Guide to Payroll Processing
February 12, 2025 | Last Updated on: February 12, 2025
By Melanie Lockert
If you want to grow your small business, at some point you likely need to hire employees. Adding employees to your team can be an exciting move but also comes with more responsibility. Once you hire an employee, you need to start running payroll. Payroll processing can be complicated and add to your to-do list. But there are different ways you can handle it, depending on your time, skills, and budget.
Article Summary:
- Once a business hires employees, they need to run payroll.
- Businesses can run payroll manually, through payroll software, a staff member, or accountant.
- Check out local, state, and federal laws before payroll processing.
What is Payroll Processing?
Payroll processing refers to the specific tasks required to handle employee compensation from calculating wages to payment. When done right, the Employee payroll must calculate wages and manage any deductions and payroll taxes. No matter how you decide to do it, your payroll system must comply with all applicable local, state, and federal laws.
Options for Payroll Processing
- Manual payroll. If revenue is tight and you want to cut costs, you can DIY it and handle payroll processing yourself. It’ll save you money, but you’ll pay for it in time and potential errors.
- Payroll software. If you want to streamline the process and save time, using a payroll system like Gusto or QuickBooks Payroll can help. You may also be able to reduce human error and make sure you’re taking all the necessary steps.
- Do it in-house with an employee. Doing payroll may fall under the duties of a Human Resources or finance professional that you employ in your business.
- Get an accountant. Outsourcing payroll to an accountant who provides this service is another option for small business owners.
How To Do Payroll Processing
As noted above, you have your pick when it comes to payroll systems. Here, we dive a bit deeper into how to do payroll for small businesses.
Manual Payroll
It’s possible to do payroll processing yourself. However, manual payroll requires many different steps that must be done with accuracy and precision.
1. Apply for an Employer Identification Number (EIN)
If you haven’t brought any new hires on yet, you need to get an Employer Identification Number from the Internal Revenue Service. Businesses must obtain an EIN to hire employees.
The good news is that it’s pretty simple to get one. Make sure to have your Social Security Number and business entity type handy. It’s completely free and takes minutes to apply for an EIN online.
If you already have an EIN, skip to step two. When filling out forms with your EIN, double check that it’s correct.
2. Go to the Electronic Federal Tax Payment System (EFTPS)
As an employer, you’re responsible for paying taxes, including:
- Federal income tax
- Social Security and Medicare taxes
- Federal unemployment (FUTA) tax
To help you make those tax payments, you can enroll in the Electronic Federal Tax Payment System (EFTPS). Through EFTPS, you can pay your payroll taxes on time at no cost.
3. Register Your Business in Your State
It’s not just federal laws you need to comply with but state and local ones as well. Make sure to register your business in your state. You’ll likely need to sign up with the specific revenue agency or tax board associated with your state and pay state taxes. For example, the New York State Department of Taxation and Finance.
4. Review Labor Laws
Before doing any payroll processing, ensure you understand federal and state labor laws. Know the hourly rate for minimum wage in your state. You don’t want to realize later on that you’re missing something important that can lead to potential penalties.
5. Collect Employee Tax Information
When you hire a new employee, you’ll need to collect employee tax information by having them fill out:
- Form W-4
- I-9 Employment Eligibility Verification Form
If applicable, employees may also need to fill out a state tax withholding and direct deposit authorization fos.ms
6. Choose a Payroll Schedule
A key part of running payroll processing manually is choosing a payroll schedule. This helps inform your pay period and lets you know when to cut paychecks for your employees. Be sure to check out the Department of Labor State Payday Requirements beforehand. Depending on your state, you may choose between weekly, bi-weekly, semi-monthly, and monthly.
7. Employee Taxes
Now comes the hard part, where typically most errors occur. You need to calculate employees’ gross wages. This refers to the total wages an employee earn before taking out certain payroll deductions. For example, retirement plan contributions in a 401(k), health insurance premiums, as well as payroll income tax withholdings.
Here’s what makes up gross wages:
- Employee wages
- Sick and vacation pay
- Commissions
- Tips
- Overtime pay
- Bonuses
- Stock options
You have two options to calculate your employees’ gross wages, depending on the type of employee:
- Multiply the employee’s hourly wage by the total hours worked during the pay period for hourly employees.
- Divide the employee’s annual salary by the number of pay periods for salaried employees.
Once you’ve calculated the employees’ gross wages, then you’ll start subtracting things like pre-tax deductions, such as retirement plan contributions, health insurance premiums, and payroll tax withholdings. Once that’s done, then you’ll start to calculate the federal tax withholdings to subtract from their pay stub.
The two types of payroll taxes you’ll need to withhold include:
- FICA taxes: These are often referred to as federal employment taxes and make up a portion of Social Security and Medicare taxes. The employer and employee both pay these taxes equally. As of 2025, employers (and employees) pay 7.65%, which is 6.2% for Social Security and 1.45% for Medicare.
- Federal income tax: Typically, businesses use either the wage bracket or percentage method to calculate federal income tax for employees based on the information on their W-4 forms. For comprehensive information about these methods for calculating federal income tax, check out IRS Publication 15-T.
Be aware that you may also have to deduct state and local taxes on top of FICA and the federal income tax.
Lastly, you may also withhold any wage garnishments or mandated child support from an employee’s paycheck before doing payroll. It’s important that your payroll runs include a pay stub for the employee that outlines tax deductions on payday. Additionally, this information should also be noted in your payroll records.
8. Pay Payroll Taxes
You can easily pay payroll taxes via EFTPS. These include FICA, which has a tax rate of 7.65% for employers and employees to cover Social Security and Medicare taxes.
Additionally, there’s the FUTA payroll tax which goes towards federal unemployment insurance. Per the IRS employers pay a 6.0% FUTA tax rate on an employee’s first $7,000 in wages. The good news is that if you pay state unemployment taxes on time, you may qualify for a 5.4% federal tax credit after filing Form 940.
If you’re in a state requiring worker’s compensation, you’ll be responsible for that as well. However, exceptions exist. If you tend to hire mostly independent contractors, you’re not required to provide any worker’s compensation. Check your state’s workers’ compensation laws.
9. File Tax and W-2 Forms
You’ll need to file certain tax forms including:
- Form 941
- Form 940
- Form W-2 for each employee
- Additional state tax forms, if applicable
During the tax filing process, keep your records up to date. Under the Fair Labor Standards Act (FLSA), you must keep certain payroll records for all non-exempt workers for a minimum of three years. These include:
- Employee’s full name
- Social Security Number
- Birthdate (if younger than 19)
- Address and ZIP code
- Gender
- Job title
- Time and day of the week that the employee’s workweek starts
- Hours worked per day
- Hours worked per week
- Basis on which wages are paid
- Hourly pay rate
- Total daily or weekly earnings on a standard schedule
- Total overtime earnings during the week
- All wage adjustments
- Total wages paid during each pay period
- Payment date and the pay period
When completing payroll processing, ensure there are no errors. Verify you have the correct bank account and personal information for all of your employees.
Payroll Software
You can find a wide range of payroll solutions to help you outsource payroll processing. Research different payroll providers and look at:
- Pricing
- Key features, like time tracking
- Integrations with other apps or software
- Accessibility and functionality, like website login and mobile app
If you have multiple employees or are expanding quickly, using payroll software can be a no-brainer. Of course, it’s not free and comes with a fee. But depending on how much time you save, and errors prevented, it could be well worth the investment.
Like in other cases, you’ll still need to have your EIN and employee information. The advantage here is that payroll software helps automate this process, making it easier for you and your employees. For example, employees may be able to fill out some onboarding forms online and set payment method preferences, like direct deposit. However, payroll software typically takes care of the payroll taxes for you.
To get started with a payroll software:
- Choose your payroll provider
- Fill out necessary information, for your business and employees
- Decide your payroll schedule
- Run payroll
If you don’t want a time-consuming process, a payroll service provider can be a godsend. It’ll help with record-keeping, payroll taxes, and do much of the heavy lifting for you.
In-House
You might already be doing payroll processing yourself and want it off your plate. You can hire a specific person with payroll experience who can manage this task for you. Another option is to assign this task to someone in Human Resources or in an administrative role. You can train them and give them tutorials and have a trusted person on your team take care of it.
An Accountant
If you want to work with a third party to handle payroll processing, you can consider hiring an accountant. Not all accountants offer this service, but some do. Costs may be steeper relative to other employee payroll options. However, an experienced accountant can help you manage payroll processing and keep organized payroll records.
Final Thoughts
As a business, you’re responsible for an employee’s paycheck and the appropriate tax withholding. That’s a major responsibility, and you want to make sure you adhere to all compliance standards. That means federal, state, and local tax and any other applicable laws and regulations. Consider your options and find a long-term payroll solution that best fits your business needs.
Lastly, be sure to consult a tax professional before making any crucial financial decisions.
FAQs about Payroll Processing
Payroll, sometimes misspelled pay roll, can be confusing. Here, we answer some frequently asked questions about payroll processing.
Do You Need an EIN to Run Payroll?
If you have employees and need to run payroll processing, you need to have an EIN according to the Internal Revenue Service (IRS).
Why is Payroll Processing Important?
Payroll processing is an important aspect of running a business. It helps keep your employees happy and compensated while keeping accurate records and being in good standing in compliance with tax laws.
Can I Do Payroll Myself?
You can technically run payroll by yourself through manual payroll processing and figuring out total compensation, taxes, deductions, etc. However, it’s often a better idea to invest in support with a payroll system to avoid costly mistakes.
What Are Compliance Requirements for Payroll Processing?
Small businesses must follow payroll processing compliance requirements, which means following any local, state, or federal laws. For example, properly calculating employees’ wages and managing payroll taxes.
