Processing payroll by yourself can be complex, and if you're doing it for the first time, it's crucial to consult an expert before you get started.
The challenge of processing your payroll is what you may miss. For example, if you enter deductions or file payroll taxes incorrectly, you could expose your business to severe liability. However, you can still process payroll manually – in eight steps – and if you're a small business owner who employs only a few people, it may be worth learning how to do payroll on your own.
How to do payroll: 8 easy steps
Step 1: Find your employer identification number.
Your first step is to set up an EIN with the IRS. The IRS issues this number so it can identify your business. If you're a new business, you'll have to apply for an EIN. You can read about how to apply for an EIN and learn more about the EIN program and process on the IRS website.
Applying is free, and the IRS prefers that you apply online, though you can also apply by fax or mail. International applicants may also apply by phone. Online applications, if approved, result in instant EIN assignment, whereas fax and mail applications take four business days or one month, respectively.
You'll also need to check with your state and local (city and/or county) for those tax ID numbers.
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Step 2: Collect employee tax information.
Once you have your EIN, you need to collect relevant tax information from your employees. This means having all employees fill out a W-4 and an I-9. If you have contract or freelance workers, you'll have to collect 1099s. On these payroll forms, employees provide legal information about their work status, elect to take out certain deductions, and fill out other important information.
You can't process payroll without the details provided on these forms. There are laws on when you have to submit this paperwork to the IRS, depending on the information your employees provide. You can read more about submitting W-2s and I-9s to determine what's required of your business.
Keep in mind that 1099s have a different set of rules for how to prepare them and submit them to both the IRS and your employees. Since the majority of work done for these forms falls to the employees, your business will only spend a short time – 15 minutes at most – distributing these forms to your employees and contractors, collecting them, and submitting them to the IRS.
Step 3: Choose a payroll schedule.
Once you've established all the relevant tax information for your business and its employees, you have to decide how you want to pay your workers. There are four types of pay schedule: weekly, biweekly, semiweekly and monthly. All four schedules have their advantages. Carefully consider how often you'll pay employees, but don't take so long that your employees go without pay for unreasonable periods. You should devote 15 to 30 minutes to looking up state laws about your payroll schedule.
Step 4: Calculate gross pay.
Calculating gross pay is simple: Just multiply the number of hours an employee has worked in a given pay period by their hourly rate.
The easiest way to track employee hours is via spreadsheet. Once you have the total hours for a pay period, multiply that by the employee's hourly rate, and you'll have that employee's gross pay. You must complete all of the steps discussed here for each employee in your company.
Here's a quick example: An employee has worked 85 hours in your biweekly pay period and is paid $10 per hour. Your pay period this time around is 80 hours.
- 80 hours x $10/hour = $800
- 5 hours x $15/hour (overtime pay) = $75
- Gross pay = $875
If you use a spreadsheet to determine your employees' gross pay, you can likely make all the required calculations in just a few minutes with your software. If you plan to calculate all your employees' gross pay by hand, you may need a few minutes for each calculation, and this time adds up quickly when you have an entire team of workers.
Step 5: Determine deductions, allowances and other withholdings.
One of the most important steps to processing payroll is determining each employee's deductions and allowances.
As a quick refresher, exemptions and allowances are the same things: They refer to how much money is taken out of your paycheck during the year. Allowances are specified on a W-4. Deductions, which are specified by the employee on a 1040-EZ form, are the things you can deduct from your income when you do your taxes. This is where you have to pay close attention to how employees fill out their tax-related forms and withhold the proper amounts.
On top of deductions and exemptions, factor in other aspects of payroll processing and withholdings from each paycheck. Depending on your business's situation, you may have to consider the following:
- Federal taxes
- Social Security
- State taxes
- Local taxes
- Medicare
- 401(k) contributions
- Workers' compensation contribution
- Other benefits
Since the rate by which you must multiply your employees' paychecks for each of these deductions and allowances varies by category and employee, this step can be quite time-consuming – potentially on the order of hours – if done by hand. However, if you’ve stored and meticulously organized all your information in a spreadsheet, it takes mere minutes.
Step 6: Calculate net pay and pay your employees.
After tallying the deductions, allowances, and other taxes, subtract what's being withheld from each employee's gross pay. The resulting number is net pay.
Gross pay – deductions = net pay
Net pay is what each employee is paid at the end of each pay period. This is also known as take-home pay. Create a pay stub for each employee and track what you're withholding. Tracking payment and maintaining the right records benefits your business in the long run. It also helps you keep track of how an employee is progressing at your company.
Once you've calculated net pay for each employee, pay each one by their preferred payment method, if you can.
Payroll is a big expense for businesses, and while using a payroll solution costs money, it can cut down on the time required to handle all these steps. It also means that your employees can receive their paychecks in various forms, including checks, direct deposits, and payroll cards.
As the prominence of payroll solutions suggests, calculating net pay – like determining deductions and allowances – can take hours by hand. Even if you can quickly determine net pay using a spreadsheet, delivering your payments to your employees without an automated system in place can likewise take hours.
Step 7: Keep payroll records and adjust to fix mistakes.
Maintaining honest and organized payroll records is essential. You want to be able to reference your records if there's ever a discrepancy between an employee's net pay and what they expected to receive. It's also important from a tax perspective to have these records on hand, in case you have to work with the IRS. Mistakes happen, and as long as you correct them quickly and honestly, you'll recover quickly.
Recordkeeping is also essential for payroll taxes you have to pay out on a regular basis. Most electronic methods of gross pay, deduction, and net pay calculation generate automatic records as long as you upload the files you used to cloud storage. Make sure to save a separate copy of any spreadsheets you used after executing your payroll.
For paper calculations and paychecks delivered by postal mail, you'll need to keep written, tangible ledgers and mailing receipts. While each of these steps can take mere seconds, the time adds up when you handle these processes for several employees.
Step 8: Withhold, report and pay payroll taxes.
Part of processing your own payroll is calculating the payroll taxes that you have to withhold from employee paychecks. This includes income taxes, Social Security, and Medicare taxes. Your business may also need to pay federal unemployment tax (FUTA), state unemployment tax (SUTA), state unemployment insurance (SUI), and Federal Insurance Contributions Act (FICA) taxes without deducting these funds from your employees' paychecks.
These are all important aspects of payroll. Luckily, there are online calculators that let you crunch FUTA, FICA, SUTA, and SUI numbers. Find out when you have to issue payroll tax payments in adherence with your state laws. Also, you must report new hires to the IRS and file your federal business taxes on a quarterly and annual basis. These steps, combined with the calculations involved in withholding, reporting, and paying payroll taxes, can take several hours per pay cycle, especially when the process isn't automated.
Why do you need a payroll system?
The most obvious reason is that you need to pay people who work for your company. It's easy to pay employees once a job is complete, but having a proper system in place mitigates risk and vastly improves your business operations.
It may sound counterintuitive, but payroll systems aren't just about paying employees. Payroll processing is a detailed documentation system that tracks who is working for your company, how long they've worked for you, and how much money you're spending on labor. Terms like "payroll processing" and "payroll system" can make this sound complicated, but it's quite simple.
If you work with a payroll provider, your "system" is automatically set up through the company. If you're on your own, you'll have to set up your own system. The point of this system is documentation.
Here's a list of things your payroll system should do:
- Track employee hours
- Track employee wages
- Track deductions and other withholdings
- Keep tax documents organized
- Track direct deposits and payments
How to create your own payroll system
Before we dive into how to do payroll yourself, it's important to review the overall process. Creating a payroll system with steps to follow is all about organization and planning. Once your system is set up, information and documentation will flow through it, and you'll be able to report on important business aspects.
Follow these steps as you plan your payroll system and decide how to structure employee payments:
- Gather the preliminary information you need to process payroll.
- Find your EIN through the IRS.
- Establish state and local tax ID numbers.
- Collect employee financial information like W-4 and 1099 forms.
- Set up a payroll schedule.
- Choose a weekly, biweekly, semiweekly or monthly payroll system.
- Establish payroll tax payment dates.
- Manually process payroll.
- Calculate employee hourly schedules and overtime pay.
- Calculate gross pay for each employee.
- Determine deductions and subtract from gross pay.
- Calculate net pay and issue payment.
- Complete these follow-up tasks after each pay period:
- Keep and document payroll records.
- Report new hires to the IRS.
- Stay up to date on any miscalculations or mistakes, which should be documented and eventually reported to the IRS.
This is a general road map that encapsulates how to both set up your payroll system and process payroll. If you've created a system that addresses all these needs in an organized fashion, you're on your way to successful payroll.
Payroll checklist: What you need to process payroll
With a road map to follow and an overview of the important steps involved, it's also important to understand exactly what payroll forms you need from each employee. Payroll is complicated, and it's easy to get lost in the details of how everything works. Use the checklist below as an overview of the information you should gather before you process each pay period's payroll.
Tax information
- Employer identification number
- State tax ID information
- I-9 for each employee
- W-4 for each employee
- 1099 for each contractor or freelancer (if applicable)
Employee information
- Hours worked
- Hourly wage
- Overtime hours worked
- Preferred payment delivery method (if applicable)
Recordkeeping system
- Reliable storage for pay stubs and tax information
How to do payroll in Excel
Processing payroll in Excel may take some time, depending on your knowledge of payroll and your familiarity with the software. Many small business owners use Excel to track budgets and other financial information, and it's a useful tool for processing payroll as well.
Follow these steps to do payroll in Excel:
- Download Microsoft's payroll calculator template. This template, which is free from Microsoft, has everything you need to process payroll. You may need to add or delete columns or edit column names to customize the template.
- Enter employee details under the "employee information" tab on the bottom left of the worksheet. This tab asks for information like an employee's hourly wage, tax status, federal allowances (from W-4), state tax, federal income tax, Social Security tax, Medicare tax, insurance deductions, and paid time off. You can easily add all the information in one place, and the math is set up automatically in Excel.
- Move over to the "payroll calculator" tab once you have all your employees' information in the spreadsheet. Here, you can enter all the hours worked in the specific pay period, including regular hours, vacation hours, sick hours, overtime hours, and overtime wages. As you type in the information, Excel automatically calculates your employee's net pay. This takes all the major legwork out of calculating payroll.
- Once it's "processed," create individual pay stubs using the next tab of the paysheet. Pay stubs allow you to track how much each employee is paid each pay period.
How to set up payroll in QuickBooks
QuickBooks provides a full payroll suite that you can add to your services. Should you add this aspect to your QuickBooks accounting program, you can follow these easy steps to process payroll in QuickBooks and manage your financial information in one place.
Step 1: Gather all the information you need before starting to work with QuickBooks.
You should have access to the following:
- Employees' individual details
- Employees' pay rates
- Any payroll deductions
- W-4 forms
- Completed direct deposit authorization forms and voided checks
- Bank account login ID and password for your business
- Basic business information
Step 2: Take your time setting up QuickBooks.
Depending on the number of employees you have, setting up payroll for the first time in QuickBooks can be time-consuming. Try to set aside enough time so the initial process is not rushed and to minimize mistakes.
If you haven't signed up for QuickBooks Payroll, you will need to do that before continuing. You can sign up from your current QuickBooks dashboard. Choose a plan based on your business's needs. You can set up payroll for employees, contractors or workers' comp.
Step 3: Answer QuickBooks' questions.
QuickBooks will ask for information about your business payroll, including pay structures, payday schedules, and company locations.
Step 4: Add employees' information.
Enter the identifying information, pay schedule, pay rate, deductions, withholdings, and payment details (e.g., bank account data for direct deposit) for each employee. If an employee is already in the system, you can double-check that their information is up to date and add any direct change requests.
Step 5: Add a workers' comp policy to your QuickBooks account.
If you don't have a workers' comp policy, QuickBooks can help you find one, or you can choose to add one at a later date.
Step 6: Set up payroll taxes.
You will need your business information (such as your federal EIN, state account numbers and withholding numbers) to complete this section. You can skip this section if you don't have all the required information, but you will need to fill it out later to ensure accurate tax filing.
Step 7: Add a bank account.
If you are offering your employees a direct deposit payment option, you will need to link your bank account with QuickBooks. It will request standard information such as your business's name, type, email and physical address, phone number, industry, and principal officer's name.
Step 8: Pre-sign tax forms.
If you have the time, QuickBooks gives you the option to pre-sign your tax forms. Signing tax forms early can save you valuable time during tax season.
The benefit of using QuickBooks for payroll is that you won't have to add this information again later. You can run payroll each pay period, and the software stores your information for future use. QuickBooks also keeps your place if you need to set up payroll in more than one sitting, and a QuickBooks assistant can answer any questions you have along the way.
Alternatives to processing payroll yourself
Choosing a payroll provider
Even if your company is small, processing payroll can be challenging. It takes time to gather employees' information, calculate each employee's gross and net pay, and ensure you're withholding the right amount for state and federal taxes each pay period. It also takes a lot of time and effort to track payroll records in an organized and efficient way.
If you're a small business owner with several employees, it may be best to invest in a payroll provider that can help you manage this whole process. Payroll providers take the legwork out of paying your employees. Many also have employee access portals, so your workers can log in to view their pay stubs, track their deductions, and make tax adjustments when necessary.
Processing payroll manually may make sense if you have a very small business with only a few employees and feel confident in your ability to calculate pay, deductions, and allowances correctly. If you run a rapidly growing and dynamic small business, it's likely best to partner with a payroll provider such as Gusto or ADP. Most companies either charge a monthly fee or take a small percentage of your total payroll. If you are looking for flexible payroll options, read our review of OnPay.
Hiring an accountant to manage payroll
Whether you run a large or small business, keeping track of your payroll can be tedious and overwhelming. Hiring a professional accountant may seem out of reach, but the costs could be worth the return.
An accountant not only keeps your books up to date, but can also manage your tax deadlines and compliance responsibilities – and an accountant who specializes in payroll can minimize costly errors. Plus, having an accountant in place as you scale can add value to your company culture, help you exceed industry standards, and help you achieve your overall goals.
Max Freedman and Julie Thompson contributed to the writing and research in this article.