Payroll en_US Learn why using a payroll service helps small business owners save time. Read about why using technology allows you to manage payroll as you grow. What are payroll services? Should your small business use one?

What are payroll services? Should your small business use one?

You know the old cliche … time is money. Nowhere is that more true than with payroll.

To succeed as a small business owner, you need to focus your time on creating great products and services for your customers as well as minimize the time you spend on administrative tasks.

Payroll is the most time-consuming accounting task. And the work gets more complex as you add employees. Staff turnover, new hires, and changes in tax withholdings make every payroll period different. All businesses, including small ones, will benefit by outsourcing this complicated process to a payroll services firm.

Not sure if an outsource payroll service is right for you? Well, think about all the work that’s required to process payroll.

Five steps for payroll processing

If you’re just getting your small business off the ground and the time has come to hire employees, be aware that payroll includes at least five steps:

1. Data collection

When an employee is hired, you need to collect withholding tax information on Form W-4. Employers must withhold federal and state income tax, and may withhold dollars to pay for company-provided benefits.

2. Calculating net pay

The net amount of employee pay is the gross pay less tax withholdings, less any benefit payment withholdings. You’ll also calculate withholdings for Medicare tax and Social Security tax (FICA tax).

3. Payments

You must pay the employee’s wages by check, or via online direct deposit to a bank account.

4. Reporting

A tax filing for federal tax and state tax withholdings must be submitted to the IRS and the state department of revenue. Retirement plan contributions, state unemployment payments, Medicare taxes, and Social Security taxes are reported to other entities.

5. Withholding payments

All of the tax and benefit payments must be forwarded to the taxing authorities, retirement plan firms, and to other benefits providers.

Keep in mind that your business must address changes to payroll, which complicates the process and requires more time. You also must determine if each worker you hire is an employee or an independent contractor.

Payroll is a moving target, which is why a payroll service is such a great time-saver.

Why use a payroll service?

Processing payroll is difficult because the inputs to calculate net pay change constantly.

Managing the inputs

How do you stay on top of these changes?

  • Hiring: Workers may change their W-4 information, due to a marriage, having a child, or to increase withholdings after a salary increase.
  • Tax withholdings: Federal, state, and local tax laws may change frequently, and you may need to change tax withholding rates every year.
  • Employee benefits: If you offer health insurance, or a retirement plan for employees, you must withhold more dollars from each worker’s pay. Benefit withholding rules can also change, which requires changes in payroll.

If you manage payroll changes in-house, you can free up hours of time by handing off the payroll system to an online payroll service.

Moving to an online payroll service can be a two-step process. The first step is to use accounting software, then to integrate your records with a payroll service.

Use technology and avoid using spreadsheets

Accounting using spreadsheets is a terrible idea, both in terms of the time invested and higher costs. It’s an especially bad idea for payroll, which involves so much detail. Here’s why:

Input errors

You run a high risk of making input errors with spreadsheets. Accounting software maintains payroll information electronically, which reduces the need to enter data.

If Sally’s gross pay is $50,000 and you process payroll 26 times a year, her gross pay is $1,923.08 each payday ($50,000 / 26). When you access your software to run payroll, $1,923.08 will be listed as gross pay for Sally. You don’t have to manually enter the number, or copy the amount from another spreadsheet cell.

Incorrect links and formulas

Spreadsheets require you to link data between cells and to manage formulas on multiple spreadsheet tabs.

More manual work can result in more errors.

Think about a spreadsheet with separate columns from gross pay, federal tax withholding, state tax withholding, health insurance premium withholdings and net pay. If you have 15 employees, each worker will have a number in each of the 5 columns.

That’s 75 pieces of data that may be input incorrectly, and information that may be generated with an incorrect formula.

Current version

We’ve all been working on a spreadsheet for 15 minutes, and then realize that we’re not using the latest version. The risk increases when more than one person processes payroll.

If the administrative assistant inputs data for new hires and the owner handles the payroll calculations, there’s a risk that the owner pulls the wrong spreadsheet.

As your business grows, you may have several people working on human resources, and they will interact with the accounting department on payroll issues. To minimize confusion, payroll reports must be processed using software.


You can’t integrate a spreadsheet with software applications very easily. If you can’t integrate data, you’ll have to do more input manually.

With software, you can integrate payroll data with you bank accounts and pay workers electronically. You can also transmit your payroll data to your accountant firm, so they can prepare your tax returns.

Moving to accounting software can make your life easier, but you’ll still need to update data in the system, and spend time on payroll each pay period.

How a payroll service can help

You use vendors that provide products and services to make your life easier.

Your IT firm handles data security and cloud backup. You let your attorney manage the legal issues of operating your business. Using a payroll service is a must-have, particularly if you’re in growth mode and adding employees.

Payroll companies will help you determine each worker’s classification.

Contractors and tax withholdings

The IRS provides a guide that explains how to assign each worker as an employee or independent contractor. Rather than plow through the IRS rules each time you hire someone, get help from your payroll service.

When your business has a great deal of control over the work performed by a worker, that individual is an employee. If the worker completes a task with little supervision, the independent contractor label will likely apply.

You must issue a 1099 form to each contractor who is paid at least $600 during the calendar year. If a self-employed worker is paid less than $600, the earnings are still taxable as income, even though a 1099 is not issued.

Don’t rely on calendar reminders to manage payroll taxes and deposits. Hand off the tasks to your payroll service.

Submitting tax deposits

Your Employer Identification Number (EIN) is used on each of your federal tax deposit forms. If you pay your tax deposits on time, you’ll avoid payroll tax penalties. Small business owners must pay deposits for these taxes:

  • Federal and state taxes on income
  • Federal Insurance Contributions Act (FICA)
  • Federal Unemployment Tax Act (FUTA)

FICA tax includes taxes to fund Medicare and Social Security. Your firm may also need to pay workers’ compensation insurance premiums each year-end. Tax withholdings are reported on Form W-2, and depositing the taxes withheld requires several steps.

Income tax and FICA tax deposits

The IRS requires business owners to make federal income tax deposits and FICA tax deposits.

Your payroll service uses the information in IRS Publication 15 to determine how often you must submit tax deposits. The dollar amount of your tax liability determines when you make deposits, and you report the taxes withheld on Form 941.

A payroll service is particularly valuable if you pay workers in multiple states.

State income tax deposits

The payroll services will check with each state’s department of revenue to verify the tax deposit process. Most states have EFT systems to accept tax deposits electronically.

Each state income tax rate may be different. If you employ workers in multiple states, the payroll service will confirm each income tax rate, and the process for depositing taxes.

Check with an accountant to determine if you need to collect any local taxes on payroll.

FUTA tax deposits

Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA) were passed to provide temporary income for workers who lose employment, generally when the employee is not at fault.

Small businesses pay unemployment insurance taxes through a joint program between the federal government and the states. Employers are the primary source of tax revenue. FUTA taxes are calculated and reported on Form 940.

Your payroll service can make the payments and complete the tax forms on your behalf.

Completing tax returns

Payroll tax returns are complex, and the information you submit must be accurate.

If you submit tax returns late, you may be subject to a late filing fee. To file your returns accurately and on time, use a payroll service to complete these forms.

  • Federal income tax and FICA returns: Form 941, which reports federal income and FICA taxes, is filed quarterly on these dates: April 30th, July 31st, October 31st and January 31st (for the fourth quarter of the previous calendar year).

  • State income tax return: Check with your state to verify the state income tax return due date. In many cases, the states use the Form 941 quarterly due dates.

  • FUTA tax return: The FUTA tax return is typically due on January 31st of the following year.

A payroll service can also provide the required tax forms to your workers.

Tax reporting to workers

You must follow IRS guidelines for issuing W-2 forms to employees, and for providing 1099 forms to independent contractors. Businesses also submit W-2 and 1099 data to the federal government.

Your firm is ultimately responsible for all of the information on each employee’s pay stub, including employee benefits.

Business recordkeeping

The Fair Labor Standards Act (FSLA) states that payroll records must be kept on file for a minimum of three years. The act also lists the specific information that must be kept by the employer, including records of hours worked and overtime pay earned by hourly employees.

To get the most out of your payroll service company, you need a process to submit your employee information.

Handing off information

If you’re already using payroll software, you can efficiently gather employee data (name, social security number, gross pay) and transmit the information to the payroll service firm automatically. Companies that still use spreadsheets must input the data manually, and you should avoid that situation.

Your role is to provide the data, and to submit the employee bank accounts needed to process payroll. The vendor will link to your firm’s bank account, and pay employees by direct deposit, based on your instructions.

The payroll service also issues manual payroll checks, generates your tax filings, and submits tax deposits.

Every routine task you perform should be documentation in a procedures manual.

Document your payroll process

Your manual should list each routine task, how the task is performed, and who is responsible for completing the work. A procedures manual clarifies how you do business, and reduces confusion about your operation. The manual is also a great training tool for your staff.

It’s particularly important to have a reliable system in place to make your tax deposits on time and avoid late submission penalties.

If you use a payroll service, growing your business is much easier. Here’s what to do next.

Next steps

Start the process by eliminating as much manual payroll work as possible.

Use an accounting software package to automate the payroll process. Automation makes the process easier, even if your basic payroll only requires tax withholdings.

Talk to business peers and accountants about your payroll options, and if they can recommend a payroll service firm. Interview the firm and make sure that you understand how their payroll process works. You also need a company that offers great customer support.

Once you hire a payroll service firm, document each of the tasks required in a procedures manual.

It takes some effort, but the payoff is huge. Use a online payroll service to free up your time, and to grow your business with confidence.

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Ken Boyd is the Co-Founder of, and owns St. Louis Test Preparation ( He provides blogs, videos and speaking services on accounting and finance. Ken is the author of four Dummies books, including Cost Accounting for Dummies. Read more