Everything Small Business Owners Need to Know About Payroll

Is payroll giving you a headache? We explore payroll in detail and give you the information you need to tackle it head-on.

Your employees are a valuable asset, and you should compensate them for their hard work. And so, payroll is a crucial part of your business operation.

On the surface, the payroll process is simple. You either pay employees a fixed salary or hourly – after factoring in their hourly wage.

The process, however, is much more complicated. There are tax considerations, new hire procedures and local, state and federal laws.

And then, you need to decide if you’re going to do it in-house or outsource the payroll process. Indeed 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.

In this post, we explore payroll in detail and give you all the information you need to tackle it head-on:

  • We look at the pertinent factors you must consider when calculating payroll.
  • We provide a step-by-step process to calculate it.
  • And, we show you how you can manage it.

A quick disclaimer: We refer to payroll in the U.S., but the same procedures apply regardless of where you stay. Just familiarize yourself with your local laws.

Let’s get to it!

What You Need to Know About Payroll

Net pay is but one aspect of payroll. You must also consider taxes, new hire procedures, minimum wage, employee status and record keeping. That’s not to mention the federal, state, and local laws.

1. Payroll Taxes

As an employer, for payroll taxes, you are responsible for withholding the tax from the employee’s paycheck. You then need to submit tax to the various tax agencies.

Tax includes:

  • Federal tax which varies depending on which bracket employee’s fall into. Consult the 2017 withholding tables in publication 15 if you are uncertain.
  • Social security tax
  • Medicare tax
  • State income tax
  • Local taxes such as school district taxes

2. New Hire Procedures

You should familiarize yourself with the following when hiring new employees:

a. You need to give new hires the correct forms to fill out. These include the Employee’s Withholding Allowance Certificate (Form W-4). The form will help determine the federal tax portion.

Do take note that you don’t need to submit this form in some states. In fact, you may need to submit other forms. Here are full State Tax Instructions to determine which tax withholding form you need.

b. You must submit employee information to a state agency within 20 days.

c. The state agency uses the information to determine if employees can work in the country and if they need to make other contributions such as child support payments.

3. Minimum Wage

The minimum wage laws differ amongst states. Abide by these laws or risk penalties. Paywizard provides a full breakdown of federal and state minimum wage laws. If your state minimum wage is higher than that of the federal rate, the state rate is applicable.

Similarly, what you pay employees depends on their status or classification.

4. Employee Classification

You can classify employees as exempt or nonexempt. Nonexempt means they qualify for minimum wage and overtime if they work more than forty hours. Exempt means they don’t qualify for overtime, and minimum wage laws do not apply to them.

Beyond that, you also need to understand the difference between an employee and an independent contractor.

An independent contractor is a self-employed person who you don’t pay through payroll whereas, an employee is.

Incorrect classifications can lead to mistakes in payroll. For example, if you classify an employee as an independent contractor they won’t get the benefits they’re entitled to. Benefits include employment insurance, family leave and overtime.

5. Record Keeping

You are also required to maintain accurate records. In the U.S., the Fair Labor Standards Act (FLSA) dictates how long you should keep records for and where to keep them.

Some documents to keep include employee contracts, time cards, and records of deductions.

You should now understand all payroll considerations.

But, how exactly do you calculate payroll?

How to Calculate Payroll

Here is a six-step process for calculating payroll. It starts from when you onboard new employees.

Step 1: Complete the Forms

Ensure your new hires complete the correct forms such as the Form W-4.

Step 2: Check the Forms

Make sure your employees sign the forms and that they are complete. Forms that aren’t signed aren’t valid.

Step 3: Calculate Net Pay

You need to calculate gross income. For those earning a fixed salary, it’s easy because it won’t differ from period to period.

When it comes to people who aren’t on a salary: Take the number of hours worked, multiply it by the hourly wage and add any overtime or commissions. For example, if they worked 60 hours at a wage of $50 and had $500 commissions, their total pay would be $3500.

Tip: Define the pay period. Is it weekly, twice-monthly or monthly?

Step 4: Deduct Taxes

Apply those tax tables we shared earlier to determine how much federal state tax to withhold.

You can get state tax from your state’s revenue department website.

Finally, apply medicare and social security tax. Both are a fixed percentage of an employee’s income.

Step 5: Deduct Other Contributions

Are there any other voluntary or mandatory contributions you must apply? Voluntary contributions included 401(k) contributions and mandatory contributions include child support.

Step 6: Check Final Figures

The final amount (gross income – tax and other deductions) is the net pay, and that’s what your employees receive. Review figures to check for accuracy.

Payroll can be daunting. But, do you need to manage it yourself? No!

How to Manage Payroll

Here are three ways to manage payroll:

1. Do It Yourself by Hand

Doing it yourself may save money, but it’s time-consuming and increases the chances of mistakes.

That’s not to mention that it takes away from time you could spend on other high-growth activities.

2. Use Contractors

Contractors provide the entire service for you. The downside? you relinquish control, and it costs more. But, the extra cost is worth it as they save you time and give you peace of mind.

Having your finger in every pie of your business isn’t always the best thing. In fact, it only causes unnecessary stress.

3. Use Payroll Software

Software is the best option if you want a nice balance between doing it yourself and using a contractor. You regain control, save a lot of time (as there’s no paperwork), and you don’t pay a fortune.

But how do you narrow down your choice of payroll software among the many options online?

When sourcing a provider think about features, cost, support, ease of use, security and reviews.

One great software solution is Gusto. They simplify the many tedious tasks involved in payroll:

  • You can run payroll on a recurring schedule according to your needs.
  • It calculates local, state and federal tax for you
  • Employees can onboard themselves. They have their own login to access pay stubs and applicable forms.

Gusto is a FreshBooks partner and trusted by 40,000 companies across 50 states.


When it comes to payroll, there’s a lot to consider. It’s not only about calculating the gross income of employees.

Tax, new hire procedures, laws, the minimum wage and the correct employee classifications are all factors.

Get to grips with that and payroll calculations will be a breeze. It’s a simple case of taking net pay and deducting taxes and other contributions from gross income.

It’s even easier when you decide to outsource payroll to a contractor or, better yet, use payroll software.

You’ll be wondering why payroll ever gave you a headache in the first place.

What does your payroll process look like? How do you calculate it?

about the author

Freelancer & FreshBooks Customer Nick Darlington is a FreshBooks customer and small business owner who's been running a writing business for close to four years now from his home in sunny South Africa. When he’s not sharing his knowledge and experience about how to successfully run, manage and grow a small service business, he’s helping aspiring and established writers succeed at WriteWorldwide.