- Payroll processing begins with obtaining business tax identification numbers and access to governmental systems.
- Payroll processing continues with information verification, wage calculations, payment and withholding allocation.
- Although this payroll checklist will help you process payroll manually, you can save valuable time and reduce errors with payroll software.
- This article is for small business owners who want to ensure they take every step required in payroll processing.
Whether you're entrusting payroll to an in-house accountant, doing it yourself or outsourcing the whole thing, trust can be an issue. How do you know whether the numbers used in your calculations are correct? How can you be sure your employees will be paid on time and in full? What about all your payroll tax obligations and the chance of a potential tax audit? Fret not – this payroll checklist is here to save the day.
As you browse this detailed payroll checklist, you'll learn about one-time steps to set up your payroll initially. You'll also find out how to collect employees' income and tax information, and use this data to calculate paycheck amounts. Then, we'll guide you through actually paying your employees once you know what you owe. Read on to master your payroll process once and for all.
Editor's note: Looking for the right payroll software for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
A complete payroll checklist: 10 steps to process payroll
To process your payroll fully, from time tracking through tax deductions, take the following steps.
1. Apply for federal, state and local employer identification numbers.
Before processing payroll, a small business must have an employer identification number (EIN). Without this identifier, you can't make federal payroll tax payments. State and local equivalents may exist as well. Consult business law and tax experts in your area to find out for sure.
2. Register for federal and state withholding accounts.
Once you've received an EIN, you should create four key federal and state withholding accounts. For federal tax payments, you'll need an Electronic Federal Tax Payment System (EFTPS) account. For state tax payments, you'll need a state unemployment insurance account. On a state level, you'll also need a new-hire reporting account and a workers' compensation account (though the latter may vary by state).
3. Collect employee tax information.
With your identifying and tax payment information all set, you can now collect your employees' tax information. To do so, have your employees file a completed IRS Form W-4, and have your contractors file a completed IRS Form W-9. Alongside these payroll forms, you'll also need to collect USCIS Form I-9 to verify your employees' U.S. employment eligibility.
4. Set up your employee payment infrastructure.
Once you've taken care of all things government-related, you can put the systems in place to pay your team. This process starts with determining your pay frequency, knowing how often you'll need to remit taxes and setting up direct deposit for employees. For most small businesses, it also means enrolling with a payroll service to calculate and pay your wages and taxes. We'll explain why these services are beneficial later in this article.
5. Verify employee information accuracy.
The above four steps describe how to set up your payroll in the first place. On the other hand, you should take this step – and each one after – every time you run payroll.
Start your payroll run by confirming whether your employees' information remains accurate. Doing so could mean checking whether employees classified as employees are indeed employees and not contractors. It could also mean checking whether wage garnishments are necessary, home addresses have changed and salaries have been raised. As long as all your records in all your systems are consistent, you can assume your information is accurate.
6. Calculate employee gross wages.
Your employees' gross wages are what you pay them before you deduct any taxes or benefit contributions. Correctly calculating them is key to any successful payroll run. The good news is that these calculations are often quite easy, even with bonuses, commissions, tips and expense reimbursements in the picture. We've also prepared a guide to calculating and paying gross wages to help you with this task.
7. Calculate employee net wages.
For contractors, gross and net wages are one and the same. Things work a bit differently for employees, from whose checks you'll need to deduct payroll taxes. You may also need to withhold benefits contributions. If you must deduct benefits contributions, do so after calculating taxes. You must calculate taxes based on the total wages you pay employees, not what remains after deducting benefits contributions.
You'll often see the taxes you pay on employees' wages loosely grouped as payroll taxes. In reality, these taxes fall into several different categories, including:
- FICA taxes: Employees and employers pay FICA taxes in equal amounts. That amount is 6.2% of the employee's gross wages for Social Security tax and 1.45% for Medicare tax.
- FUTA and SUTA taxes: Federal unemployment taxes (aka FUTA) are levied at a flat rate of 6% on the first $7,000 of an employee's wages. However, if you pay your state unemployment taxes (aka SUTA) on time, you can potentially have this 6% rate lowered to 0.6%. Your SUTA rate will vary based on your state and several other factors. We've prepared a guide to FUTA and SUTA taxes to explain more.
- Additional federal and state income taxes: The information your employees share via their W-4 forms determines their federal income tax rates. Each state has its own additional tax rates that you'll need to factor into your calculations. In some cases, municipalities also have tax rates. On the other hand, some states and localities have no income taxes whatsoever. Consult your local tax authority or a small business lawyer to learn more.
Examples of deductions you might take from an employee's paycheck after calculating taxes include health insurance premiums, retirement account contributions and health savings account contributions. Note that some 401(k) retirement plans are pretax, affecting how you factor them into employee paycheck calculations.
8. Review all your calculations.
Earlier in this process, you verified that all the employee information on which you've based your calculations is correct. Now you need to check all your calculations for accuracy. To do so, verify that all numbers involved in your calculations are correct. Then run each calculation once again. If you see the same results a second time, you can assume that everything is correct and good to go. If not, review all your information for errors.
If you do have errors, they could stem from discrepancies in your records. Perhaps your payroll software has a different salary recorded for a particular employee than what's noted in your accounting or staffing records. Investigate discrepancies with your employees and the team members responsible for keeping your records, correct everything accordingly, and rerun your calculations. You should now get the correct numbers.
9. Pay your employees.
After all your numbers have been verified, it's time to cut checks or initiate direct deposits. Paying via paycheck can mean breaking out your checkbook or printing paychecks from your computer. In some cases, it can also mean having a third-party company send checks to your employees. Direct deposit is typically more straightforward, as it's either automatic or something you can trigger with just a few clicks after entering and verifying payment amounts.
10. Allocate withholdings.
When you pay employees, you should also allocate the money you've withheld from their checks to the proper accounts in your ledger. Chances are you remit your taxes quarterly, not every pay cycle, so you should store your payroll tax withholdings in your tax account until then.
Similarly, if you've withheld money for benefits contributions or premium payments, you should move this money to whatever account you use to cover these costs. And if you were to use payroll software instead of doing it yourself, this allocation and everything else in your payroll process would happen automatically.
Faster payroll processing with payroll software
Although the above steps aren't necessarily complicated, they're undoubtedly time-consuming. That's why 61% of businesses use payroll software. With fully automated payroll, you just need to take steps 1, 2 and 4 above exactly once, then give your employees self-service access for step 3. From there, your software can completely execute your payroll with no input from you – and no human error – every payday.
If you're interested in streamlining your payroll but worry about trusting technology, know that different payroll services exist for different types of companies. For example, ADP is a leader among payroll services in executing complex payrolls, OnPay's specialty is very small business payroll, and Gusto is known for its added HR services. (Read our ADP payroll review, our review of OnPay and our Gusto payroll software review for more information.)
You can find our top choices for many potential small business needs on our payroll software best picks page.
Admittedly, payroll software doesn't relieve you of the burden of verifying employee information. No matter how well your payroll software works, it will lead to incorrect calculations if, for example, you've entered an outdated employee salary. Occasional payroll audits solve this problem, but you should also keep a close eye on things so that your employees have no trouble receiving the money they earned.