Managing payroll can end up being arduous for many small business owners. Cutting those paychecks — while staying in compliance with federal and state agencies — is a big responsibility to your employees, and to your company.
Payroll made simpler
October 18, 2023 | 5 minute read
Getting it right matters
With payroll tax withholdings being a major source of revenue collected by the IRS, the agency takes mistakes in this complex area seriously. Businesses that file late or withhold the wrong amount from employees’ paychecks are routinely charged penalties and/or interest — in some cases even if it was the result of an honest mistake.
Fortunately, getting payroll right can be easier than you might think. The keys are getting set up properly, staying organized and keeping your system as simple as possible. And if you don't have time to manage it all, there are many relatively inexpensive payroll service providers to help you.
By staying on top of payroll, you'll have critical records at your fingertips if you need to secure funding, such as a loan. And knowing exactly how much of your overall expenses is going toward payroll will also help keep your budget and spending on track.
Steps to streamline your payroll process
Set yourself up to succeed
Some business owners DIY their payroll taxes with the help of accounting software. If you want to try, start by setting up the accounts and following the IRS information about employment taxes.
However, it’s easy to make mistakes. For this reason, many small businesses hire bookkeepers or accountants to get them organized. Others may outsource the setup to payroll service providers like ADP®, QuickBooks® Online Payroll, Gusto, OnPay or Paychex. Some of these providers even allow you to pull critical data points into your online banking dashboard so you can keep up to date on information that matters for your business.
As part of the setup, you will need to establish tax accounts with the federal government and the governments of states where you have employees. Sometimes state governments will require you to set up more than one account, such as an income tax account and an unemployment tax account — to make it easier to stay organized and in compliance with their laws.
Paperwork is your friend
Stay on top of the paperwork you and your employees need to fill out. This includes having each employee complete a Form W-4, which helps determine how much federal income tax to withhold from that employee’s paycheck (similar forms are used for state tax purposes) and providing each employee a Form W-2, which is your annual report of wages paid and taxes withheld for that employee during the taxable year. (In the case of independent contractors, you may need to provide them with a Form 1099-NEC to report nonemployee compensation.)
You’ll also need to file forms on behalf of your business to state and federal governments to let them know how much in taxes you’ve withheld and remitted, and you’ll need to file annual federal and state income tax returns. You can find the forms you need on this list from the IRS and on each state treasurer’s website. Set up a filing system, whether it’s digital or paper — or both — so you’ll have the records handy if you need them.
Classify employees correctly
From the point of view of the taxing agencies, the fundamental question when it comes to paying employment taxes is whether a worker is an employee or an independent contractor (freelancer). You are responsible for withholding taxes from the paychecks of employees but not from the payments you make to independent contractors. A worker’s classification depends on multiple factors, so when in doubt, consult the IRS’s guidelines or a labor attorney.
Make sure to take care of both federal and state taxes. Federal taxes include federal income, Social Security, Medicare and unemployment tax. States may levy some taxes including state income tax and state unemployment tax.
Commit to being organized
If you have hourly employees, you’ll need a system for keeping track of hours worked. Some payroll providers allow employees to clock in through their systems, automating that part of the process. If you're manually entering information like hours worked or wage garnishments, develop a system to input the information regularly.
Watch those deadlines
All employers need to keep track of the deadlines for sending employees and independent contractors their annual earnings and tax summaries. Here’s a deadline guide from the IRS. Most payroll service providers will send you reminders of upcoming deadlines, trigger your payroll automatically and file your tax returns automatically, too.
Handling payroll usually isn't a small business owner's favorite task, but the more organized and methodical you are, the easier it will be — and the more time you'll be able to spend on the business activities you enjoy.
Glossary
Here is a quick summary of terms you need to know as an employer.
If a person is performing work integral to your company on a long-term basis — and if your company has significant control over how the job is done — that person is probably an employee.
A part-time employee usually works less than 30 hours a week; sometimes employers define part-time as anything less than 40 or 35 hours. How a part-time employee is defined is a matter generally left up to employers to decide, according to the U.S. Department of Labor.
Workers are generally considered independent contractors if the employer controls the results of their work but not how it’s done.
If an employer can clearly state the end date of a person’s engagement with the company, that person is probably a temporary employee.
A Form W-2 is a federally required annual wage and tax statement that summarizes an employee’s annual wages and taxes withheld from them.
This is a statement employees complete for their employers for the purposes of determining how much in federal income taxes should be withheld from an employee’s paycheck and remitted to the IRS.
A Form 1099-NEC is a federally required annual statement that reports nonemployee compensation payments made of at least $600.
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