How Do I Set Up Payroll for the First Time

Taking the leap and setting up payroll for the first time can feel daunting for small business owners. The numerous considerations and legal requirements might make your heart race, overwhelming you. But don't worry! This vital step ensures that your hardworking employees receive well-deserved pay, keeping your business compliant with government regulations. Our comprehensive guide is here to hold your hand through every step of the payroll setup process. Once you've mastered it, you and your passionate team can turn your focus to the heart of your small business: nurturing its growth and making your dreams a reality.

1. Obtain an Employer Identification Number (EIN)

Before embarking on the payroll journey for your small business, you must first acquire an Employer Identification Number (EIN) from the Internal Revenue Service (IRS). 

Key EIN facts:

• Over 1.5 million new EINs were issued by the IRS in 2020
• Businesses can obtain an EIN for free through the IRS website
• The online EIN application process typically takes less than 15 minutes
• An EIN is needed not only for payroll but also to open a business bank account and apply for various licenses and permits
• Non-US residents can also apply for an EIN for their US-based businesses

This distinctive number serves as your business's tax ID and is crucial for submitting taxes and other necessary documents to the IRS. The process of applying for an EIN on the IRS website is generally simple and efficient.

2. Register with Your State's Labor Department

After registering with the IRS, you must also register with your state's labor department. This critical step ensures compliance with each state's specific regulations concerning unemployment insurance, workers' compensation, and various employment-related matters. By registering, you can avoid potential pitfalls and adhere to your state's unique requirements.

Essential state labor department registration statistics:

• The United States has 50 state labor departments, each with its specific regulations
• Unemployment insurance tax rates vary by state, with rates ranging from 0.2% to 13.5% in 2021
• As of 2021, the national average for workers' compensation insurance premiums was $1.63 per $100 of payroll
• Most states require employers to carry workers' compensation insurance, with Texas being a notable exception
• There are over 180,000 state and local employment-related laws in the United States
• Employers are required to display state-specific labor law posters to inform employees of their rights
• State labor departments often provide free resources and guidance to help employers navigate regulations and compliance requirements

3. Choose a Payroll Schedule

An essential step in setting up payroll is determining how frequently you'll pay your employees. There are multiple payroll schedules available, such as weekly, biweekly, semimonthly, and monthly. When selecting a schedule, consider the needs of your business, the preferences of your employees, and potential state regulations dictating how often employees must be paid.

Informative statistics and facts on payroll schedules:

• Approximately 36% of U.S. businesses use a biweekly payroll schedule, making it the most popular choice
• Weekly payroll schedules are utilized by roughly 32% of U.S. companies, followed by semimonthly at 20% and monthly at 12%
• Payroll frequency can impact your business's cash flow, with more frequent payroll schedules typically requiring more cash on hand
• Employees often prefer more frequent paychecks to help manage their personal finances and expenses
• Some states, like California and New York, have specific regulations regarding minimum payroll frequency for different types of workers, such as non-exempt and exempt employees
• Switching payroll schedules can be a complex process, so it's essential to carefully consider the needs of your business and employees before making a decision
• A survey by the American Payroll Association found that 92.5% of employees are satisfied with their current payroll schedule, emphasizing the importance of selecting a schedule that works for both your business and your workforce

4. Set Up Employee Records

Details to consider when setting up employee records:

• Information collection: Collect each employee's full name, address, Social Security number, and a completed Form W-4. Form W-4 is used to determine federal income tax withholding based on an employee's allowances and filing status.
• Additional documentation: Depending on your state and industry, you may need to collect additional documents, such as state withholding forms, I-9 forms for verifying employment eligibility, and direct deposit authorization forms.
• Record organization: Maintain a well-organized filing system, whether digital or physical, to ensure easy access to employee records when needed. Organize records by employee or category (e.g., tax forms, hiring documents) based on your preference and business requirements.
• Record security: Keep employee records secure by implementing proper access controls, such as password protection for digital files or locked cabinets for physical records. This ensures the privacy and confidentiality of sensitive employee information.
• Retention requirements: Familiarize yourself with federal and state record retention requirements. For instance, the IRS recommends retaining Form W-4 for at least four years after an employee's last payroll period. Each state may have its specific guidelines for retaining various employment-related records.
• Regular updates: Encourage employees to update their information as needed, especially if they experience life events that could impact their tax withholdings, such as marriage, divorce, or the birth of a child. Regularly updating records helps ensure accurate payroll and tax reporting.
• Compliance audits: Periodically review your employee records for accuracy and completeness. Regular audits can help identify potential issues, such as missing documents or outdated information, and ensure compliance with relevant laws and regulations.

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5. Determine Employee Classification

Employees can be classified as either exempt or non-exempt, with different rules and regulations applicable to each category. To avoid penalties and fines due to misclassification, familiarize yourself with the Department of Labor guidelines and ensure the correct classification of your employees.

Key aspects of employee classification:

• Exempt employees:
• Typically receive a salary instead of hourly wages
• Not eligible for overtime pay under the Fair Labor Standards Act (FLSA)
• Must meet specific criteria concerning job duties, responsibilities, and minimum salary thresholds (as of 2021, the minimum salary is $684 per week or $35,568 per year)
• Often hold executive, administrative, professional, or outside sales positions
• Non-exempt employees:
• Usually paid hourly wages
• Eligible for overtime pay (generally, 1.5 times their regular pay rate) for hours worked beyond 40 hours per week under the FLSA
• Not required to meet specific job duty or salary criteria
• Can include a variety of roles, such as clerical, manual labor, or technical positions
• State-specific regulations:
• Some states have their overtime laws and regulations that may differ from the FLSA
• Employers must adhere to both federal and state regulations, ensuring compliance with the more stringent of the two
• Independent contractors:
• In addition to exempt and non-exempt classifications, some workers may be classified as independent contractors
• Generally, not considered employees and not subject to the same labor laws or tax withholding requirements
• Misclassification of employees as independent contractors can result in penalties, fines, and back payment of taxes and wages
• Regular review and updates:
• Periodically review your employees' classifications to ensure ongoing accuracy and compliance, particularly if job duties or responsibilities change
• Keep abreast of changes in federal and state labor laws, as regulations and thresholds may change over time
• Training and resources:
• Train your human resources and management teams on employee classification guidelines to ensure consistency and compliance throughout your organization
• Utilize resources provided by the Department of Labor, such as fact sheets and guidance on employee classification under the FLSA

6. Calculate and Withhold Taxes

Withholding taxes is a critical component of payroll management. You'll need to withhold federal income tax, Social Security tax, and Medicare tax from your employees' paychecks. Additionally, some states require the withholding of state income tax. Consult the IRS website and your state's revenue department for current tax rates and guidance on calculating withholdings.

7. Track Employee Time and Attendance

To accurately pay your employees, you'll need to track their work hours, including any overtime. There are many time and attendance systems available, ranging from traditional time clocks to digital solutions. Choose a method that works best for your business and ensure that it's consistently used by all employees.

• Traditional time clocks:
• Analog or digital wall-mounted clocks that use time cards, badges, or biometric data (e.g., fingerprints) for clocking in and out
• Easy to use and understand, but can be less accurate due to rounding, buddy punching, or human error
• Examples: Acroprint Time Recorder, Lathem Heavy-Duty Time Clock
• Digital time and attendance software:
• Cloud-based or on-premise solutions for tracking employee work hours
• Allows employees to clock in and out using computers, mobile devices, or designated time clocks
• Automatically calculates hours worked, overtime, and breaks, reducing the risk of human error
• Examples: TSheets, TimeClock Plus, When I Work
• Mobile applications:
• Track employee hours using smartphones or tablets, ideal for remote or field-based workers
• Often equipped with GPS tracking, ensuring accurate location data and preventing time fraud
• Examples: ClockShark, QuickBooks Time, HoursTracker
• Biometric time and attendance systems:
• Use unique biological data, such as fingerprints, facial recognition, or iris scans, to clock employees in and out
• Reduce the risk of time fraud and unauthorized access to sensitive areas
• Examples: uAttend BN6500, TimeClock Plus, AMGtime

When choosing a time and attendance system, consider factors such as the size of your workforce, your industry, budget, and the level of integration needed with your existing systems. Engage employees in the selection process to ensure user-friendly and effective solutions that meet their needs.

8. Process Payroll 

Once you've gathered all the necessary information and have calculated the appropriate withholdings, it's time to process payroll. Many small business owners choose to use payroll software to streamline this process, while others prefer to work with a payroll service provider. Whichever option you choose, ensure that it meets your business's needs and complies with all relevant tax and labor regulations.

9. Submit Payroll Taxes and Reports

After you've processed payroll, you'll need to submit payroll taxes and reports to the appropriate government agencies.

Key components of submitting payroll taxes and reports:

• Federal payroll taxes:
• Includes Social Security tax, Medicare tax, and federal income tax withholding
• Deposited to the IRS using the Electronic Federal Tax Payment System (EFTPS)
• Reported on Form 941 (Employer's Quarterly Federal Tax Return) or Form 944 (Employer's Annual Federal Tax Return) depending on the size and tax liability of your business
• State payroll taxes:
• Vary by state and may include state income tax withholding, unemployment insurance tax, and other employment-related taxes
• Typically submitted to the state revenue department or state unemployment agency
• Reporting requirements and deadlines differ between states, so it's crucial to familiarize yourself with your state's specific guidelines
• Local payroll taxes:
• Some cities and counties impose additional payroll taxes, such as local income taxes or local services taxes
• Submission requirements and deadlines vary by jurisdiction, so consult your local tax office for details
• Filing Form W-2 and Form 1099:
• At the end of the calendar year, provide Form W-2 (Wage and Tax Statement) to employees and Form 1099-NEC (Nonemployee Compensation) to independent contractors
• File copies of these forms with the Social Security Administration (for W-2) and the IRS (for 1099-NEC) by the annual deadline, usually January 31
• Recordkeeping:
• Maintain accurate records of your payroll tax deposits, reports, and employee wage information for a minimum of four years, as recommended by the IRS
• Regularly review your records to ensure accuracy and compliance with tax and reporting requirements
• Outsourcing and software solutions:
• Consider using payroll software or outsourcing your payroll tax and reporting obligations to a payroll service provider to streamline the process and ensure compliance
• Examples: ADP, Paychex, Gusto

By staying up to date with payroll tax and reporting requirements, you can avoid costly penalties and fines, maintain compliance, and protect your business's reputation.

Conclusion

Setting up payroll for the first time is a significant milestone for any small business. It demonstrates growth and commitment to supporting your employees. By following the steps outlined above, you can create a seamless and efficient payroll process. 

By staying informed, organized, and compliant with relevant regulations, you'll not only foster a healthy work environment but also safeguard your business's reputation and financial stability. 

Remember, investing time and effort in establishing a robust payroll system now will pay dividends in the long run. Schedule a free consultation today and we’ll help you grow and nurture your business for years!

Is payroll a thorn in your side? Let us handle all the stress related to payroll so you don't have to...