Running payroll for the first time is a momentous event for any small business owner. Not just symbolically, but because calculating payroll taxes is complicated and the legal implications of making a mistake can be steep. It’s not the kind of business responsibility you want to get wrong. That’s why small business owners must have a clear understanding of payroll prior to hiring their first employee.
How to set up payroll
When setting up payroll for your small business, you’ll find a lot of details come down to whatever payroll system you’ve chosen to implement. We’ll get more into those in a minute, but first, here are a few general steps for setting up payroll.
Step 1: Do your research
Before you hire a new employee, review local and federal labor laws. These will help you figure out if the position you had in your head, including compensation and benefits, is legal. One resource to check out is the Fair Labor Standards Act (FLSA), which pertains to overtime pay, minimum wage, and more. Reviewing information like this will help you create your business’s payroll policies.
Step 2: Choose a payroll system
Even before you’ve officially hired for your open position, it helps to know how that employee will be paid. There are a few different options when it comes to payroll systems, from hands-on to hands-off. But more on that in a minute.
Step 3: Gather your employee’s payroll information
Once you’ve officially offered them the job, your new employee will need to provide you with payroll-related documentation. Have them fill out a W-4, an I-9, and state withholdings. You’ll also need information from them related to employee health insurance and retirement savings if applicable. If you plan to offer direct deposit, collect your employee’s banking information as well.
Step 4: Set a pay schedule
Whether you decide to pay your employee biweekly, semimonthly, or on a completely different cadence, you’ll need to set up a pay schedule. Just be sure that schedule is compliant with local, state, and federal regulations. Note that employees are typically paid several days after a pay period ends to allow time to calculate hours and withholdings.
Step 5: Run your first payroll
The only way to know if you’ve set everything up correctly is to put your payroll plan in motion. Practice processing your first payroll, including calculating withholdings, deductions, and benefits like overtime pay. Then, ask your bookkeeper or accountant to check your work. If everything looks good to go, you’re ready to run your first payroll.
Choose a payroll system
Choosing a payroll system is critical for setting up payroll, because it’s the method that will guide your process each pay period. Determining which one to use may come down to convenience, budget, and necessary features.
1. Manual payroll
Manual payroll is any process of running payroll by hand. It includes everything from pen-and-paper records to using an Excel spreadsheet template.
- Price: In regard to cost of materials, manual payroll is easily the most affordable option. Even if you don’t have Excel, Google Sheets is a free spreadsheet option for those who prefer to record payroll digitally.
- Control: Running payroll by hand means you naturally get a lot of insight into your payroll expenses. You’ll never be the last to know if payroll costs have gone up, because you likely recorded them yourself.
- Liability: Calculating your own payroll means doing everything yourself, including remembering all the components that must be calculated, from Medicare to unemployment taxes. Forgetting can lead to serious financial consequences.
- Errors: Manual payroll can sometimes lead to more miscalculations, recording errors, and inconsistencies, since all the data is entered by hand.
- Time: Entering and calculating payroll information yourself is highly time consuming. Most people save themselves hours each pay period by switching from manual payroll to a payroll software.
2. Do-it-yourself payroll software
Do-it-yourself payroll software looks different from product to product, but noteworthy features generally include direct deposit, digital payroll records, and integration capabilities. If you’re tracking time electronically, you may be able to connect that software to your payroll, eliminating the need to transcribe employee time cards.
- Time savings: If you’re going from manual payroll to payroll software, you’ll notice a significant difference in time saved.
- Lower price: Do-it-yourself payroll typically costs a lot less than full-service payroll software, while still giving you access to the most important benefits.
- Calculations done for you: Most payroll programs calculate payroll taxes for you, eliminating stress and cutting down on potentially costly errors.
- Add-ons: Because this is the most basic payroll software option, there’s a good chance if you want anything extra, you’ll have to pay for it.
- Labor: Compared to full-service payroll, this option may be less intuitive and require more hands-on work from business owners each pay period.
3. Full-service payroll
Full-service payroll typically implies an all-in-one solution, meaning everything you need is included. Depending on the product, users might enjoy features like automatic payroll tax deductions, automated tax filing, digital pay stubs, and same-day direct deposit.
- Easy to use: Full-service payroll combines tools that work together, so tracking and approving time, running payroll, and paying employees is one seamless process.
- Fewer mistakes: Because everything from tax calculations to employee time card approvals is done digitally, there’s less chance of human error.
- Liability: Full-service payroll takes into account state and federal payroll regulations, helping business owners avoid liability issues. This often includes automatic deductions and calculations for overtime pay, benefits, payroll taxes, insurance withholdings, and more.
- Price: You might be surprised to learn there is a full-service payroll software that fits your budget. Some software providers start as low as $20 per month, depending on the size of your team. This option is more expensive than manual options, but less expensive than fully outsourcing.
- Tech-savvy: Unlike paper-and-pen payroll, mastering a full-service payroll software can be intimidating to those who don’t feel very technology-savvy. Fortunately, most software solutions have a customer service team and online tutorials.
4. Outsourced bookkeeper
Outsourcing payroll to a bookkeeper is the most hands-off payroll solution available. In this case, it’s the bookkeeper, not the business owner, who calculates employee time and payroll taxes and updates payroll records.
- Less stress: If calculating payroll yourself makes you nervous, handing the task to someone else can help reduce anxiety each pay period.
- Business expertise: Bookkeepers can help you with more than just payroll. Many bookkeepers can provide invaluable advice based on what they know about the business’s financials.
- Efficient transparency: If you have a payroll software as well, consider sharing your login information with your bookkeeper. Your bookkeeper can still run payroll for you, but you’ll be able to view payroll reports and employee data whenever you need.
- Less control: When someone else is in charge of your payroll, you may find there are times when you don’t fully understand your overall financials. You’ll want to meet with your bookkeeper regularly to eliminate any confusion.
- High price: Hiring a bookkeeper is an investment in your business that typically impacts more than just payroll. Still, some business owners choose not to hire a bookkeeper, based on cost.
Running payroll for your small business
How you run payroll will depend on the payroll system you’ve chosen. We suggest checking out this 2020 guide to processing payroll or even this introduction to payroll guide. Both can walk you through the finer points of running payroll for the first time.
Stay on top of payroll taxes
Payroll taxes are easy to forget but really hard to ignore once the IRS realizes your mistake. If you’re using a payroll software, see if you can set up automatic payroll tax deductions, so you don’t neglect them. If you’re running payroll manually, set reminders for yourself each pay period so you never fall behind.
Keep documentation of payroll expenses
Keeping accurate records of payroll expenses and other factors isn’t just beneficial for you—it’s the law. To ensure compliance, consider digitizing your records and keeping copies of them on the cloud so they aren’t lost or damaged. As for the kind of records required, here are a few examples listed by the FLSA:
- Employee’s full name and social security number
- Time and day of week when employee’s work week begins
- Basis on which employee’s wages are paid ($9 per hour, $440 a week, piecework)
- Total wages paid each pay period
Running payroll for the first time is a major undertaking, but it’s also a huge win. With an eye to compliance, documentation, and detail, you’ll soon have a handle on this important task. Just don’t forget to celebrate what it means when you’re done: your business is growing, one employee at a time.
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