Handbook / Hiring and growth

Payroll for a small business: setup, taxes, deposits and filings

Hiring your first employee means running payroll: paying wages, withholding taxes, sending them to the government and filing returns on time. It feels complicated at first, but it follows a regular cycle. This guide gives a plain overview; IRS Publication 15, the Employer's Tax Guide, has the detailed rules and current rates.

Employee or contractor first

Payroll applies to employees. Independent contractors invoice you and handle their own taxes. Classify workers correctly before you start; the guide to hiring your first employee covers the distinction, and subcontracting covers working with other freelancers.

Setup steps

1. Get an EIN from the IRS if you do not have one.
2. Register with your state for income tax withholding and state unemployment insurance, where required.
3. Collect forms from each new hire: Form W-4 for federal withholding, Form I-9 for employment eligibility (see Form I-9), and any state withholding form.
4. Report new hires to your state's new hire registry.
5. Check workers' compensation insurance requirements in your state.
6. Choose pay periods, such as weekly, biweekly or semimonthly.
7. Choose a payroll method.

What happens each pay period

1. Calculate gross pay from salary or hours worked, including overtime where it applies.
2. Withhold federal income tax based on Form W-4 and IRS withholding tables.
3. Withhold the employee share of Social Security and Medicare.
4. Withhold state and local taxes where they apply.
5. Subtract other deductions, such as benefit contributions.
6. Pay the net amount to the employee.
7. Record the employer's own share of Social Security and Medicare, and unemployment taxes.

The main federal employment taxes

According to the IRS overview of employment taxes:

• Federal income tax withholding is taken from employee wages.
• Social Security and Medicare taxes are withheld from employees, and the employer pays a matching share. Only the Social Security part has a wage base limit.
• Federal unemployment tax (FUTA) is paid from the employer's own funds, not withheld from wages, and reported on Form 940.

Publication 15 gives the current rates and limits.

Deposits

Withheld taxes and the employer share must be deposited on a schedule, monthly or semiweekly, depending on your past tax liability. Publication 15 explains how to determine your schedule. Deposits are generally made electronically, and the IRS's free EFTPS system is one option. Late deposits can lead to penalties.

Filings

• Form 941: quarterly federal employment tax return for most employers.
• Form 940: annual FUTA return.
• Forms W-2 and W-3: annual wage statements for employees and the Social Security Administration.
• State returns for withholding and unemployment insurance.

Ways to run payroll

Payroll software. You enter hours and the software calculates withholding, and many products also file and deposit.

Full-service payroll provider. Handles calculations, deposits, filings and year-end forms.

Accountant or bookkeeper. Useful if you want a person reviewing your setup.

By hand. Possible for one or two employees, but time-consuming and error-prone.

Whichever you choose, the employer remains responsible for making sure taxes are deposited and filed correctly. Review provider reports each quarter.

Records to keep

• employee names, addresses and Social Security numbers, stored securely
• W-4 forms
• dates and amounts of wages paid
• tax deposit records
• copies of filed returns

Publication 15 covers record-keeping requirements.

Paying yourself

Sole proprietors and single-member LLC owners generally take owner draws, not payroll wages. If you have an S corporation or C corporation and work in the business, you usually pay yourself wages through payroll. Speak to a tax professional before changing structure.

A simple payroll calendar

Set reminders for:

• each payday and the deadline to submit hours to your payroll system
• each federal tax deposit date under your schedule
• the quarterly Form 941 due dates
• state withholding and unemployment filings
• year-end Forms W-2 and Form 940

Reconcile payroll reports with your bank account after every run. Errors are easier to fix in the same quarter than at year end.

When to get help

Ask an accountant or payroll provider to review your setup before the first payday, and again if you add employees in another state or change your business structure.

Get an EIN and state registrations, collect W-4 and I-9 forms, withhold and pay employment taxes each pay period, deposit on schedule, file quarterly and annual returns, and consider a payroll service.