Small Business Payroll and Taxes: Your Guide to Save Time And Money
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Most small business owners work longer hours than their employees–people joke that small business owners quit the 9-5 to work the 24/7. And unfortunately, day-to-day admin tasks like running payroll or doing taxes occupy a significant portion of that time. The average small business owner spends 71 days per year on admin tasks like payroll, invoicing, and HR services.
You want to reduce the time spent on repetitive upkeep to maximize time spent on core business needs that drive growth. That’s why we created this guide: to help you set up your small business payroll efficiently and streamline the way you handle tax-related matters for you and your employees.
How to set up small business payroll in 8 steps
Setting up your small business payroll is front-loaded work: you must gather many documents and set up a system before issuing your first paycheck. But once you do the initial set-up, you can automate payroll so it’s a hands-off task–especially with the right payroll software or service.
1. Obtain an Employer Identification Number (EIN) and business ID
Before you choose a payroll service for your small business, register as an employer and obtain an Employer Identification Number (EIN). This nine-digit identification number is the IRS’s method of identifying businesses. Think of the EIN as a Social Security Number for employers-it’s unique to your business and required on many payroll documents.
You must acquire an EIN if your company
- Has employees or operates 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)
Some states require a unique, additional EIN. Check whether you need a state EIN on top of your federal EIN.
2. Register for EFTPS
You can only make tax deposits for businesses using the Electronic Federal Tax Payment System (EFTPS). Before you start paying taxes, 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.
3. Determine your workers’ employment status
Whether you have one or multiple workers, you need to determine whether they are independent contractors or employees. The difference is sometimes subtle but important: misclassification results in steep fines.
Independent contractors work on specific projects for predetermined periods and are more affordable because companies don’t have to provide employment benefits. Full-time employees provide long-term, in-depth support. In exchange, employers must cover their mandatory employee benefits, such as Medicare and social security taxes.
If you’re still unsure how to classify your employees, consult the DOL’s criteria or fill out Form S-8 to get an official determination from the government. By classifying your workers correctly from the beginning, you’ll avoid a lot of stress and possible financial and legal penalties.
Note: independent contractors are not technically on a company’s payroll–they get paid via invoices instead. Read more about independent contractor invoices on our blog.
4. Account for statutory employee benefits and wage garnishment
Your total employer cost for US employees entails more than their net salary. In the US, there are several mandatory employee benefits that you need to account for:
- FICA taxes (Social security and Medicare taxes)
- Unemployment insurance
- Workers’ compensation insurance
- Health insurance
- Family and Medical Leave Act protections: the unpaid leave is mandatory, while paid time off (PTO) in these cases is up to the employer
- Disability insurance (in some states, such as California or Rhode Island)
- Federal wage garnishment (protection for employees’ income)
5. Collect W-4s and I-9s from employees, and W-9s from contractors
Before you start managing your payroll, you must collect forms from each of your workers.
All your employees need to fill out Form W-4, which is known as Employee's Withholding Certificate. This form estimates the amount to withhold in payroll taxes from each paycheck.
Later, at the beginning of each calendar year, you’ll fill out and give each employee Form W-2. Form W-2 tells employees how much they earned the previous year and how much the employer withheld from their paycheck.
In addition to the W-4 and W-2, 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 must 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.
Some states in the US require additional documents for new-hire reporting. Find a complete list of new-hire reporting documents broken down by state in the Department of Health and Human Services’ interactive map.
Finally, gather information such as deduction amounts for health benefits and retirement plans since they will be crucial for running payroll.
If you work with contractors, you’ll need Form W-9 to collect their tax identification numbers (TINs) and other relevant personal information. US contractors will also need a 1099-NEC form if you pay them over $600 per year.
You may need Forms W-8BEN and W-8BEN-E if individuals or entities you hire reside outside of the US.
6. Determine a payroll schedule
There are several ways to structure your employees' pay period and payment methods. You can choose one of the four standard payroll schedule options and pay employees:
- Monthly payments
It's critical to keep timesheets in order and track working hours accurately so you can calculate employee wages. Always double-check the data before making final payroll calculations, or use automated payroll software to avoid human error.
Although every employee prefers a specific pay schedule, base the payday decision on your cash flow and other factors that make payroll easier for you as an employer. Your full-time employees, who have a fixed salary, might have different paydays than your hourly employees, who get paid based on the number of hours they've worked. Note that most services typically delay between the payroll run (the date when the administrator initiates payment) and the date employees receive their paycheck.
The usual payment methods are a paycheck, a direct deposit into the employee's bank account, payroll card, or cash.
7. Payroll taxes
Payroll processing method refers to how you’ll keep track of your employees’ hours, wages, make payments, and keep payroll records.
Nowadays, payroll software automates this process, reduces the possibility of error, and guarantees data protection for your employees.
While this is the simplest way to process payroll, many companies choose a third-party, full-service payroll service provider and outsource the task altogether. They also choose to hire employees through an EOR to expand their business overseas. It’s up to you to choose a suitable (and scalable solution) for your small business. We’ll discuss your options below.
8. Document your process
Here’s an underrated step, but one we highly recommend! Many business owners fail to document their payroll plan and process from the outset and iterate on the fly until they find a method that works.
We recommend mapping out your process from the jump so it’s repeatable each time you make a new hire. Also, if you decide to expand your team and hire people to handle your payroll, they can take over this task more efficiently, thanks to a documented process.
What payroll taxes does my small business have to pay?
As an employer, you pay several payroll taxes when you run payroll. We advise all business owners to create and keep a tax calendar to keep track of their different tax deposits and obligations to help track these tax obligations.
Federal Insurance Contributions Act (FICA) is the tax that funds Social Security and Medicare benefits. The employer pays FICA taxes, but the employer and employee split the costs–the employer deducts the employee's contribution 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, 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.
In 2022, there haven’t been any changes to FICA tax rates.
Federal Income Tax
Employers need to withhold income tax from their employee's 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 and wage bracket methods.
Neither method is simple, but the wage bracket method is more prevalent among small business owners. Use the IRS's Publication 15-T and the wage bracket method table. Find the values corresponding to the wage of each of your employees and 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 gross pay.
Federal Unemployment Tax Act (FUTA) is an employer-paid tax that helps fund unemployment insurance for workers who lose their jobs. Unlike FICA taxes, employers don’t deduct these taxes from their employee’s paychecks. Most businesses pay both Federal and state unemployment tax for their employees.
As of 20221, you need to pay the FUTA tax at a rate of 6% of your employee’s wages. To be exact, 6% of the first $7,000 you pay to an employee per year. However, if you pay your state unemployment insurance, you’re eligible for a 5.4% tax credit, which means you only pay the FUTA tax at a rate of 0.6%.
Some US states cannot claim 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.
National, state, and local taxes
Each country, state, and local administration has its own taxes. Each country has its own federal tax laws, and each state has its state taxes within the US.
Small business owners hiring within the US should check their state and local tax authorities website to check which taxes they collect and how much they amount to. Small business owners hiring outside the US should consider partnering with an EOR to hire and pay foreign employees without having to open a local entity in each new country.
You can find accurate information regarding your specific state and business size here.
Why you shouldn't process payroll manually
Manual payroll processing is an outdated approach where you need to do all calculations by hand. It may seem like a cost-effective method at first, but it doesn’t pay off in the long run: 49% of workers will look for a new job after just two payroll errors.
Payroll software with automation has replaced manual payroll processing and proves more reliable. Payroll software can save you time and money and keep your data and calculations error-free, protecting you from fines and fees. Online payroll services also syncs between devices via the cloud, protecting your information from getting lost and allowing you to collaborate with team members as you grow.
What is payroll software?
Payroll software is an increasingly popular option for small business payroll because it allows you to automate most payroll-related tasks. You can manage all the data like wages, hours, and important paperwork within a program.
Benefits of using payroll software
Automation saves time and reduces the possibility of making a mistake in entering data. Many payroll software solutions are user-friendly, so you don’t need extensive training on using them. They typically offer a lot of add-ons and integrations: for example, with HRIS or accounting software.
Other benefits of payroll software include:
- Employee self-service options
- Compatibility with all types of devices
- Payroll tax filing
- Different pay options, including direct deposit and reloadable cards
- Year-end processing, including Form W-2, Wage and Tax Statement
5 best-rated small business payroll solutions
The best payroll service for your business depends on your unique business needs, team distribution, and size. For small businesses, we recommend looking for robust HR support, strong customer service, and a suite of appealing add-ons and integrations that support your existing tools.
Gusto offers full-service online payroll and a suite of add-ons, even with its Core plan. The platform has solutions for onboarding new hires, time tracking and employee benefits tools, and access to human resources experts for questions and advice.
Gusto is suitable for small businesses that plan to stay small since it eliminates the need for an HR department altogether. It’s also more affordable than most payroll service providers.
Deel is a payroll service with a full suite of additional HR services, like EOR services, independent contractor hiring, and much more. Deel offers employee contracts, hiring support, new-hire onboarding, automated tax form collection, and payroll features for companies hiring independent contractors or employees from 150+ countries at an affordable rate.
. One of the most impressive payroll features is the ability to make mass payments for international teams: you can fund unlimited payroll in seconds, in one click.
Paychex is a suitable payroll and HR solution for small businesses and startups with 50 employees. Paychex offers customer support and a cloud-based platform with labor compliance tools and quote-based pricing.
The platform focuses on regular employees on a company’s payroll and provides solid data security processes.
ADP is a user-friendly payroll software solution. It has a streamlined dashboard and even uses color-coding so you can easily navigate through large volumes of documents. The software is self-service and available on a mobile app, so employees can review their paychecks and download their pay stubs.
Many users love ADP for its graphic interface and simplicity, allowing you to find your way around even if you’ve never used a payroll system before.
OnPay offers plenty of useful features packed in easy-to-use software. It has an accuracy guarantee and provides customer service on weekends. The software also provides an automated onboarding flow and other HR tools at an affordable cost.
With the responsive customer support team ready to help out, you can process your payroll in 10 minutes.
You’ll find several other payroll companies with a simple Google search, including Square payroll, Quickbooks payroll, Intuit payroll, and many more. Before choosing a payroll service, we recommend ensuring they are SOC2 and ISO compliant, both external evaluations of the provider’s data security.
Outsource payroll to an EOR or a PEO for a full-service employment solution
If you don’t want to oversee payroll software yourself, you can outsource the whole payroll process to a third-party organization. Some business owners choose a Professional Employer Organization (PEO), while others outsource their payroll to Employer of Record (EOR) companies.
Use a PEO for domestic HR services
When you hire through a PEO, you enter a co-employment relationship to provide more attractive benefits for your employees. A PEO also takes over all your admin, payroll, and HR tasks, which frees up your time so you can focus on growing your business.
Co-employment means you share the legal responsibilities for your employees, so you’re still liable in case of a mistake. Moreover, the cost of using PEO services may go up as your team (or their salaries) grow: many PEOs charge you a percentage of your employee’s wages or determine a flat fee, up to $1,500 per employee per year.
Use an EOR for international hiring, payroll, and tax compliance
An EOR (also called an international PEO) is an excellent choice for small businesses hiring outside national borders. EORs give companies a way to hire foreign employees in compliance with foreign laws. You don’t have to worry about taxes or contracts–the EOR takes care of it for you. Also, an EOR can support your onboarding process, administer your employee benefits, create and terminate employment contracts, and more on top of managing your payroll.
Read more about the difference between EORs and PEOs.
How to do small business payroll and tax recordkeeping
Keeping payroll records isn’t only important for your internal operations: the law requires it. You can choose to store them in paper format or electronically. It’s up to you.
Employers must store each document for a specific period. Not all the paperwork has the same “expiration date” or needs to entail the same data.
How long do you need to keep payroll records?
According to the FLSA, you need to keep payroll records for at least three years. However, this rule doesn’t apply to all documentation: check out the table below to learn how long you should keep specific documents.
Six years: retirement income and 401(k) plan paperwork
Four years: employment/payment dispute paperwork, tax forms, pay stubs
Three years: FMLA leave records, hiring and termination documents, I-9 forms, employee handbook
Two years: pay grade and merit increases
Note: Some states may have different laws and documents for certain situations and employee classes. For instance, California law requires the employer to keep payroll records for an exempt employee for eight years in case of a tax audit.
What should your employee payroll records include?
Your employee payroll records must include the following information:
- The employee’s full legal name
- Their Social Security number
- Their hourly rate
- Their pay schedule (with pay dates included)
- Their daily/weekly straight-time earnings in total
- Their overtime earnings per week
- Their deductions
- Their final payments (unused paid leave or severance pay for termination paperwork)
- Rationale for merit increases
- Rationale for pay increases
- Amounts of money paid for FMLA leaves
- Payments made towards 401(k) savings plan
Plan for your future payroll needs
Choosing the right payroll processing method for your small business isn’t a small or short-term decision. Consider your long-term growth goals: you may have five employees today, but what if your team counts 200 people within a year? What if you decide to expand your company to new markets?
The right payroll solution is the one that’s scalable and flexible. It should accommodate your growth, not force you to find a new service in a few years.
Deel’s flexible options help you hire and pay your team, whether it’s small and local or enormous and multinational. We ensure each contract a full-time employee or contractor signs is entirely compliant with local regulations, whether it’s one person or 500 new hires, wherever you decide to look for talent. Deel also makes paying your team simple. With one mass payment and a click, you can fund and pay your entire global team on time and in minutes.
Running your payroll can be simple, fast, and reliable.