Let’s explore payroll in detail and provide the information you need to tackle it head-on.
Your employees are a valuable asset, and you want to compensate them accurately and reliably for their hard work. As an extension, payroll is a crucial part of operations for your small business.
When you hire your first employee, you’re now responsible for making payroll. But what does that mean and how do you make sure you take on this new responsibility in the right way?
On the surface, the payroll process is simple. You either pay employees a fixed salary or hourly.
The process, however, is much more complicated. There are tax considerations, new hire procedures, and local, state, and federal laws to comply with.
And then, you need to decide if you’re going to do it in-house or outsource the payroll process. Many small business owners outsource due to the complexity of it all.
While complex, the payroll process doesn’t have to give you a headache. Here’s what small business owners need to know about payroll.
What Exactly Is Payroll (and Payroll Taxes)?
When you bring on an employee and pay them, you’re not just writing them a check at the end of the week for their hard work. You pay them through your company payroll.
Payroll isn’t as simple as cutting a check every week or month. A lot of what makes payroll complicated are the taxes that need to be paid and withheld each pay period. As an employer, you’re responsible for paying and withholding payroll taxes from your employee’s paycheck.
Payroll taxes include:
Federal Insurance Contributions Act (FICA) taxes are social security and Medicare taxes that both the employee and employer pay. The government deducts and remits these taxes from every paycheck regularly throughout the year. Social security tax is 12.4% and Medicare tax is 2.9% of the earnings, split evenly between employer and employee.
Federal, State, and Local Taxes
An employee also has other taxes to pay, aside from FICA taxes. Your employee is responsible for paying federal, state, and local income taxes. These taxes are a percentage of their income, based on how much they earn.
Even though you don’t have to pay these taxes on behalf of your employee, you still have a job here. As an employer, you’re responsible for withholding these taxes from their paychecks and remitting them to the correct government agency. Your employee will fill out a Form W-4, which should provide you with the information you need to determine how much should be withheld from each of their paychecks.
Federal and State Unemployment Taxes
Both federal and state unemployment taxes are collected to fund unemployment insurance—a safety net fund out-of-work employees can use while they are looking for a new job. As an employer, it’s your job to pay these taxes. They aren’t taken from your employees’ paychecks, though the amount of tax you have to pay depends on how much your employees earn.
Each state has a different unemployment insurance tax rate. While the federal rate is the same for most states, businesses in some states can take a credit that lowers the federal unemployment tax that they need to pay.
Payroll for Small Business Owners: DIY or Payroll Service
Payroll is something you can manage yourself in-house or outsource to a payroll service.
If you want to handle the task of payroll on your own, be prepared for some extra math and record-keeping. You’ll need to:
- Collect and remit employee withholding forms: For each employee, you’ll need them to fill out Form W-4 to determine their federal tax withholding. Depending on the state you live in, you won’t necessarily submit this form. But you may be required to file a state withholding form. You can find a link to your state requirements here.
- Calculate gross pay for the period: This is a simple task for someone who is paid a consistent and regular salary, but it can get trickier when you pay someone hourly or on commission. You’ll need to re-calculate their pay each pay period, depending on the number of hours worked, the hourly rate, and any commissions or bonuses they’ve earned.
- Deduct applicable taxes: You’ll need to calculate and withhold the payroll taxes discussed in the previous section. You’ll also be required to remit taxes regularly to the appropriate government agency. For example, you’ll use Form 941 to pay the employer portion of social security and Medicare taxes.
- Deduct additional contributions: Your employees may have additional amounts that need to be deducted from their paychecks. This could include deductions such as 401(k) contributions or child support payments.
- File Form W-2: Each year, you’re required to send a W-2 Form to your employees detailing how much you paid them and how much was withheld from their paychecks for taxes and retirement.
If additional forms, filings, and calculations aren’t something you want to keep track of, you might decide to outsource to a payroll service provider. A payroll service provider usually takes the important employee information provided on Form W-4, any optional deductions, their payment, and compensation information, and handles the rest.
They’ll calculate gross and net pay for the period, deduct taxes and any other contributions, and file required tax returns. They’ll then manage the actual process of paying your employees either by direct deposit or by check. And at the end of the year, they’ll take care of filing each employee’s W-2 forms and sending them a copy.
What to Consider When Picking a Payroll Service
There are a number of good options to pick from when choosing a payroll service provider. But the option for you depends largely on your business needs.
Consider these things when making your selection:
- Integration with products you already use: Does the service integrate with programs you already use, like your accounting system and human resources (HR) system? A service that integrates with what you already use can make things operate more smoothly.
- Ease of use: Some services are more user-friendly than others. Picking a service with an easy-to-understand interface will make things easier for both you and your employees. A free trial or video tutorials can help you determine how easy it will be to use.
- Customer service availability: When you have questions, you want to know that your payroll provider will answer them quickly and correctly. Do they have a customer service team that’s easy to reach? What are the qualifications of their customer service agents?
- Security measures: How do they keep your employee data safe? Have they ever had any issues with data breaches? You’re trusting your and your employees’ sensitive information with this company, so don’t be afraid to ask questions to get comfortable with their security measures.
- Any additional services needed: Do you need your payroll service provider to do additional tasks, like making 401(k) deductions, offering multiple payment options like direct deposit and mailing paper checks, or keeping track of employee paid time off? Some services also offer other benefits beyond payroll that may be important to you.
- Cost: How does the pricing structure work? Is the cost per month or annual? Is it based on the number of employees? You want to find the right program for you, but at some point, cost is going to be a factor. Assess the cost of each option to make sure it’s something you can afford and that you’re getting the most use of benefits from the money you spend.
What If You Are Worried You Can’t Make Payroll for Your Small Business
At some point in the life of your business, you may worry about making payroll. Cash flow issues can be challenging for business owners, especially if this is your first time needing to make consistent and regular payroll payments to your employees.
If you’re worried about your ability to make payroll, you should take action quickly. Some things that might help include:
- Asking for longer payment terms from vendors: It’s difficult to choose between paying your employees and paying your vendors, though your vendors may be more accommodating if they need to wait an extra week or two for payment. Reach out to your vendors and ask if they can grant you an extension. Sometimes all you need is a few days to get the money you need to pay them.
- Collect receivables: One reason that businesses struggle with cash flow is that they aren’t collecting receivables in a timely manner. If you’re worried about missing payroll, check to see if there are any outstanding receivables you can collect quickly.
- Factor invoices: An option for a company with outstanding receivables in need of a short-term loan is to factor invoices. Factoring outstanding invoices means that a company will essentially buy them from you for a fee. You get the cash quickly, which can help you make payroll, but you get less than you would have you not sold them.
It’s a good idea to speak with your accountant about the options available to you. They can advise you about what makes sense to do given your financial situation and brainstorm new ideas to help ensure that you don’t need to worry about missing payroll in the future.
Gusto x FreshBooks Integration
FreshBooks doesn’t offer payroll services, but we do offer an integration with a partner we believe in: Gusto.
Gusto is an easy-to-use payroll, benefits, and HR software built specifically for small businesses. It offers full-service payroll, handling everything from payroll taxes to answering HR questions. Gusto also offers additional services, like health insurance plans, retirement plans, and the creation of employee onboarding handbooks.
The integration FreshBooks has with Gusto means better bookkeeping, easily. Import payroll data into FreshBooks for more accurate books.
Learn more about the FreshBooks and Gusto integration.
Payroll is a big responsibility. Getting it right will keep staff relations smooth, and encourage loyalty and trust on your team. It can be confusing at first. But soon payroll will just be another easy process for your small business.
Webinar: How to Stay Compliant While Growing Your Remote Team
This post was updated in July 2020.
about the author
Erica Gellerman is a CPA, MBA, content marketing writer, and founder of The Worth Project. Her work has been featured on Forbes, Money, Business Insider, The Everygirl, and more. She currently lives in Hawaii.