Pay Up! 10 Steps to Establishing a Payroll Process (Part 1)

Starting a business is a rewarding experience, and your employees would likely agree. The reward they’re thinking of, however, is a steady paycheck. How do you get started? Which taxes apply to which employees? Where does the money go, and when does it have to be there?

Whether you have one employee or 1,000, the process for implementing a payroll system is the same. In this two-part blog series, we’ll walk through the 10 steps you need to take.

1. Know what you’re up against.
As an employer you shoulder a lot of responsibility, especially when it comes to employee compensation. Not only do you have to figure out the proper way to pay your people, you have to withhold the appropriate taxes, deposit them and report them to the government. Having a firm grasp on these responsibilities and why they are important will help you stay up-to-date and in compliance.

2. Get your IDs in order.
Before you start hiring employees, you must first obtain an employer identification number (EIN) from the Internal Revenue Service (IRS) by filing a Form SS-4. Applying for an EIN can be done online or by phone. Also, there are some states and local governments that require separate ID numbers in order to process taxes.

3. Understand the different kinds of employment taxes.
Not all taxes are created equal. Knowing which ones you will be required to deduct from your employees – and where the money is supposed to go – is of vital importance.

These taxes are:

• Federal income tax
• State income tax (depending on the state)
• Local taxes (if applicable)
• Federal and state unemployment taxes
• Social Security and Medicare taxes

4. Gather employee paperwork.
During the onboarding process, each new employee must fill out a Federal Income Tax Withholding Form (W-4) and return it to you. Doing so will ensure you’re taking out the right amount of federal income tax from each paycheck. Employees are also required to submit Form I-9, which verifies work eligibility.

Note: Federal and state agencies require certain documents to be retained for a specific period of time, and not having this information on file can lead to fines and penalties.

5. Classify your employees.
Employees can be classified as exempt, non-exempt or independent contractors. Understanding the difference means knowing how to report income, withhold and pay taxes, and handle overtime for each group. If you are unsure about the designation of any employee, it is recommended that you seek the advice of a trusted HR professional.

Exempt – These are typically salaried employees who are not eligible for overtime compensation. Be careful in using this distinction though—you cannot assign someone an arbitrary title to avoid paying them overtime if they do not perform relevant duties. The U.S. Department of Labor keeps a close eye on employers in this regard, and penalties for non-payment of overtime can be quite severe.

Non-exempt – This includes hourly employees who qualify for overtime compensation. Remember that for hourly employees, overtime is at least 1.5 times the pay rate for every hour worked beyond the standard 40-hour workweek.

Independent contractor – Outside consultants are often hired to assist with specific projects, and are responsible for paying most of their own payroll taxes. They are, however, required to fill out a Form W-9 and submit it to you.

Note: As a general rule, if you do not control an employee’s day-to-day activity and are issued an invoice or a bill for the work they perform, the employee can be treated as an independent contractor.

Once you’ve obtained your employer tax ID, learned the payroll ropes and gathered the necessary information from your employees, you’re well on your way to preparing your first payroll. In the next installment of this two-part blog series, we’ll take a look at the final steps. Stay tuned!

 

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