When you hire part- or full-time W-2 employees, one of the first things you’ll need to do is get them set up in your payroll system.
Like many tax-related business requirements, this can be a complicated and frustrating process, which is why many companies hire payroll providers to handle it for them.
However, if you can’t afford a payroll service or would simply prefer to handle it yourself, here’s what you need to know about payroll and payroll taxes.
Preparing for payroll
Before you can run payroll, you need to have the following information:
- W-4 forms, up-to-date from each employee, which determine their tax filing status and personal allowances/dependents.
- Pay schedule, as you determine, outlining pay periods and pay days.
- Federal and state tax amounts to be deducted from each employee’s paycheck based on their W-4 information.
- Other deduction amounts, such as health insurance or retirement plan contributions.
- Amount of hours worked for any hourly, non-exempt employees (specific timekeeping requirements for these employees can be found on the Department of Labor’s website).
Each employee’s pay stub must state gross pay (total before taxes and withholdings) for the period, and then include an itemized list for each payroll deduction made. The final check amount after deductions is the employee’s net pay.
Before the checks go out, you should print and review your payroll register to ensure that all pay and deduction amounts are correct.
What’s included in payroll taxes?
As an employer, you will be required to collect from each employee’s pay check
- Federal income tax, and
- FICA taxes (Federal Insurance Contributions Act, which covers taxes for Social Security and Medicare).
You as the business owner will have to pay matching amounts of
- Social Security tax,
- Medicare tax, and
- Federal Unemployment Tax (FUTA).
The IRS Withholding Calculator can help you figure out exactly how much must be taken out for each individual employee, but the specific amounts to deduct will depend on the employee’s filing status (single, married, head of household, etc.), the number of allowances or dependents they have, and any additional amount the employee has requested to be withheld.
Some states also require employers to collect and pay additional state income and unemployment tax on top of federal taxes, so be sure to check your local tax laws.
More information on your employment tax obligations can be found on the IRS website.
Once you've distributed your employees' paychecks, you are then responsible for paying and reporting payroll taxes to the IRS.
How do I file my payroll taxes?
Once you’ve distributed your employees’ paychecks, you are then responsible for paying and reporting payroll taxes to the IRS.
Below are the steps you will need to take post-payroll to meet federal and state requirements:
- Federal tax deposits. All employee tax withholdings and your share of FICA taxes must be paid to the IRS and, if applicable, state government on a semi-weekly or monthly basis, depending on your total tax liability, according to Form 943. The IRS states that you must use electronic funds transfer (EFTPS) to make federal tax deposits.
- FUTA tax deposits. Federal unemployment taxes are made to the IRS on a quarterly basis.
- File Form 941. Form 941 reports your total payroll tax liability and payments from the previous quarter and must be filed with the IRS quarterly.
- File Form 940. Form 940 reports your total unemployment tax liability and payments throughout the year, and must be filed with the IRS annually.
- File state tax reports. If your state requires you to collect and pay income and unemployment taxes, you will need to report this according to your state’s schedule and regulations.
At the end of the calendar year, you will also need to prepare W-2 forms for each employee summarizing their total gross payments and tax withholdings throughout the year.
What if I have out-of-state employees?
The general rule as a business owner is to follow the tax regulations in the state where your employees work.
For instance, if your company is based in a state without income tax, but you employ someone who works from home in a state that does require income tax withholding, you would be responsible for collecting and paying the state taxes for that employee.
Some states have reciprocal agreements that allow out-of-state employees to only pay income tax in their resident state, rather than being taxed in both their resident and nonresident (work) states.
If no reciprocal agreement is offered, you can arrange for a courtesy withholding to deduct both sets of state taxes during regular pay cycles so the employee won’t owe it all when they file their annual taxes.
Payroll advice for small business owners
Meeting federal and state payroll requirements is a big responsibility. The IRS penalties for employment tax noncompliance are steep, so it is strongly recommended that you outsource the process to a reputable payroll service provider to avoid mistakes.
Alternately, if you decide to run your own payroll, consulting professionally with a CPA or tax law attorney to ensure that you are deducting the proper amount from your employees’ paychecks each pay period can save you thousands of dollars in fines down the road.
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