How To Do Payroll: A Step-By-Step Guide
Whether manually or with the help of payroll software, you can easily calculate and process payroll yourself. We'll teach you both payroll methods with this simple step-by-step payroll guide.
Learning how to do payroll is an essential part of growing your business. Before you hire anyone, you need to have a firm grasp of payroll processing, how to pay employees and contractors, and how to handle payroll taxes.
Fortunately, learning how to do payroll is the same for manual payroll processing or using payroll software (although payroll software definitely makes the process easier).
Keep reading for a step-by-step breakdown of how to do payroll, including getting an EIN for your business, paying payroll taxes, and everything in between.
Table of Contents
What Is Payroll Processing?
Payroll processing is the method of paying employees and contractors, including managing payroll taxes, withholding, deductions, calculating pay, and keeping payroll records.
Payroll has an impact on your business’s finances (especially considering salary inflation), tax liabilities, and your employee management. Not only will you have to account for employee payments and payroll taxes in your business budget, but you’ll also need to ensure that your employees are compensated fairly, on time, and in accordance with the law.
How To Do Payroll In 16 Steps
To run payroll for your business, you’ll need to ensure that you have your tax documents and registrations handled, calculate employee pay, withholdings, and deductions, pay your employees, and make payroll tax payments.
Keep reading for a step-by-step breakdown of how to do payroll for your business.
1. Get An Employer Identification Number (EIN)
To run payroll, you’ll need to establish an Employer Identification Number (EIN) for your business as it is illegal to pay employees without an EIN.
An EIN, or business tax ID, is a nine-digit number used to identify your company for tax purposes at the federal and state levels. This number appears on your business’s tax forms and various business documents.
If your business has been paying employees already, you should already have an EIN. However, if your business is newly established or has yet to pay an employee, you’ll need to apply for one via the IRS.
You can get an EIN for your business by applying online, by fax, through the mail, or via phone call (if you’re an international applicant).
2. Register Your Business At The State & Local Levels
Depending on your business structure, you may need to register your business at the state level to ensure tax compliance. In general, businesses structured as a corporation, limited liability company (LLC), nonprofit, or partnership may need to be registered at the state level.
However, you’ll need to check in with your state’s tax agency and laws to determine whether you need to register your business.
3. Set Up A Business Bank Account
You need a business bank account before running payroll. While having a business bank account isn’t mandatory to run payroll, most businesses use a dedicated business bank account to handle all their business transactions, including payroll.
As many small business owners operate as sole proprietors before hiring their first employee, they can make the mistake of using their personal bank account for business expenses.
Not only does using a personal bank account for your business make it harder to support your business’s tax claims, but it also makes it more difficult to maintain a business budget when you’re using the account to cover personal tasks.
So, be sure to open and maintain a business bank account before running payroll. Just remember that most business bank account providers require applicants to provide an EIN to open an account. Fortunately, if you apply for an EIN online, you can use the number you get to open a business bank account immediately after applying.
4. Review Employee Tax Documents
An IRS Form I-9 is requisite for verifying the identity of your employees as well as their employment availability. Every new hire must fill out this form during the onboarding process.
Your employee fills in the first part and you fill in the second part. New employees must furnish you with a document of identity, which could be their passport, green card, birth certificate, social security card, or alien registration card.
Employees should fill out their own W-4s to document withholding tax (tax that the employer withholds from their salaries and pays to the government directly).
If your business will be paying contractors, you’ll need to request a completed W-9 form from each 1099 contractor you pay. These forms are filled out by the contractor and include all their relevant tax information. You’ll use the information on this form to provide them with Form 1099-NEC at the end of the tax year.
5. Review Employee Benefits & Deductions
Before you begin calculating payroll, you need to know which deductions to make from your employees’ pay.
Your employees’ responses on Form W-4 tell you whether they are exempt from payroll tax deductions. If an employee isn’t exempt from tax withholding, Form W-4 tells you how much you should deduct from their paychecks based on their filing status.
In addition to tax withholding, employees may be subject to voluntary tax deductions, including insurance premiums and retirement plan contributions, based on which employee benefits your business offers.
Involuntary deductions include court-ordered wage garnishments, which you will be informed of after hiring the employee or after the order has been made.
It’s important to have this information before running payroll, especially if you are doing payroll manually. You want to ensure that you’re making the right deductions for each employee.
6. Choose A Payroll Schedule
Businesses pay their employees weekly, bi-weekly, semi-monthly, or monthly. Each payroll schedule has its own benefits and drawbacks, and you have to choose the right pay schedule for your business.
That being said, choosing the right payroll schedule for your business depends on a multitude of factors, not least of which is your state’s payday laws. Nearly every state has a law on pay frequency, so it’s important to review your state’s payday laws before setting a pay schedule.
The Department of Labor maintains a helpful state payday law chart to help businesses stay compliant.
Another consideration for setting your business’s pay schedule is the industry standard.
Some industries have standard pay schedules. For example, the construction industry tends to pay its employees on a weekly schedule rather than the most popular semi-weekly pay schedule. If your business’s industry has a prevailing payroll schedule that adheres to state payday laws, it may be beneficial to implement that payroll schedule.
Keep in mind that not all employees are subject to payday laws. If you are paying a 1099 contractor versus a W-2 employee, you may not need to pay contractors on the same schedule that you pay your employees.
7. Choose Employee Payment Methods
Figuring out how to pay employees is just as important as deciding when you pay employees.
The most common method of payment in the US is direct deposit. However, some employees opt to receive their pay via paper check or cash (though, it’s inadvisable to pay employees in cash). Of course, there are other payment methods available, so you may need to do a bit of research to determine which is best for your business.
8. Calculate Employees’ Gross Pay
An employee’s gross pay is the total amount of money the employee earns before deductions, such as payroll taxes and insurance premium contributions. To calculate an employee’s gross pay, add up the employee’s hourly or salaried wages and any supplemental earnings.
Here’s a breakdown of all the earnings that may influence an employee’s gross wages:
- Hourly Employees: To calculate an hourly employee’s gross pay, multiply the hours they worked during the pay period by their hourly wage.
- Salaried Employees: Salaried employees earn a set annual wage regardless of hours worked. To calculate a salaried employee’s earnings, divide their annual pay by the number of pay periods in the year. For example, an employee paid twice a month would have their salary divided by 24 pay periods.
- Supplemental Earnings: Supplemental earnings include everything from overtime pay to bonus pay. These are the wages that your employee earns outside of their hourly or salaried wages. Supplemental earnings may be taxed such as bonuses are taxed at a different rate than standard earnings.
Once you’ve calculated your employee’s gross earnings, you can move onto the next step.
9. Calculate & Withhold Any Pre-Tax Deductions
Some employees may be subject to pre-tax deductions or deductions that must be made from an employee’s gross pre-tax income. Most commonly, pre-tax deductions include health insurance premiums, life insurance premiums, health savings accounts, transportation programs, and eligible retirement plan contributions.
If any of your employees are eligible for pre-tax deductions, you need to ensure that you withhold those deductions before you calculate and withhold any tax payments.
Withholding deductions just means that you reserve a portion of your employee’s pay to remit at a later date. You don’t have to do anything special when withholding payroll deductions — simply let your employee know how much was withheld for each payroll tax or deduction via their pay stub.
The reserved funds should be held in your business bank account (or another secure account) until it’s time to pay your business’s payroll taxes and make deduction payments.
10. Calculate Payroll Taxes & Withhold Them
To calculate payroll taxes, multiply your employee’s gross wages by the payroll tax rate. If your employee had pre-tax deductions withheld from their paychecks, their gross taxable wages should be calculated as their gross wages minus any pre-tax deductions.
Refer to IRS Form W-4 to determine the payroll taxes you are required to withhold from your employee’s earnings. In addition to federal payroll taxes, you may be required to withhold state or local taxes from your employee’s earnings. Here’s a look at the most common federal payroll taxes and their current rates:
- Medicare Taxes: Medicare taxes are taxed at a rate of 2.9% with employers and employees contributing 1.45% each. Employees grossing $200,000 or more will have an additional 0.9% withheld from their pay to cover the Additional Medicare tax.
- Social Security Taxes: Social Security taxes are taxed at a rate of 12.4% with employers and employees each contributing 6.2% of the employee’s gross wages. The Social Security tax wage limit is $160,200 in gross earnings. Once your employee has earned $160,200 in gross annual wages, you no longer have to withhold social security taxes from their wages.
- FUTA Taxes: Employees are not required to make FUTA contributions, but employers are required to pay 6% of the first $7,000 paid to employees annually. For any employees earning $7,000 or more annually, employers must pay $420 in FUTA contributions.
- Federal Income Tax: Non-exempt employees will need to have federal income taxes withheld from their paychecks. The federal income tax is a progressive tax, so income is taxed at different rates depending on the tax bracket your employee falls under. The current income tax rates range from 10% to 37% of an employee’s gross wages.
11. Calculate & Withhold State Payroll Taxes
In addition to federal payroll taxes, your business may be subject to state and local level payroll taxes, including:
- State unemployment insurance contributions
- State income taxes
- Local taxes
As each state and locality’s payroll taxes will differ, you’ll need to research your state’s payroll taxes. If you need help getting started, check out our state payroll tax guides:
- Arizona payroll taxes
- California payroll taxes
- Colorado payroll taxes
- Florida payroll taxes
- Maryland payroll taxes
- Massachusetts payroll taxes
- New York payroll taxes
- Oregon payroll taxes
- Texas payroll taxes
- Washington payroll taxes
12. Make Post-Tax Deductions
Outside of payroll taxes, employers are responsible for withholding employee earnings to cover deductions. Employee deductions can be voluntary or involuntary. Some voluntary post-tax deductions include Roth IRA contributions, disability insurance, and charitable contributions.
Involuntary contributions are called wage garnishments. An employee may have their wages garnished to cover child support payments, student loan payments, court-ordered settlements, and more. If your employee has been ordered to have their wages garnished, you’ll receive correspondence about it after completing your new-hire reporting.
You’ll also be responsible for withholding garnished wages and making garnishment payments to the appropriate agencies.
As with pre-tax deductions and payroll taxes, you’ll need to withhold funds for post-tax deductions and use the withheld funds to make payments on your employees’ behalf.
13. Calculate Net Pay & Pay Employees
Now, it’s time to calculate your employee’s net pay. An employee’s net pay or take-home is the amount they are paid after all payroll deductions are made. To calculate an employee’s net pay, subtract all deductions and payroll taxes from your employee’s gross pay.
Once you have calculated your employee’s net pay, you’re ready to pay them. Depending on whether you have set up direct deposit or paper check payments for your employees, you’ll need to complete payroll by the direct deposit or paycheck delivery deadline.
14. File & Pay Payroll Taxes
To pay payroll taxes, you’ll need to be familiar with payroll tax deadlines. In general, businesses must make federal payroll tax deposits on a monthly or semi-weekly basis depending on their reported taxes during the most recent lookback period.
At the time of writing, the lookback period for 2023 starts on July 1st, 2021, and ends on July 30th, 2022. Businesses that reported $50,000 or more in taxes during this period are required to make semi-weekly payroll tax deposits, while businesses that reported less than that amount will be on a monthly deposit schedule.
State payroll tax deadlines vary, so be sure to research your state’s payroll tax deadlines to avoid late payment penalties.
15. Make Payroll Deduction Payments
In addition to payroll taxes, you’ll need to make payments or contributions based on your employee deductions. For example, you may be required to make health insurance premium contributions on behalf of your employees.
Be sure to make these payments on time!
16. Maintain Payroll Records
Most businesses are legally required to maintain payroll records for a set period of time. Payroll records include any documents that show your business has been legally paying employees and contractors, including tax forms, bank statements, employee pay stubs, and more.
Be sure to update your business’s payroll records throughout the year on a regular basis to avoid scrambling to find them when filing your business taxes or during a tax audit. While it’s impossible to completely avoid a tax audit, having your payroll records handy will help the audit be settled more quickly.
How To Do Payroll Manually
To do payroll manually, you’ll need to complete the following steps:
- Get An EIN and register your business
- Review employee and contractor tax documents
- Choose your payroll schedule
- Calculate gross pay
- Subtract withholdings, deductions, and allowances
- Calculate net pay
- Pay your employees and contractors
- Keep payroll records
- File & pay payroll taxes
In addition to these steps, you must set up direct deposit or check printing for your employee payments, get comfortable using a calculator, and ensure that you have a way to securely store your business’s confidential payroll records.
How To Do Payroll Yourself With Payroll Software
To process payroll with payroll software, you’ll do the same steps as you would processing payroll manually, including getting an EIN for your business, calculating payroll, and paying payroll taxes.
Using payroll software tends to speed up and simplify the make the process of running payroll, but you’ll still need to spend time putting your information into the software and becoming acquainted with the payroll software you choose.
If you’ve already chosen payroll software for your business, check out our guides on how to run payroll with payroll software:
What To Consider When Choosing Payroll Software
If you decide to purchase payroll software for your business, there are several things to consider before you make a final purchasing decision. Here are the factors you should consider when choosing payroll software for your business.
- Ease Of Use: If you are new to running payroll, finding payroll software that is easy to use should be a deciding factor.
- Level Of Payroll Tax Support: Full-service payroll software plans handle your payroll tax filing and payment, while self-service payroll software plans will not. In some cases, even full-service payroll software solutions can’t handle your local-level taxes, so you’ll need to consider what level of payroll tax support you’re comfortable with when choosing payroll software.
- Your Business Size: Some products are tailor-made for microenterprises while others are better suited for mid-sized companies. If you intend to grow your business, you’ll need a scalable payroll software solution.
- Industry-Specific Payroll Software: A payroll app made for your industry will serve you better than one that isn’t. Hospitality companies, for example, have their own unique payroll needs that may be different from those of companies in a different niche, like education or manufacturing.
- Third-Party Integrations: If your business currently uses time clock software, accounting software, POS hardware, or any other type of business software, be sure to look for payroll software that integrates with what you are already using.
- Pricing: Payroll software is an added monthly expense for your business. Be sure to review the pricing of each payroll software solution that you are considering to ensure that it fits into your business budget.
- Support For Contractors & Employees: If your business pays both W-2 employees and 1099 contractors, ensure that the payroll software you choose can handle contractor payments.
Choosing The Right Payroll Processing Solution For Your Business
When choosing the right payroll processing solution for your small business, it’s essential to consider your business’s needs and budget.
There is no one-size-fits-all payroll solution, but there are a collection of the best payroll software options that you can choose from and a ton of payroll calculators for those businesses that want to manually process payroll.
Regardless of the payroll processing option you choose for your business, you’ll still need to have some foundational knowledge about running payroll, including payroll best practices.
Ultimately, we hope that this guide has helped you learn more about how to run payroll and enabled you to make an informed decision about which payroll processing solution works best for your business.