Rachel Blakely is a content writer at Patriot Software, LLC. She provides accounting, payroll, and small business tips in her writings. Patriot Software offers affordable payroll and accounting software for small businesses.
7 min. read
Updated October 25, 2023
When you own a business, you are in charge of hiring employees. Top-notch employees can help you streamline business processes, add innovative ideas, and grow your business. Before you start worrying about a candidate sourcing strategy or hiring your first employee, you need to have a little understanding of payroll.
Most business owners are experts in their industry, not payroll. Setting up and running payroll might seem overwhelming, but once you have extra hands helping to run your business, it will all be worth it.
Read on to learn your employer responsibilities, like how to set up payroll and withhold taxes from employee wages.
If you want to hire employees at your business, you need to first set up payroll. To run payroll, you’ll have to establish a system; do you want to do payroll by hand, use software, or hire an accountant?
Keeping your business documents organized will make setting up payroll a smoother process. To set up payroll for your business, you need a little bit of information about your company and new employees.
In order to set up payroll, you need to have some identification numbers. You need to apply for an EIN (short for Employer Identification Number), which you can get from the IRS. The EIN is a nine-digit number that identifies your business. You will need it when you report taxes or send any tax-related information to the government.
To pay federal taxes, you can set up an Electronic Federal Tax Payment System (EFTPS) account. That way, you can make secure payments online or over the phone.
You also need to register with your state’s labor department. You will need a new hire reporting account to report new employees to the state. Depending on your business location, you might also need state and/or local ID numbers. And, don’t forget to get workers’ compensation insurance.
To set up payroll, you need to have information for each new employee, including name, address, and Social Security number. You will also need tax information, like their filing status and details on current deductions and contributions.
New employees must fill out Form W-4 (also known as a Personal Allowances Worksheet) to be set up in your payroll system. Form W-4 helps you determine how much federal income tax to withhold from each employee’s wages.
Employees will also need to complete Form I-9 when you hire them, but this form does not affect payroll. It does, however, confirm an employee’s eligibility to work in the U.S., so it’s important for hiring. Some states also require E-Verify, a system you can use to ensure employees are authorized to work in the U.S.
Don’t forget one of the most important parts of setting up payroll—pay rate and frequency. Will the employee receive hourly wages or a salary? And, how often will you pay them (weekly, biweekly, monthly)?
You will need an attendance management system for tracking employee hours, overtime, and paid time off. And, you need to know whether your employees are exempt or nonexempt. If the employee qualifies for exemption status, you do not pay them overtime. To find out more, consult the U.S. Department of Labor. Keep your payroll information organized to stay efficient and comply with legal requirements.
To run payroll, you need to know how you plan on paying employees. You can choose from a few different payment types, including checks, direct deposit, payroll cards, and even cash. If you pay via direct deposit, collect bank information from your new hires.
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In order to comply with the IRS when you run payroll, you need to get familiar with withholding payroll taxes. Every pay period, you will need to withhold taxes from each employee’s gross pay.
Though it might sound intimidating, handling taxes is easier when you know the types of taxes you need to withhold. And, you also need to know what to do with the money after you withhold it.
As a business owner, you are required to withhold taxes from employee wages. Withhold federal income tax, state and local income tax (if applicable), and FICA tax.
You must withhold federal income tax based on the number of allowances an employee claims on Form W-4.
The IRS’s Publication 15 is a great resource if you decide to learn how to do payroll manually. You can choose one of two income tax withholding tables to help you figure out the amount to withhold: the wage bracket method or the percentage method. Payroll software will automatically calculate taxes for you.
What does tax exempt mean on an employee’s Form W-4? In certain circumstances, some of your employees might be tax exempt, meaning you do not withhold federal income tax from their wages. The employee’s Form W-4 tells you whether an employee is tax exempt or not. They need to give you a new Form W-4 by the deadline each year to keep the exempt status.
Depending on what state you conduct business in, you might need to withhold state taxes from your employees’ wages. And, some localities require an additional income tax.
To find out if you need to withhold state and local income taxes from employee wages, you will need to check with your state.
FICA (Federal Insurance Contributions Act) tax includes two types of taxes: Social Security and Medicare taxes. Both the employer and employee contribute to FICA tax equally. That means that you will withhold a certain percentage from your employee’s wages and contribute a matching percentage.
Each year, the FICA tax rate is subject to change. Currently, the Social Security tax rate is 6.2 percent of each employee’s gross wages. Only wages up to $127,200 are taxed. The Medicare rate is currently 1.45 percent (on all wages) of each employee’s gross wages. Don’t forget, you also must pay 6.2 percent and 1.45 percent of the employee’s gross wages toward the employer portion! And, you must withhold an additional Medicare tax of 0.9 percent for employee wages over $200,000 ($125,000 if married filing separate or $250,000 if married filing jointly). There is no employer match for additional Medicare tax.
If you have employees, you also need to pay federal unemployment (FUTA) tax and state unemployment (SUTA) tax. But, you won’t withhold these taxes from employee wages.
Your state will let you know your SUTA tax rate. The FUTA tax rate is a percentage of your employee wages, up to a certain amount. Most employers pay .6 percent of the first $7,000 paid to each employee per year unless they live in a credit reduction state.
If you have a headache by this point, you’re not alone. Dealing with employment taxes can be difficult. But, fear not—you’re almost done with understanding the basics of how to handle employment taxes!
After withholding taxes, you need to file and remit them to government tax agencies. You must follow a depositing schedule, determined by the IRS, to figure out how often you pay taxes.
For federal income and FICA taxes, follow a semiweekly or monthly deposit schedule. Your schedule depends on your total tax liability reported on Form 941 during a four-quarter lookback period. You must deposit monthly if you reported $50,000 or less in taxes during the lookback period. If you reported more than $50,000 in taxes, you must deposit semiweekly. See the Form 941 instructions for more details.
Deposit FUTA taxes on a quarterly basis. Quarter due dates are April 30, July 31, October 31, and January 31.
You also need to report taxes on government forms. Report federal income tax and FICA tax (Social Security and Medicare taxes) each quarter on Form 941. You will also report FUTA tax on Form 940, which is due by January 1 each year.
For state and local income taxes and SUTA tax, you will need to get the scoop from your state. Check out the IRS’s Publication 15 for more information on depositing and reporting taxes.
Before you can hire employees, you do need to put work into the payroll setup process. And when you have employees, don’t forget to withhold, report, and remit taxes. To streamline payroll, you can always consider investing in a payroll software that fits your business needs. Some payroll software systems will withhold, deposit, and file taxes. All you do is enter the withholding information for your employees.
If you have questions, you can always contact your local tax agency. The IRS provides resources about employment taxes as well:
You might have thought it would be difficult to understand the legal requirements for hiring new employees and running payroll. But, you’re a business owner! You’ve gone through the wringer and decided to pursue your passion. Setting up payroll will be manageable as long as you have a clear outline of what to do.