The Basics of Setting up a Small Business Payroll System

Ensuring employees get paid is one of the most basic and essential tasks of small business. For many businesses, particularly those which are labor intensive, such as food service and hospitality, the cost of payroll can be the single largest line item on the P&L statement. Doing it flawlessly is very important. Nobody wants to lose track of their legal and regulatory responsibilities as an employer, or incur costly Internal Revenue Service (IRS) penalties and/or fines. Not to mention frustrating (or potentially losing) your employees, because their paychecks were processed incorrectly.

According to the SBA, there are “10 Key Steps to Setting up a Payroll System”

Obtain an Employer Identification Number (EIN). The EIN is necessary for reporting taxes and other documents to the IRS. In addition, the EIN is necessary when reporting information about your employees to state agencies. You can apply for an EIN online or contact the IRS directly.

Check Whether You Need State/Local IDs. Some state/local governments require businesses to obtain ID numbers in order to process taxes.

Independent Contractor or Employee – Know the difference. Be clear on the distinction between an independent contractor and an employee. In legal terms, the line between the two is not always clear and it affects how you withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes.

Employee Paperwork. New employees must fill out Federal Income Tax Withholding Form W-4. Your employee must complete the form and return it to you so that you can withhold the correct federal income tax from their pay.

Decide on a Pay Period. You may already have a manual process for this, but setting up a pay-period (whether monthly or bi-monthly) is sometimes determined by state law with most favoring bi-monthly payments. The IRS also requires that you withhold income tax for that time period even if your employee does not work the full period.

Document Employee Compensation Terms. As you set up payroll, you’ll also want to consider how you handle paid time off (not a legal requirement, but offered by most businesses), how you track employee hours, if and how you pay overtime, and other business variables. Don’t forget that other employee compensation and business deductibles such as health plan premiums and retirement contributions will also need to be deducted from employee paychecks and paid to the appropriate organizations.

Choosing a Payroll System. Typically, your options for managing payroll include in-house or outsourced options, such as an accountant or online payroll services such as Proliant. Outsourcing can significantly improve your payroll operations and save time, but you can’t completely remove yourself from the process if you want to ensure that everything is running smoothly. Ultimately, you are the one accountable for payroll taxes.

Running Payroll. Once you have all your forms and information collated, you can start running payroll. Depending on which payroll system you choose, you’ll either enter it yourself or give the information to your payroll provider.

Keep Good Records. Federal and some state laws require that employers keep certain records for specified periods of time. For example, W-4 forms (on which employees indicate their tax withholding status) must be kept on file for all active employees and for three years after an employee is terminated. You also need to keep W-2s, copies of filed tax forms, and dates and amounts of all tax deposits.

Report Payroll Taxes. There are several payroll tax reports that you are required to submit to the appropriate authorities on either a quarterly or annual basis. Visit your state tax agency for specific tax filing requirements for employers.

Those are the basics. Do these correctly, and you will be well on your way to having a firm foundation for future growth of your small business, while avoid running afoul of the IRS.