Paying employees fairly, legally and on time is an important part of running a business. But with taxes, tracking paperwork and setting a payroll schedule, it can be hard for busy small business owners to know where to begin. If your company grows and your number of employees increases, you’ll need to be familiar with the legal requirements around payroll, create a set schedule for paying employees and build a master plan for keeping employee and tax records.
Payroll is the process by which companies pay their employees’ wages. For many businesses with employees, payroll is their biggest expense. It can also be a complicated process to manage. You’ll need to track time, classify employees, collect employee health insurance premiums and retirement contributions and pay taxes, which requires careful planning and recordkeeping.
When it comes to payroll, there are three ways to approach it: handle it yourself, use a payroll service or hire an expert to do it for you. No matter which approach you take, it’s still your responsibility as the leader of the business to know basic payroll laws and requirements.
Know the requirements
Employees of a small business are covered by federal, state and, sometimes, local employment laws. The main federal law that affects payroll is the Fair Labor Standards Act (FLSA). Check with your local government for state and local laws that apply to your business. The FLSA outlines rules for:
- Current minimum wage and overtime laws
- Exempt and nonexempt employees
- Child labor laws
- Tipped wages
- Hours worked
- Travel time
- Waiting time
- On-call time
- Sleeping time
- Meeting and training time
- Permitted to work
For help understanding each of these criteria, check out the Fair Labor Standards Act Advisor. For a poster that lists FLSA minimum wage requirements, which employers are required to display in their place of business, visit the U.S. Department of Labor website.
Decide on paid holidays, vacation and sick time
As you approach setting a payroll schedule, you’ll also need to decide how many paid days off you want to offer your employees, if any. Although paying employees for days they haven’t worked isn’t required by federal law, it may be required by state and local governments, and offering this perk can help you stay competitive with other companies and attract better employees.
Holidays offered by many employers in the U.S. include:
- New Year’s Day
- Memorial Day
- Independence Day
- Labor Day
- Thanksgiving Day
- Christmas Day
Many businesses also offer paid or unpaid days off that employees can use for religious holidays, along with bereavement leave (time off work in the event an employee’s family member passes away).
On average, businesses offer full-time employees with one year of experience 10 days of vacation time per year, and those with five years of experience 15 days per year. You can decide whether you’d like your employees to finish a certain amount of time before tapping into this benefit. This could be a year of work or a probationary period (meaning an introductory period). Some business owners have employees earn paid time off each month (for example, 8 hours per month), which can be taken at any point after the time is earned.
Sick leave is not required by federal law, but many states and some cities require employers to meet certain criteria for the benefit. Even if your local laws don’t require you to provide it, giving employees paid time off for illness can help you stay competitive as an employer and may even save your business money. For instance, if a sick employee comes into work, he or she could make you or any other employees sick, costing you valuable resources over a longer period of time. If that person is serving your customers directly, he or she could also get your clientele sick, leading to unhappy clients.
Whatever leave you decide to offer, it’s wise to explain it clearly to new employees in writing, and to include it in your employee handbook if you have one.
Getting started with payroll
Between managing employee paperwork, collecting taxes and making payments to the state and federal entities, payroll can be an intimidating task. Here are some of the steps you can take to set up payroll for your business.
1. Set a pay schedule
This is the schedule that defines when you’ll pay employees for a particular amount of time worked. Most pay periods are weekly, bi-weekly or monthly. Decide what will work best for your business depending on whether you want the simplest option in terms of paperwork and calculations (weekly or monthly) or the one that most employees prefer (bi-weekly). Every state has unique pay schedule requirements, so be sure to check the laws in your state.
2. Classify employees
You’ll need to make sure your employees are classified correctly for their own benefit and for that of your business. These are the main categories of employees to know.
Non-Exempt: This is an hourly employee who must be paid at or above the required federal, and, where applicable, local minimum wage, plus overtime in accordance with federal and state regulations.
Exempt: This is a salaried employee who will not have some of the rights and protections given to non-exempt workers, like overtime. To be considered exempt, an employee must earn the minimum salary threshold established by state law (or the FLSA where there is no state law), receive a guaranteed salary and perform certain duties defined by state law or the FLSA.
For help determining whether an employee is non-exempt or exempt under federal law, visit the Department of Labor – Wage and Hour Division website.
To determine whether your state imposes additional standards, visit the website of your local department of labor. It’s also a good idea to consult with an attorney.
3. Learn the tax basics
Both employers and employees need to pay federal income taxes, along with state and local taxes in some areas. As an employer of exempt or non-exempt employees, you’ll be responsible for collecting and submitting federal income tax, Social Security and Medicare from employees’ paychecks based on the information they’ve completed in their W-4 form (a tax form all employees in the U.S. must complete). You’ll also pay taxes for Social Security, Medicare and unemployment insurance.
Healthcare fees and retirement contributions will also need to be taken out of your employees’ paychecks each pay period, depending on the benefits you provide and that your employees select.
Employers must submit federal tax filings to the IRS, state tax filings to their state agency and Forms W-3 and W-2 to the Social Security Administration (SSA).
For more details on federal employment taxes, visit the IRS website. It’s also a smart idea to check with an accountant or tax advisor as you begin hiring employees, just to make sure you’re handling payroll taxes correctly.
4. Plan out timekeeping
As an employer, you’ll need to keep track of how many hours your employees work. Most businesses have non-exempt employees record their own time, with the owner approving those hours each pay period. Many businesses also track the time worked for exempt employees for a myriad of reasons, including easier payroll administration and benefits management. There are countless software options you can use to help.
5. Keep records for each employee
Anytime you welcome a new employee into your business, you should create a folder with the following pieces of information. This is required by federal law and can also make the payroll process easier. Required information includes:
- Employee’s full name and Social Security Number
- Address, including zip code
- Birth date, if younger than 19
- Sex and occupation
- Time and day of the week when employee's work week begins
- Hours worked each day
- Total hours worked each work week
- Basis on which employee's wages are paid (per hour, per week, by project, etc.)
- Regular hourly pay rate
- Total daily or weekly earnings
- Total overtime earnings for the work week
- All additions to or deductions from the employee's wages
- Total wages paid each pay period
- Date of payment and the pay period covered by the payment
You can view a list of the requirements here. Check out the website of your local department of labor to learn about state-specific recordkeeping requirements.
In addition to the required documents, maintain a record of the employee’s salary and benefits, and consider keeping reviews, accomplishments and other documentation in the folder, as well. To keep this process as simple as possible, you’ll need to set up a system for collecting and maintaining each piece of information, whether it’s a file folder, a digital folder or both.
You’ve learned the basics about payroll. Now it’s time to decide whether you’ll be handling the process yourself, using a payroll service or hiring an accountant to help you. Here are some of the benefits, drawbacks and steps involved with each option.
1. Do it yourself
This option is the lowest in cost, but also the most time consuming, especially if you have multiple employees or other complicating factors in play. It can also lead to more errors, which can cost you in the form of legal or tax penalties. If you do decide to handle payroll yourself, here are some basic steps you can follow to get your process in place.
Step 1: Have every new employee submit a W-4 form
Step 2: Request an Employer Identification Number if you don’t have one already
Step 3: Choose and begin executing your payroll schedule
Step 4: Calculate and withhold payment taxes
Step 5: Pay federal, state and local taxes
Step 6: File tax forms and employee W-2 forms
You may also want to choose payroll software to support you as you begin the process. For more on keeping great business records check out our recordkeeping tips here.
2. Use a payroll service
There are many payroll services available, usually at a cost of $1 to $15 per worker per pay period, depending on the services and features included. Some perks of this option are that you can spend less time on payroll and more time managing the business, and that you can get individualized payroll advice. The downside is that it will cost more than doing it yourself. Most services charge employers either by month or by payroll. Note that you’ll still need to have employees fill out W4s, keep employee records and track employees’ time worked. Here are a few things to think about when researching which service to use:
- Cost. Are there are a range of packages, and which one best fits your needs?
- Software used. If the solution is technology-based, does the software integrate well with the accounting software you use?
- Employee access. Many services allow employees to view their pay stubs and other information online.
- Support features. Do they offer 24/7 support, and is it by phone or online?
- Liability. Will they assume responsibility if there is a payroll error, or related tax issue?
3. Hire an expert
The most expensive option is also the one that will require the least time and headaches on your part. Generally, accounting services cost between $500 and $3,000 per month depending on the accountant’s experience; this fee generally covers accounting services and support beyond payroll. If you’re able to hire someone who you know is skilled at payroll, you may be able to get similar support for a lot less. One added benefit of using a payroll professional is that this person may also be able to help out with other areas of the business, like giving you advice on expense tracking, helping you open a business banking account and making sure your overall business accounting meets regulations. Using a professional can reduce your liability, as well.
If you do decide to hire an accountant, here are a few tips for finding the perfect fit:
- Consider looking for a certified or chartered accountant. Although more expensive, this professional will be more highly qualified and will have degree-level training, meaning their services and advice are likely to be more accurate and can potentially save you more money in the long run.
- Ask about relevant expertise. Does the person have experience handling accounting for businesses of the same size and in the same region as yours? You can ask for a client list to see which businesses they’ve helped at a glance.
- Check their software experience. Are they familiar with the technologies you already use in your business?
- Interview them carefully. Because this person will be handling sensitive financial and employee information for your business, you’ll want to be sure he or she is reliable, skilled and honest about their qualifications. After the interview, make sure to check references and even consider running a background check.
- Decide on virtual or local. Would you rather have someone you can meet with face-to-face, or are you comfortable communicating by email, phone and video call?
When it comes to planning and running payroll, knowledge is half the battle. Whether you handle the task yourself, delegate it to an employee or hire someone to manage it, it will take some work and planning to get off the ground. Just remember that keeping payroll information confidential is important, so only rely on trusted staff or professionals to handle the job. Once you have a good system in place, it’s likely to get easier with every pay period.