Run payroll for your employees
Getting payroll right is essential. Paying your employees on time and at the agreed rate is important to maintaining a productive relationship. It’s also a legal requirement. Let’s take a look at the payroll process.
First, what is payroll?
Payroll is a list of your employees and the total amount of money you pay them. It includes salaries or wages, bonuses, allowances, and benefits. Deductions such as tax are also part of payroll.
Four ways to run payroll for employees
Running payroll for employees can take on different forms, with each having its pros and cons. Here are four ways to run payroll for employees:
- Spreadsheets or pen and paper
A lot of small businesses with less than five employees run payroll on a simple spreadsheet or pen and paper. It’s free, but it will start to cost a lot of your time as you hire more people. You’ll also have to stay on top of tax laws to avoid making mistakes or getting in trouble with the tax office.
- Outsource to a specialist
You can get a payroll expert to do the work. They know the ins and outs of tax and will help you stay compliant. Using a consultant will cost you money, and you’ll need to communicate regularly about staff changes, but a lot of employers are happy to pay for peace of mind.
- DIY software
Many software packages can do the math and some of the admin work for you. For example, they’ll work out the pay you owe and the deductions needed, create pay stubs, and fill out tax forms automatically. But it’s up to you to make the actual payments.
- Full-service software
You can sign up to systems that do everything DIY software does – plus make payments. You’ll still have to set up employees in the system and update their details if circumstances change, but most of the rest is taken care of.
A good payroll system simplifies the complexities, helps you avoid mistakes that may lead to costly penalties, and does all the heavy lifting for you so you can focus on other parts of your business. Choose a payroll method that’s best for you and suits your business needs.
Check out our guides How payroll accounting software benefits your office and Small business payroll: To outsource or not?
How to run payroll – from start to finish
With quite a few steps along the way, the payroll process can get complicated. We’ll take you through it step by step so you can process payroll properly.
1. Prepare for payroll
You may want to set up a payroll bank account to keep your business transactions separate from your payroll transactions. Your payroll bank account will be used to pay your employees and hold funds for taxes, deductions, and other payroll-related items. You might need to set up a direct deposit with your bank for paying employees into their bank accounts (if this is the method of payment you agreed on).
You’ll also need to lodge some paperwork before paying a new employee. See the chapter on employee onboarding for more information on this. And check out our guide on setting up online payroll with your bank.
2. Calculate employee pay
You’ll need to calculate the gross pay for each of your employees. Gross pay is the total amount you owe an employee for the pay period based on the terms of their offer. It also includes overtime pay and pay for work done during public holidays. Employees don’t take home their gross pay – you’ll make deductions before they’re paid. Good payroll software can do this automatically. It will even handle leave requests and timesheets if you have hourly workers.
3. Calculate pre-tax deductions
Payroll deductions are amounts taken from an employee’s pay. Some are legally required, while others are voluntary. If you make a deduction, you’re responsible for sending that money to the right place – be it a government agency or a retirement fund. Some deductions are made before tax is taken out of your employee’s pay, while others come after.
Pre-tax deductions include:
If you offer a health plan to your employees, you can generally make your contributions before tax. Your contribution will be based on what the health insurance plan specifies.
If you offer a retirement plan, generally the money is not considered taxable for income tax at the time of contribution. Deduct the contribution based on what your retirement plan specifies and the contribution limit set by the IRS. Learn more on the IRS pages on small business retirement plan resources and retirement plan contributions.
4. Calculate employee-related taxes
Each payday, you need to deduct taxes from your employees’ earnings and work out what payroll taxes you owe as an employer. You may need to hold on to these withheld taxes for a while before passing them on to the government. It’s a good idea to set up a special bank account for them.
Social security and Medicare
For most employees, you’ll need to deduct 6.2% of their pay for social security and another 1.45% for Medicare. The rates may be different for highly-paid individuals. Check out the social security and Medicare taxes section of the IRS website. You’ll then need to make a matching payment to the IRS from your business expense account.
Federal income tax
This is what your employee is taxed on earnings. The IRS has an online withholding calculator to help you work out how much to deduct.
The employer must pay federal unemployment tax on the first $7,000 each employee earns for the year. The employee pays no part of this. You may also owe state unemployment taxes. If you pay those state taxes in full and on time, you get a discount on the federal rate. Check out what the IRS has to say on federal unemployment tax.
Most states also have their own payroll taxes, which employers must collect and hand over. Check with the state tax agency where your business is based, and where your employees live.
Taxes on benefits
Your employees are expected to pay tax on company benefits such as educational assistance, group term life insurance coverage, or personal use of a company car. Check out the IRS publication Employer's Tax Guide to Fringe Benefits.
5. Calculate post-tax deductions
Some deductions come out of an employee’s pay after tax, including:
Roth IRA or Roth 401(k) retirement contributions
employee-paid insurance contributions
Garnishments are legal documents served to employers to collect a debt owed by an employee. Common types of garnishments include child support and debt collection for things like car loans or privately funded student loans. Check out the Department of Labor page on garnishments.
6. Make payments to employees
Take out all taxes and deductions from your employees’ gross pay to get their net pay. Once you’ve calculated net pay, it’s time to pay them. Make payments based on the method of payment you’ve agreed on. Make sure to issue pay stubs to your employees. Their pay stubs will show their gross pay, along with all the deductions taken from it and the net pay they receive.
Good payroll software automatically looks after all the calculations for you, processes payments on time, and makes it easy for employees to view their pay stubs.
7. File and pay taxes, deductions, and contributions
Now that you’ve calculated all taxes, deductions, and contributions, it’s time to file and pay them. You need to do it on time to avoid paying any penalties or interest.
Internal Revenue Service (IRS)
Deposits are due according to your assigned deposit schedule (which can be twice a week, monthly, or quarterly) for:
employee social security tax, Medicare tax, and income tax
employer social security tax and Medicare tax
federal unemployment tax
You’ll also need to file federal tax forms, which may be due on a quarterly or yearly basis. For more information, start with the depositing taxes section of the IRS employer's tax guide.
State tax agencies
Check with your state tax agency to learn what’s due and when. Check both the filing and payment dates – they may be different.
8. Keep payroll records
You’ve finally reached the last step of the payroll process: record-keeping. You need to keep payroll records in case any questions (or government audits) come up. You’ll need to keep records in paper or electronic form for:
- salary or wages and time worked
- holidays and leave
- taxes and other deductions
- employer contributions
- when money was paid and where to for employee pay
You must keep these records for at least four years, even if your employee has left.
For more information, visit the record-keeping section of the IRS employer's tax guide.
Chapter 8: Manage employee evaluations
Employees help you grow your business but they need your support too. Here’s how to do employee evaluations so you can get the best out of your team.Read chapter 8