Learning how to do payroll for your small business is essential for hiring new workers. Hiring and paying employees is regulated by federal and state laws, so you must determine which laws are applicable to your business. You’re responsible for submitting tax and hiring documents in addition to paying taxes and wages on time.
You can opt to do payroll manually, but software, like Gusto, our recommended payroll software for small businesses, can help automate the process. New employees can complete all new hire paperwork online and store the documents in the cloud. You can automate payroll with a few clicks, and Gusto will take full responsibility for ensuring payroll taxes are paid on time. To see how it works, you can sign up to start paying your employees free for 30 days.
Free Small Business Payroll Checklist
Here’s a checklist you can download to make sure that when you’re processing payroll, you don’t forget steps like collecting employee documents, paying taxes, or processing employee paychecks, if you choose to do or calculate payroll manually. This checklist will also be helpful if you use payroll software to do payroll. If you’re only processing payroll for yourself, your payroll options will be limited based on your business’ structure.
Steps for How to Do Small Business Payroll
You must first establish your business before you can hire and pay employees. To do so, it must abide by federal labor laws, adhere to state requirements, and set up accounts to remit payroll taxes on behalf of your business and employees (there are some industry-specific payroll rules you may have to follow as well).
The following six steps will take you through the components of an effective payroll process and help you grasp exactly what payroll is all about. The first step is only required once for each employee. It allows you to set the employee up in your payroll system. If you’re doing payroll for existing employees and already have their data in your files, skip ahead to Step 2.
1. Collect Your Employee’s Documents
Once your employee is ready to start work, you need to collect some important payroll documents. These include tax and work authorization forms, which the employee needs to sign.
The forms change slightly depending on whether you’re hiring employees versus independent contract workers.
You’ll use the data on the payroll forms described below to add the employee to your human resource (HR) or payroll system, if you have one. And, it’s a good idea to store this information in a paper or electronic personnel file as well.
A W-4 form is the federal tax withholding document that tells you what tax rate to use for the employee. Collect a signed federal W-4 form for tax withholding. You don’t have to submit it to the IRS, but you should store it in a paper file or electronically in a personnel file (like Gusto provides).
State W-4 (or equivalent)
The state tax withholding document is similar to the federal and may be called by a different name in your state. Collect a signed state W-4 form for tax withholding (only in states that charge state income taxes) and store it in a paper personnel file or electronically.
Collect a signed I-9 Form for work eligibility verification (within three days of the employee’s start date). You’ll want to make sure the employee can verify their identity and eligibility to work in the United States with a passport or two forms of identification.
Direct Deposit Forms
Collect direct deposit information from the employee from a voided check (if applicable). You’ll need written proof that the employee consented to you depositing their paychecks into their bank account.
2. Calculate Hours Worked
Calculating hours worked is as simple as having the employee write down their start and end times each day and counting up the hours. Time taken for lunch is not counted in the total.
Most businesses start out with a simple time sheet. As they grow, they often move up to a time and attendance system to manage employee schedules, break time, and hours worked. Many of the most popular systems integrate with the some of the best payroll services, or you can use Excel for payroll if you opt to handle it yourself.
Straight time is the hours worked up to 40 hours a week (in most states). These hours are to be paid at the employee’s regular hourly pay rate, which can’t be less than minimum wage.
Overtime is calculated in most states as any hours worked over 40 in a week. However, in California, it’s calculated as any hours over eight worked in one day. Overtime rules can also vary by industry, such as home healthcare.
Salaried employees may be paid a fixed salary based on standard hours (such as 30, 35, or 40) or a weekly pay rate, regardless of the actual hours worked. You may not need to track their hours.
For easy-to-use time and attendance software that manages state overtime rules and also allows you to schedule your employees, consider using Homebase. It’s free, and it integrates with payroll software like Gusto, or accounting systems like QuickBooks, to streamline your timekeeping.
3. Calculate Gross Pay
Calculating gross pay is as simple as adding up the straight-time hours and multiplying by the employee’s hourly rate. Then, add up the overtime hours worked in the pay period and apply the employee’s overtime pay rate to those hours. Straight time is paid at the employee’s regular pay rate, while overtime is calculated at 1.5 times the regular rate of pay.
The results are added together to determine the employee’s gross pay.
Example: Sam is a laborer who is paid $12 per hour. Last week, he worked 44 hours.
- 40 hours of straight time are paid at $12 per hour. That totals $480.
- Four hours are paid at 1.5 times that, or $18 per hour. That totals $72.
- $480 (straight-time pay) + $72 (overtime pay) = $552 (gross pay)
You can create a payroll spreadsheet in Excel to do this manually. Of course, you’ll need to know how to convert minutes for payroll to ensure your results are accurate, or you can use free time card software like Homebase to do the calculations for you.
4. Process Deductions
Doing payroll requires you know in advance what payroll deductions you’re going to make. Deductions include federal and state payroll taxes, benefits you might offer, and things like unemployment insurance or Social Security.
Here’s a list of potential deductions with links to more information, such as how to determine what to deduct for each employee. If you use payroll software like Gusto, deductions are processed automatically.
- Social Security and Medicare (FICA)
- Federal unemployment tax (FUTA)
- Deductions based on benefits you offer employees, like health insurance
- Tax deductions based on employee tips
- Miscellaneous deductions, such as a uniform expense
To process those deductions, add up all the deductions for each employee to get a total. Then, subtract that total from the employee’s gross pay. Alternatively, you can list each deduction as a line item and subtract them one by one from the employee’s gross pay until you come up with a net pay amount.
Example: Sam has deductions taken out of his gross pay of $552:
- Federal income tax: $25.02
- Social Security tax: $34.22
- Medicare tax: $8.00
- State income tax: $9.94
- Total deductions: $77.18
$552 (gross pay) minus $77.18 (deductions) = $474.82 (net pay).
Free payroll calculators let you input deductions as a separate line item, so you don’t have to do the math yourself. This saves you time and helps prevent you from making calculation errors you’d have to correct in the future.
Most likely, you’re going to want to record employee deductions and payments by account within your general ledger accounting system. For example, there’s an add-on fee if you want to run payroll if you’re using QuickBooks for accounting.
Or, you may want to hire an outside bookkeeper to manage these details for you. They will manage your payroll accounting needs in addition to your payroll process, sometimes outsourcing the basic tasks to save time.
5. Provide Net Pay
Once you have subtracted deductions from the gross pay, you’ll have the net pay amount for each employee and be ready to pay them. The total is what each employee will receive in their check.
At this point, you have a few options. You can write checks manually using payroll checks that you can order, or you can print payroll checks and pay stubs by entering the data into a template. Either way, it’s a lot of manual work.
The other thing you can do is provide employees with direct deposit or a paycard. Those options require you to upload data to your bank and set up (or obtain account information) for each employee. In the long run, this saves time.
You’ll also need to determine whether you have enough funds in your payroll bank account. Banks charge insufficient funds (NSF) fees when customers initiate transactions they don’t have money to complete.
Payroll software like Gusto can set up direct deposit for your employees. In addition, it provides them with a self-service option, so they can see their pay stub online or via their mobile phone once payroll is processed. That saves you from having to give them copies of their pay stubs or year-end tax forms. They can use the mobile-optimized, self-service option to download these documents themselves.
6. Document & Store Your Payroll Records
To remain compliant with federal labor laws, you’ll need to document specific data each pay period. Retain payroll documents like time cards, pay stubs, and any information regarding pay increases.
If you’re using software like Gusto, the documents are already online or can be uploaded and attached to the employee record. If you’re maintaining documents manually, you’ll want to ensure they’re stored securely.
Payroll documents contain confidential information such as employee Social Security numbers. Alternatively, you can set up paper files, or upload documents to your network.
Compliance Requirements to Consider When Doing Payroll
In addition to following the steps required to do payroll, you also have to comply with payroll laws, both federal and state. For example, most states require you to report your new hires, and federal law regulates how you treat and pay your employees.
New Hire Reporting
Register your employee in your state’s New Hire Reporting Program (within 20 days). A new requirement since 1996, you will want to make sure that you report all new or rehired employees to your state. Payroll software programs like Gusto often file these reports automatically.
Important Note About Workplace Compliance
This is a good time to make sure that your taxes and insurance are set up and that you’re compliant with labor laws, such as break-time rules and overtime. You’ll also want to put up any required posters.
Verify that you have:
- Federal and state notices and posters put up around the workplace (if you have a physical space)
- Registered for state taxes—states mandate payroll taxes, and you will need to pay these on behalf of your employee
- Obtained workers’ compensation insurance (required in most states); this is required of employers to protect employees from injuries sustained on the job
If you need help with HR and compliance in addition to or instead of payroll, consider Zenefits. It’s a great solution for managing, onboarding, HR management, and streamlining simple HR tasks. You can also opt in to using its payroll services, if needed, as an add-on.
How to Do Small Business Payroll Using Software
Next, we’ll show you how to set up payroll, using Gusto as an example. To follow along, you can sign up for a free one-month trial at Gusto. Afterwards, the cost is $39 per month plus $6 per employee. So for five employees, it would cost only $69 per month. You can estimate your price using their cost estimator.
Note that these activities will include inputting your business Employer Identification Number (EIN), tax information, and bank account details as part of the setup. The setup of an online payroll system need be done only one time. After that, you can use the payroll software to do your payroll. Here’s how.
Start With a Free Trial
Once you sign up for a Gusto account, you’ll be asked to add some basic company information, including your business address(es). This helps Gusto determine what specific forms you need for your state. If you have only one location, this will be easy.
If you have trouble at any point in time, you can chat with a Gusto support representative. Just click the green question mark icon on the bottom-right corner of the screen when you are on their website and a chat window will open on the right side.
You can also call their support team, or schedule a call for a future date and time if you have a tight schedule but still need to learn how to do payroll.
Provide the Software With Your Business Tax Information
What’s great about payroll software is you don’t need to know much about the tax rates. You add your physical business address and a few other details. Then, the system references the appropriate tax tables.
For example, you’ll input federal and state tax information (if required), like your federal deposit schedule and your company type, such as limited liability company (LLC), S corporation (S-corp), and so forth.
If you’re unsure about any of these, Gusto will give you advice on the right side of the menu. They can even help you get an Employer Identification Number (EIN), if you do not have an EIN or taxpayer identification number (TIN) already. Gusto will link you to the IRS page where you can apply online.
You’ll likely need to enter a State Employer ID number and a State Unemployment Tax (SUTA) rate. As with the previous menu, Gusto will give you suggestions on what to enter and provide links to agencies, where needed. Here’s what one of the tax setup pages looks like.
Add Your Bank Account
Next, you’ll link your business bank account with Gusto. This is required so that Gusto can pay employees from your business payroll checking account and pay state and federal payroll taxes on your behalf.
Enter your bank account and routing number. Gusto will make two small bank deposits (that will appear in a day or so) that you’ll enter into the system later on to verify your account.
Choose Your Pay Period
Now it’s time to answer some specific questions on how you’ll be running payroll:
- How frequently will you pay your employees?
- When (day of the week or month) is your business’ payday?
- When will you run the first payroll?
- What work period will that first payroll cover?
Example: Weekly Payroll Paid One-week in Arrears
If your pay period runs from Sunday night at midnight to the next Sunday, you may want to pay one week in arrears starting each Friday. You’ll collect hours for the prior week and pay employees on Friday for the prior work week.
If you’re not sure how to answer these questions, read our article on the what and when of payroll processing.
Purchase Workers’ Compensation Insurance
If you’re hiring your very first employee, there’s a good chance you also need to buy workers’ compensation insurance. Most states require it as soon as you add your first employee; coverage usually needs to start on your employee’s first day.
Fortunately, you can sign up for workers’ comp insurance directly through Gusto. There’s no additional cost (besides the cost of insurance), and premiums will automatically be calculated and deducted each month from your business bank account.
To sign up, go to the “Stay Compliant” tab, then click “I Need A New Policy.” From there, you’ll fill out some details about your business and employees to generate quotes. Their partner, AP Intego, should find several different offers in your area for you.
Add Benefits (Optional)
Gusto also lets you offer certain benefits to your employees. You can sign up to offer health insurance, retirement plans, transportation benefits, charity matching, and more. As with workers’ comp, payments for these are automatically calculated and deducted each pay cycle.
Sign Company Forms
With federal and state tax forms submitted and your pay schedule set up, you’re just about ready to do payroll. Before you can do so, however, there are two forms you’ll need to sign:
Company Direct Deposit Authorization
This gives Gusto approval to transfer money in and out of your bank account in order to pay employees and payroll taxes. Employees can register for direct deposit on their side of the process when they set up their profiles in Gusto. We recommend requiring direct deposit for all employees in order to avoid the hassles of paper checks and reliance on snail mail.
Reporting Agent Authorization
This gives Gusto the authority to pay payroll taxes on your behalf.
To sign the forms, add yourself as the company signatory. The signatory is the person at your business who has the authority to approve these forms, as well as future documents sent to the government (like payroll tax forms). Once entered, you can sign the forms electronically.
Gusto will notify you via email of any forms that need signing. Likewise, you can add your e-signature with a single click.
Once your software is set up, adding employees and paying them is similar to what we provided in the How to Do Payroll checklist above. However, the software will automate and even consolidate some of these steps by doing calculations for you and managing data electronically.
Add Employees to the Software
Similar to adding your business information above, you’ll gather the employee’s information and add them to the system. You’ll start with some basic information, including their name, address, email, hire date, and salary or wage. If you are switching from a manual system to an online system, you may have to add several employees at once.
The next step is to enter personal details, like Social Security number (SSN) and birth date, as well as tax withholding preferences. The employee should have indicated their tax withholding preferences on their W-4 form.
However, for new hires, we recommend using Gusto’s handy “employee self-onboarding” option. By selecting this option, employees will receive an email with a link to create their profiles and enter withholding and direct deposit information themselves. This is useful if you don’t have employees’ birthdays, tax forms, or Social Security numbers (SSNs) on hand.
At this stage, you can automatically file a New Hire Report. This is a notice you must send to your state office within 20 days of hiring a new employee. By selecting the option below, Gusto will automatically file the report with your proper state agency.
Once each employee is added, Gusto will automatically fill out federal and state W-4 forms. Then, Gusto will notify employees via email of any forms that need signing. Likewise, they can e-sign the documents directly through the system, where they’re filed as well. Or, you can print them to have employees sign a paper copy. (W-4 forms do not have to be sent to the IRS.)
Input the Hours the Employee Worked
You will have two options to enter the hours the employee worked. You can manually enter the hours each pay period based on the employee’s time card, or you can use a timekeeping system, like Homebase. Simply import the hours worked from the time and attendance system into Gusto.
Gusto interfaces with several of the top time tracking software systems. We recommend Homebase because it’s free for small businesses and provides timekeeping as well as employee scheduling and messaging—all in a mobile app.
Using software, this run payroll task replaces Steps 3, 4, and 5 of the manual process above. Instead of manually calculating the employee’s hours, overtime, and deductions, the software will do it for you. It will then provide you an estimate of the employee’s gross and net pay. You’ll also be able to see exactly how much money you’ll need in your payroll bank account to pay employees, giving you time to deposit money into that account.
When you run payroll in Gusto, it lets you verify that you’ve input data correctly, haven’t forgotten anything (like bonuses, tips, or uniform deductions), and haven’t made any major mistakes (such as keying in an extra zero).
Here’s what it looks like to run payroll with Gusto:
Running Payroll on a Regular Cycle
Once you have gone through all of the payroll setup steps, whether it’s with Gusto, another payroll provider, or manually, the next step is to start using the program as it’s intended—for running payroll automatically.
Most payroll software, including Gusto, have an option for “auto-pilot.” This means that every month, week, or two weeks, or whatever payroll schedule you set, it will automatically run payroll and distribute payments via direct deposit or print checks.
If you need to make adjustments, however, like adding hours, bonuses, commission, or sick days, you can do this very easily from the payroll menu. Most payroll software systems have an automated email reminding you of the adjustment deadline.
Employees Receive Their Pay via Direct Deposit
This step replaces Steps 5 and 6 in the manual process above because you no longer have to write out or print paychecks (unless you want to). Your employees will receive their pay by direct deposit instead. Because Gusto provides employee self-service, your employees will be able to see their paycheck stub online.
Direct deposit saves you time and paper, and eliminates the risk of lost or damaged checks or employees having to leave work to run to the bank and deposit their paycheck.
In addition, all your payroll documentation, such as pay stubs, are online. There’s no need to maintain paper files.
Frequently Asked Questions (FAQs) About How to Do Payroll
Here are some questions small business owners may have about doing payroll.
What are the risks of doing payroll without software?
The biggest risk to your business is that you’ll make a mistake. Without a system to guide you, you may forget to pay taxes, collect deductions, or apply the correct overtime rate, as examples.
What are the most common mistakes made when doing payroll?
The most common mistakes are misclassifying employees and paying the wrong wages or taxes, according to software provider Patriot. To avoid these mistakes, we recommend you understand the difference between paying employees (W-2) and paying independent contractors (1099), as well as exempt vs non-exempt staff.
Using payroll software will also eliminate many common payroll mistakes, as they have federal and state labor laws and tax rates built into the software.
What happens if I make a mistake doing payroll?
The good news is that if you make a mistake in good faith, you can notify the employee and fix the mistake with no ramifications by providing retroactive pay. However, that doesn’t allow you to willingly violate labor practices, such as minimum wage (or tipped minimum wage), overtime, or sick time pay. Those kinds of mistakes can cost big fines if you’re audited. Do educate yourself on labor laws and workplace requirements in your state and location to avoid as many mistakes as possible.
Learning how to do payroll can be a pain. You have to make sure your business is registered with all the right agencies, fill out forms for each employee, and often purchase workers’ compensation coverage—all on a tight deadline (less than 20 days for most states by law). Even a seasoned business owner can get overwhelmed when they want to learn how to do payroll.
For most small business owners, we recommend using Gusto instead of trying to do payroll yourself. It not only makes employee onboarding much faster, but you have a huge burden lifted off your shoulders when it comes to calculating payroll taxes and sending them to the government, purchasing workers’ compensation insurance, and more. Sign up for a free 30-day trial today.