How to Do Your Own Payroll: 8 Steps to Follow
So you’ve started a business, hired your first employees, and now you’re figuring out how to do payroll. But there’s more to payroll than signing a check and mailing it out. The process is pretty involved between tracking hours, calculating taxes and withholdings, and complying with federal and state regulations.
You’ll learn that managing your small business HR can be a lot of work and payroll is no exception. If you think you’re up to the task, stick around. Here are the steps you need to know to learn how to do payroll yourself.
How to Do Payroll Yourself in 8 Steps
Step 1: Obtain an employer identification number.
If you’re a sole proprietor, you can file your taxes under your social security number. But if you’re a business owner with employees, you must use your employee identification number (EIN). Without it, you can’t pay employee taxes.
If you’re still in the planning stage of your business, you should obtain your EIN as soon as you can. You will use it on all your business tax filings and forms moving forward. Fortunately, it’s a straightforward process and you can apply for an EIN online through the IRS website. The process is quick and free.
Step 2: Have all employees complete a W-4.
When onboarding your new employees, you should always have them complete their W-4 forms, among other new hire paperwork. As their employer, you are responsible for withholding taxes from your employees’ gross pay, and their W-4 forms will indicate additional withholdings you must accommodate.
The amount of taxes you withhold from your employees’ gross pay depends on:
- Whether the employee is married, single, or married and filing separately
- Their tax allowances that might exempt them from certain taxes
- Whether the employee requests additional withholdings to ensure they don’t pay taxes come filing time
Step 3: Set up direct deposit.
Direct deposit is becoming increasingly popular among employees for its convenience. Employees save a trip to the bank and no longer need to worry about losing a physical check.
Learning how to set up direct deposit for employees is also a simple process. During the onboarding process, you should also include a form for whether an employee wishes to opt in for direct deposit.
This form will request the employee’s bank name, bank account number, and routing number. You can then forward this information to your business bank account provider in order to set up direct deposit.
Step 4: Track employee hours worked.
When learning how to do payroll for your small business yourself, you’ll need to know the number of hours each employee worked.
If you’re running a lean enterprise, you can have employees track their time on a form and submit it by the end of each period. You can also invest in attendance management or time tracking software, which can save you time from tedious data entry.
There are also a variety of services for small businesses that feature built-in employee tracking systems.
Step 5: Choose your payroll schedule.
Next, you’ll need to choose your payroll schedule. Most businesses pay employees bi-weekly, or every other week. But some businesses pay weekly or just once a month. Your payroll schedule should depend on your cash flow—you’ll want to ensure you issue payroll during periods when you have liquid assets in your business bank account.
When determining your payroll schedule, you should also research your state-specific-requirements. For example, Alabama does not have specific regulations regarding payday frequency. Maine, in contrast, requires payment to be issued at regular intervals, not exceeding 16 days.
Step 6: Calculate and withhold income taxes.
After collecting information from your employees and choosing a payroll schedule, you’ll need to crunch some numbers. If you want to know how to do payroll yourself and skip investing in HR software, you can still use free tools like Microsoft Excel to improve your accuracy.
Microsoft offers a free employee payroll calculator you can download, which includes:
- Employee wage and tax information
- Payroll calculations based on hours worked
- Ability to create pay stubs
After choosing where to record your payroll, the next step is calculating gross pay.
Calculate Gross Pay
Your payroll schedule will determine how many hours an employee works within a period. For example, if you issue payment bi-weekly, then a typical full-time employee works 80 hours.
Then, you’ll multiply the number of hours worked by the employee’s hourly wage rate. Remember to factor paid time off, such as a holiday or sick leave, if applicable.
Be sure to distinguish overtime hours from regular hours. The Department of Labor reports that eligible employees “must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rates of pay.”
If you have salaried employees, on the other hand, their pay usually won’t change from period to period.
An employee’s gross pay is not the actual amount they take home. There are several common withholdings deducted from an employee’s paycheck, such as:
- Federal income taxes
- Medicare and social security taxes (FICA taxes)
- Premiums for health insurance
- Retirement fund contributions
- Court-ordered wage garnishments for child support or alimony
After you deduct these amounts from your employees’ gross pay, you finally arrive at their net income, the actual amount that gets deposited into their bank account.
Step 7: Distribute paychecks.
The math (aka the hard part) is over. Now, it’s time to distribute what your employees are eagerly anticipating: their paychecks.
Depending on how you distribute your paychecks, you can print them and physically distribute or mail them. If you set up direct deposit, you can forward your direct deposit file to your bank and they will deposit your employees’ paychecks directly in their bank accounts.
Step 8: Pay taxes.
You’re not done yet—there’s still more money to pay. In addition to paying your employees, you have to make tax deposits to the IRS.
Before you became a business owner, you only had to file your taxes once a year. Now, filing and paying your taxes is a quarterly occurrence throughout the year.
When you’re filing your business taxes, you can expect to file the following forms related to payroll:
- W-2 forms (annual form)
- Wage and Tax Statements from 1099 employees (annual form)
- Form 940 to report federal unemployment taxes (annual form)
- Form 941 to report social security and Medicare tax deductions (quarterly form)
- Form W-3 which summarizes total wages paid and total taxes withheld (annual form)
Create a Tax Deadline Calendar
Part of learning how to do your own payroll is keeping up with your tax payments. We recommend that you create a calendar for your payroll taxes. Your calendar should have essential reminders and due dates that keep you on top of your tax obligations.
You’ll want to have some system in effect as missing a deadline can subject you to financial penalties, fines, and interest payments.
Along these lines, it’s important to remember that not only are you responsible for submitting Form 941 on a quarterly basis, but you’ll also need to make separate deposits of the FICA and income taxes you’ve withheld from your employees’ paychecks.
These deposits are due on either a semiweekly or monthly schedule depending on the amount of your payroll tax liability during a one-year lookback period.
Ultimately, filing and staying on top of your taxes can be the most complex part of figuring out how to do your own payroll. We’d recommend consulting with a tax expert or certified public accountant (CPA) if you have any questions or need professional advice.
Pros and Cons of Learning How to Do Payroll Yourself
Learning how to do payroll yourself is a daunting task. The process involves collecting several items, crunching numbers, and meeting federal and state requirements. Is all the work and stress worth it?
Let’s explore some pros and cons of taking a DIY approach to payroll.
- Save money: Learning how to do payroll yourself is the most cost-effective option at first glance. By handling everything yourself, you create significant savings that would have been spent on a bookkeeper or accountant. Foregoing payroll or HR software adds to your bottom line.
- Full autonomy: When you learn how to do your own payroll, you set your own rules and processes. You have full autonomy over the procedure, deciding how you set up your payroll, when you run it, and more. You also gain valuable knowledge about tax codes, as well as federal and state requirements—useful information for a small business owner.
- Time-consuming: Doing your own payroll can be a significant time-sink. First, you have to gain intimate knowledge of tax codes and labor laws—without this, you can risk racking up some costly infractions. Moreover, payroll is a recurring business operation. You will spend hours each week processing employee timesheets, calculating taxes, distributing paychecks, and filing paperwork.
- Increased chances for error: Since you are likely not a trained professional, you run the risk of making clerical mistakes, increasing your legal risk. Unfortunately, these errors may result in fines and penalties. These fees can easily overshadow any savings accumulated from foregoing hiring an accountant.
Consider Using Payroll Software
When it comes down to it, using payroll software is an excellent compromise if you still want to take a DIY approach and streamline the payroll process. Subscription fees for payroll software are often nominal and their services can save you from costly mistakes made by doing everything by hand.
Also, many payroll and HR software systems have accessible customer support representatives, who can help you navigate their services. Even if you’re not the most tech-savvy entrepreneur, you can still handle your payroll with finesse.
The setup process, when using payroll software, can take some time. When starting, you’ll need the following items:
- Employees’ information (name, address, social security number)
- Employee tax withholding information
- Employees’ hours worked (some HR software has built-in time tracking systems, which can consolidate all your payroll processes in one place)
The tremendous advantage of using payroll software is that it can free up your time. Instead of sinking several hours into payroll, you can use that time to work on other business priorities.
Frequently Asked Questions
How do I do payroll manually?
Doing payroll manually is better accomplished when using spreadsheet software like Microsoft Excel. Doing everything by pen, paper, and calculator leaves you vulnerable to calculation and clerical errors.
You can download this Excel employee payroll calculator that allows you to calculate employee wage and tax info and even create pay stubs.
Is it difficult to do payroll?
Payroll can be a complicated process, especially as your company expands to employ more people and open multiple locations. You’ll need to stay on top of your tax obligations, collecting information from your employees, and complying with region-specific regulations (if you have multiple locations in different areas).
Over time and with more experience, you can do payroll effectively. But many employers will outsource payroll by investing in HR software or hiring an accountant.
What is the formula for payroll?
To calculate gross pay, you can multiply wage rates by the number of hours an employee worked. Keep in mind that hours that qualify for overtime must be paid at not less than time and one-half their regular rates of pay.
For example, if an employee worked 80 hours and makes $15 per hour, the calculation would look like this:
80 hours x $15.00 = $1,200
After you calculate their gross pay, you can deduct any withholdings and pay deductions to arrive at their net pay.
Is there a free payroll software?
Yes, there are some free payroll and HR software options that offer free plans.
Some examples include Payroll4Free, Wave Payroll, RiseLite, and TimeTrex.
Still, your time is valuable. Consider investing in payroll software or hiring an accountant so you can spend less time crunching numbers and more time growing your business.