Payroll for Small Business Owners: The Definitive Guide (2019 Update)

Small business payroll is never a fun task. Usually, it involves an overwhelmed company owner—who has a million other tasks and to-dos at the forefront of their mind—struggling to make sense of payroll taxes and mandatory reporting, coming through time records and hour logs. In the best case scenario, you spend a ton of time and earn yourself a few gray hairs. In the worst case scenario, you get slapped a hefty fine from the IRS and lose a disgruntled employee over a late paycheck. Don’t let this be you! Use this guide to learn how to do small business payroll and make your life a whole lot easier. After this read, you’ll know more about how payroll works, how you should approach payroll processing, and why you might consider small business payroll services.

• What is payroll?
• How does payroll work?
• What are small business payroll taxes?
• How do I calculate payroll?
• How do I do payroll for my small business?
• When do I have to deposit employment taxes?
• Why use small business payroll services?

What is payroll?

Payroll is defined as the total amount of wages paid by a company to its employees. While expanding your bandwidth and adding members to the team can certainly help your business grow, it undoubtedly adds complexity to your former self-employed income. You’ll need to acquire an employer identification number, gather your employee’s information, distribute and collect appropriate tax forms, establish a regular pay period, track hours worked, calculate tax withholdings, plan your payroll processing… and that’s just the tip of the iceberg. According to 40% of small business owners, bookkeeping and taxes are the worst part of owning a small business. And that’s for good reason: it’s complicated. Don’t worry, we’re here to help.

How does payroll work?

Let’s say you’ve recently launched a startup company. After a few months, you’re beyond happy and relieved to witness the success of your fledgling business. To lighten your load and keep up with the demand, you’ve decided it’s the right time to hire additional help. After narrowing down applicants and finding the best fit, you extend the job offer and soon have your very first employee! As exciting as this chapter may be, you can’t neglect your new responsibility as an employer and need to learn the ins and outs of small business payroll. At this stage, it’s unlikely that you’ve hired a bookkeeper or accountant to handle your payroll, so the job’s on you to learn how to do payroll and ensure your new employee is justly compensated. If you think you’ll have room for growing pains as you figure out your new system, think again: 49% of employees will start looking for another job after only two payroll errors.

Here’s a step-by-step guide for setting up your small business payroll to ensure best practices:

1. Schedule a pay period

How often will your employees get paid? Depending on your industry, you might pay them weekly, bi-weekly, monthly, or bi-monthly. Laws vary state to state, so make sure you check with your local labor agency regarding which pay days you can use.

1. Distribute new hire forms

Within 20 days of hiring a new employee, you’ll be required to file IRS payroll tax information. Collect and submit a completed Form W-4 for hourly workers or Form I-9 for independent contractors (if your small business pays them an annual total of $600 or more). You can download these forms from the Bureau of Labor Statistics and you must keep them on record for a minimum of four years.

1. Determine tax withholdings

Independent contractors are responsible for their own income tax, but you’ll need to use Form W-4 to calculate how much federal income tax to withhold from employee paychecks during your small business payroll. You’ll also be tasked with ensuring your company and its employees contribute to Social Security taxes and Medicare taxes.

1. Pay employment taxes Businesses are required to pay the Federal Unemployment Tax (FUTA) along with applicable State Unemployment Tax (SUTA). These programs are designed to provide compensation to employees who have lost their jobs.
2. Know your penalties

Your employees aren’t the only ones you need to keep happy; deposit your payroll taxes accurately and on time to avoid stiff failure to file penalties issued by the IRS.

What are small business payroll taxes?

Incorrect tax filing penalties recently totaled nearly $5 billion—meaning the IRS takes their business seriously. Be mindful of these small business tax obligations and their corresponding due dates if you want to steer clear of expensive fines.

Annual wage and tax reporting

Taxable wages include compensation for services performed such as hourly or salary remuneration, bonuses, and gifts. Some forms of compensation, such as reimbursements for travel or meals, are not taxable. Gross wages equal the total amount paid to the worker before deductions (including benefits, taxes, and withholdings); the remaining amount is the worker’s “net pay”.  

Federal and state income tax

Within your payroll processing, you must withhold income tax from every employee paycheck. The amount of state income tax to be withheld, if any, depends on location. Nine states don’t collect individual income tax at all, others mandate a flat tax regardless of income level, such as Pennsylvania’s 3.07% tax, and it reaches as high as 13.3% in states like California. FICA taxes The Federal Insurance Contributions Act (FICA) requires employers to withhold Social Security and Medicare taxes from their employees’ wages. Employers are also required to contribute a matching FICA tax amount per employee. Federal and state unemployment taxes Employers must submit FUTA taxes if they pay wages totaling at least $1,500 in a quarter, or if they have at least one employee on any given day for 20 weeks in a calendar year. Check with your state’s unemployment agency to see whether you’re obligated to pay additional SUTA taxes. If so, you may be eligible for a tax credit that reduces your federal liability.  

How do I calculate payroll?

If you’re handling your own small business payroll, you might need a little accounting help. Learning how to calculate payroll can be tricky considering the various tax brackets and tax withholdings per employee. Use these percentages as a business guide to correctly calculate payroll taxes (as of 2019).

• Your small business payroll must withhold federal income tax according to instructions within IRS Publication 15-A. Pick the applicable pay period and wage bracket for your employee(s), then read across the table to the column that shows the number of allowances claimed in order to determine their withholding amount.
• State and local income tax vary by location. Do your research and seek payroll processing help to determine the additional amount you may need to withhold per employee paycheck.
• In 2019, the Social Security tax rate is 6.2% subject to income up to $132,900 (which grew from the 2018 income cap of $128,400).
• Medicare is taxed at 1.45% on the first $200,000 in wages. If your payroll processes an employee’s wages in excess of $200,000, they will be taxed at 2.35% (the standard 1.45% plus 0.9% additional Medicare tax).
• The FUTA tax rate is 6.0% for the first $7,000 paid to each employee as wages during the year. If your state requires additional unemployment tax, you may be entitled to as much as 5.4% (which reduces the FUTA tax rate to 0.6%).

How do I do payroll for my small business?

To complete your small business payroll, follow these steps:

1. Determine the amount of taxable employees; to ensure compliance, you must file the appropriate tax form for each employee and keep these records on hand should the IRS ever request them.
2. Determine the amount of each employees’ taxable wages. Be sure to carefully track the hours worked within a given pay period to avoid payroll mistakes.
3. Calculate the employee’s federal income tax withholding using the information on their Form W-4.
4. Calculate the employee’s FICA tax contribution.
5. Calculate your employer FICA tax contribution.
6. Calculate your employer FUTA tax and SUTA tax, if applicable.
7. Combine these figures to determine the necessary tax withholding for both your business and your employee.

Let’s take a look at an example to see how payroll works in action. Mark is scheduled 25 hours per week at a rate of $15 per hour. He is a single filer, claimed one allowance on his W-4, and lives in Florida where there is no individual income tax. His bi-weekly gross wages amount to $750. To calculate his federal income tax… Account for Mark’s allowance, then multiply his gross wages by his 12% federal income tax rate. ($750 – $208.17) x .12 = $65.02 To calculate his Social Security tax… $750 x 0.062 = $46.50 To calculate his Medicare tax… $750 x 0.0145 = $10.88 In total, Mark’s FICA taxes amount to $57.38. After his tax deductions, Mark’s total bi-weekly net pay equals $627.60 [$750 – ($65.02 + $57.38)], which you can then send to your bank for payroll processing. Note that if your company offered a retirement plan or health insurance, his paycheck would be further deducted; the same would apply if Mark had garnished wages for child support, back taxes, or another cause. Your small business payroll process is not yet complete though, since you’re still required to pay your contribution of employment taxes. To calculate your company’s portion of Social Security tax… ($750 – $208.17) x .12 = $65.02 To calculate your company’s portion of Medicare tax… $750 x 0.062 = $46.50 To calculate your company’s FUCA tax… $750 x 0.06 = $45 To calculate Florida’s SUCA tax*… $750 x 0.027 = $20.25 *Florida’s SUCA tax ranges from 0.1-5.4%; the tax rate for new employers is 2.7% as of 2018. Your company’s portion of payroll taxes adds up to $176.77 ($65.02 + $46.50 + $45 + $20.25), which you’re responsible for withholding and depositing to the IRS and state taxing authority by the appropriate deadline.

When do I have to deposit employment taxes?

There are two deposit schedules for income tax withheld and both the employee and employer FICA taxes: monthly and semi-weekly.

• Monthly Depositor: Deposit taxes on payments made during a month by the 15^th of the following month.
• Semi-Weekly Depositor: Deposit taxes for payments made on Wed., Thurs., and/or Fri. by the following Wednesday; deposit taxes for payments made on Sat., Sun., Mon., and/or Tues. by the following Friday.

You must determine which one your small business is required to use before the beginning of each calendar year. Regardless of the schedule your small business payroll follows, you must report your deposits quarterly or annually by filing Form 941 or Form 944. FUTA deposits are due by the last day of the first month that follows the end of a quarter using Form 940. If you fail to make untimely deposits, you may be subject to a penalty of up to 15%. You might also be assessed the Trust Fund Recovery Penalty Tax, which requires a 100% penalty be paid to the IRS when payroll taxes withheld from employees’ paychecks are not forwarded or improperly forwarded to the IRS. Reporting employment taxes in a timely manner is important; 40% of mid- to small-sized businesses incur IRS penalties related to incorrect payroll filings averaging $845 per year. That’s no small number when the fate of your startup hangs on the balance of thin profit margins.

Why use small business payroll services?

If this information seems like a lot to process, that’s because it is. That’s why so many turn to small business payroll services and the many benefits they offer.

The Benefits of Outsourcing Payroll

Accurate reporting

Accuracy is everything, and a small business payroll service can better guarantee the taxes you submit are correct and on time.

Employee satisfaction

As we noted earlier, employees have little patience for payroll processing—but an accountant with an eye for numbers will make sure no detail is overlooked.

Improved compliance

Worse than being fined, employers who do not comply with the employment tax laws may be subject to criminal and civil sanctions for failing to pay employment taxes. Hiring a trained professional who knows the ins and outs of the IRS tax system to handle your small business payroll helps improve your compliance.

Recovered time

Stop counting time cards and crunching numbers; enlist a small business payroll service that can do the grunt work for you and free up your administrative time.

Business growth

Apply your newly recovered time to what actually matters: growing your business and driving your profit margins.  

Community Tax Payroll Services for Small Businesses

According to a recent small business buyer’s report, purchasers are most concerned with the reporting functionality of their payroll service or accounting software. Whether reporting is your primary concern or you just want to spend less time on payroll, Community Tax can help. By enlisting the help of our bookkeeping service and team of experts—who have decades of combined experience filing taxes, summarizing earnings, organizing payroll information, and so much more—you’re guaranteed to have better financial reporting and feel significantly less stressed. Contact us today to see how we can help take control of your small business payroll, so that you can stop sweating your finances and start focusing on the future.