroll and how long these alternative payroll processes take.


Step five: Calculate each employee’s gross pay

How you calculate an employee’s gross pay depends on whether they are salaried employees or receive an hourly wage. 
To pay hourly employees, you must track the total number of hours worked and calculate their pay for every pay period, as their earnings may vary. You will need to check timesheets for their standard and overtime hours and multiply this by the pay rate. 
Be cautious of overtime laws. Exempt employees are not entitled to overtime pay, while non-exempt employees must receive overtime pay at a higher rate than regular hours. 
You must also factor in additional bonuses, commissions, profit shares, merit pay, and incentives when calculating remuneration. 
Learn more about the different types of employee compensation

Step six: Subtract payroll tax deductions and withholdings

Next, it’s time to subtract payroll deductions and file them with the local authorities. Employees will require different deductions depending on their pay frequency, withholding allowances, and benefit entitlements

In the US, The most common deductions are as follows: 

  • Federal income tax (FICA): The FICA tax rate is 15.3% of the employee’s pay
  • Social security tax: 12.4% for Social Security
  • Medicare taxes: 2.9% for Medicare health insurance
  • State and local taxes: Some states and municipalities have additional payroll taxes for short-term disability, paid family medical leave, or other programs. Employers should check with their local authorities for specific requirements.
  • Voluntary deductions: Voluntary deductions are amounts which an employee has elected to have subtracted from gross pay, such as retirement plan contributions, life, and dental insurance
  • Wage garnishments: The state, IRS, or even private organizations can garnish employees’ wages to collect any unpaid debt, such as:
    • Spousal or child support
    • Federal or state tax levy
    • Creditor garnishment
    • Student loans

How do I file taxes?

Depending on the country you’re operating in, you must file taxes online on or before each payday with the local tax authority. 
You can only make business tax deposits in the US using the Electronic Federal Tax Payment System (EFTPS). If you choose to pay via credit card, you might have to pay some fees, while direct deposit doesn’t charge any extra cost.

Do I need to deduct Federal Unemployment Tax? 

No. In the US, Federal Unemployment Tax (FUTA) is an employer tax that only applies to employers and isn’t a payroll deduction. However, employers are obligated to pay this tax if they pay more than $1,500 during one quarter to employees. There is also a State Unemployment Tax (SUTA) for employers with at least one employee for 20 weeks during the calendar year. 

Is employee compensation tax deductible for the business?

Yes. The compensation you pay your employees and your portion of the income tax are deductible expenses for the business. On your annual tax return, you can claim this deductible.

Do I need to make deductions for independent contractors?

No. You have fewer obligations if you hire independent contractors (also known as 1099 employees in the US) instead of full-time employees.

Step seven: Fund payments to your employees and distribute pay stubs

After you have calculated gross pay and made all of the deductions, what is left is the employee’s net pay. The net pay is the amount you will distribute to the employee via the agreed payment method.
You will need to distribute electronic payslips to each employee for their records. 

Step eight: Keep meticulous payroll records

Retaining digital payroll records is required for tax purposes and is sensible in case of any payment disputes that need backing up with evidence. 
The term ‘payroll records’ refers to any form or documentation collected or produced for processing payroll. These records include things like:  
  • Collective bargaining agreements
  • Wage rate increase forms
  • Timekeeping logs and timecards
  • Tax withholding forms

Learn more about typical payroll mistakes and how to avoid them.

What’s the best way to run payroll? 

Depending on the size of your human resources team, their capacity, and the location of your workforce, you can handle payroll in the following ways:  

Manually in-house

Small business owners with few employees or a dedicated payroll manager or team with plenty of experience and know-how can process their own payroll in-house.

Check out 12 Payroll Best Practices to Implement in 2023 to stay in the know. 

Automated in-house

Automating payroll removes some of the stress of manually executing every aspect of payroll. Payroll automation uses software to run payroll calculations and distribute payments automatically. That means less work (and math) for you since the payroll software calculates wages based on every employee’s hours and applicable tax rates. Some programs will even disburse the payment through direct deposit or another digital method at the end of the pay cycle.

Automation makes in-house payroll significantly easier while saving time and increasing overall accuracy. Check out our Payroll Automation Guide to learn more.

Outsourced to a local payroll provider

If you don’t have the capacity for an in-house payroll team, then you might want to consider payroll outsourcing. Payroll outsourcing means bringing in a third-party provider to handle your payroll. 

Hiring a third party to take care of your company’s payroll ensures that all payments are accurate and timely and that all your payroll paperwork is in place.

Check out The Complete Guide to Payroll Outsourcing to learn more. 

Outsourced to a global payroll provider

If you have a global workforce and want to outsource your payroll, you’ll need to work with a payroll service provider specializing in international payroll processing. With global payroll, you must comply with new labor laws, provide global benefits, calculate wage conversions, factor in exchange rates, and send payments to various countries. And don’t forget about possible bank fees.

Outsourcing your global payroll saves you time and ensures you stay compliant with payroll regulations no matter where your employees live.

Run hassle-free payroll with Deel

Paying your workforce shouldn’t be stressful. With Deel, you can set up payroll with just a few clicks, automatically calculate taxes, and distribute employee paychecks without lifting a finger. Our multiple currency options and various withdrawal methods make it even easier for your team to get paid on time every time. 

Sound like something your business could use? Reach out and book a demo to see Deel in action.

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