Whether you run a two-person operation or your business has 50 employees, setting up a payroll system is very important for entrepreneurs. Not only will it streamline your ability to stay on top of your legal responsibilities as an employer; it can also save time during tax season and prevent costly penalties from the Internal Revenue Service (IRS).
According to the Small Business Association’s website, there are 10 specific steps that should be taken when setting up a payroll system (“10 Steps to Setting Up a Payroll System.”)
Here is what the SBA recommends for your small business:
- Get an EIN: Before you can legally hire employees you must first obtain an Employment Identification Number (EIN) from the IRS. This is also known as an Employer Tax ID or a Form SS-4. The ID number is necessary for reporting taxes and other documents to the IRS, but it is also used to report information about your employees to state agencies.
- Find out if you need State/Local IDs. Some state/local governments require businesses to obtain ID numbers before local taxes can be filed. Look into this early on, not just before tax season.
- Determine the “status” of your employees. As an employer, it is important to know the difference between independent contractors and employees. Legally, this distinction affects how you withhold income taxes, whether you pay Social Security and Medicare, and how the employee must file his/her taxes.
- Get employee paperwork done promptly. Even if you don’t yet have a Human Resources department, it is important that you follow certain standards set forth by the IRS. One of these is the necessity of a Federal Income Tax Withholding Form (W-4). This form must be completed and returned to you before a new employee can be added to the payroll system.
- Determine pay periods. Establishing a pay period, whether it is weekly, bi-monthly or monthly) is necessary for setting up payroll.
- Document your employees’ compensation plan. Setting up payroll requires you to do more than pay your employees; it also requires you to track their regular, sick, vacation and overtime pay. Other employee compensation and deductibles must also be considered for their tax implications and the funds redirected promptly. These include health plan premiums and 401(k) contributions, among others.
- Select a payroll system. Payroll administration requires a special attention to detail and accuracy, so try not to rush through the selection of a payroll system. Ask other business owners which company they use and if they have any recommendations for how to set up and administer payroll. As an employer you are responsible for reporting and paying of payroll taxes no matter which option you choose.
- Start running payroll. Once you have all the forms and information collected, you can begin running payroll. You will then have to decide whether to enter it yourself or send the information to an accountant for entry.
- Develop a record-keeping strategy. First, find out about the laws requiring employers to hold onto certain records and how long you must keep them. For example, employee W-4 forms for all active employees must be kept on file for at least three years after the employee is terminated. You will also need to keep copies of filed tax forms, W-2s and the dates and amounts of all tax payments.
- Report payroll taxes on time. As an employer, there are several different tax reports that must be submitted to the governing authorities on either a quarterly or annual basis. If you are unsure about what is required of your business, check out the IRS Employer’s Tax Guide for federal tax filing requirements and ask your state tax agency for this information as well.
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