Finances and Taxes

How to do Payroll For Your Small Business: The Complete Guide

Andi Smiles Small business financial consultant 
woman working on laptop

Your business is growing. Exciting times are ahead, but before you can reap the rewards of extra help, you need to figure out how to do payroll. 

There are four ways to run payroll as a small business. You can:

  • Do payroll yourself
  • Use an online payroll service like Gusto
  • Hire an accountant
  • Hire someone to do it at your business

(If you already know how you want to run payroll, skip ahead to the corresponding section to learn exactly how to do it.)

This guide will explain how to do payroll manually, along with the biggest pros and cons of going with that approach. We’ll also reveal the other options you have if manual payroll isn’t your thing.

How to do payroll yourself

The only free payroll processing solution is to do payroll by hand. Payroll software, accountants, and bookkeepers all charge a service fee. 

If you don’t have extra funds to spend on a payroll service, the DIY approach can save you some cash. Doing manual payroll isn’t the most straightforward task, but armed with the right knowledge, time, and a sturdy calculator, you can do payroll for your small business yourself.

Here’s how to do payroll manually.

What you need to do before you start running payroll

It’s easy to get swept up in the idea of hiring your first employee, but there are a few things you need to do as a new employer before you ever start interviewing people. 

These are one-time tasks but need to be completed before you can run payroll. 

1. Get a federal Employer Identification Number (FEIN)

A federal employer identification number, commonly called an EIN, is a number the IRS uses to identify and track your business’s payroll tax payments and forms. It’s like a Social Security number for your business. 

If you’re running payroll, you’re required to get an EIN. Luckily, getting an EIN is free and easy. You can apply for one directly through the IRS website, and learn more in this EIN overview

2. Register with the Electronic Federal Tax Payment System (EFTPS)

A big part of running payroll involves paying payroll taxes on time. The EFTPS is a free payment system that lets you do just that, by allowing you to pay both your federal payroll taxes and federal unemployment taxes right from your computer. 

If you’re using a payroll service, then you can skip this step since they’ll send in your tax payments for you. 

Get started with the EFTPS here on their website. 

3. Register as an employer in your state

Before doing your own payroll, you’ll also need to register as an employer with your state. Every state has a different registration process and requirements;most states require employers to also register with agencies that collect tax information (like the state-specific Department of Revenue and Department of Labor), so check out your state small business registration requirements to get started. 

4. Learn federal and state labor and pay laws

When using an automated payroll service, you typically don’t need to have as much in-depth knowledge of pay and tax laws, since they’re usually already applied to the software.

But if you don’t, it’s important to know about relevant pay and labor laws before you run payroll. Some of these laws relate to things like how often you run payroll and what information you need to provide on your employees’ pay stubs. These can be tricky because there are federal, state, and even local laws you need to comply with. 

The general rule of thumb is that you must follow the law that provides the greatest benefit to your employees. For example, if the federal minimum wage is $7.25 per hour, but your city’s minimum wage is $15 per hour, you’ll pay your employee $15 per hour. 

At the very least, these are the payroll-related laws you should know:

If you use an online payroll service then you won’t have to go as in-depth with your research. Your payroll service can help you comply with things like pay stub requirements and state disability and local income tax withholdings.   

5. Choose your payroll schedule

Before you hire someone, you’ll need to decide how often you’ll run payroll. Don’t forget to check your state’s labor laws about payday frequency before making the call. 

6. Ask employees to complete new hire paperwork

After you hire your new employee, they need to complete new hire paperwork. These forms are mandatory and provide the details you need when you run payroll. 

Keep in mind that many online payroll services can handle this type of paperwork for you by enabling employees to electronically submit the required forms.

You need to collect:

Some payroll services send these forms to new employees via email and even let them submit their forms and documents electronically. 

7. Report your new hires to the state

The last thing you’ll need to do is to report your new hire to your state’s new hire reporting agency. Every state has its own new hire reporting agency and data requirements. 

Click into this PDF to view a state-by-state list of new hire requirements and agencies

You can typically skip this step if you’re using a payroll service, since most will report your new hires for you.

What do you need to have before running manual payroll?

Okay, you’re finally ready to run payroll! But before you do, it’s helpful to have a few things handy. 

  • Employee’s W-4: You’ll use this to reference your employee’s withholding allowance, which impacts how much taxes you’ll withhold.
  • Federal payroll tax withholding tables: The withholding tables are located in Publication 15-T
  • State or local payroll tax withholding rates: If you’re required to withhold state or local income tax, then you’ll also need your state’s tax tables or withholding rates. 

How to do payroll manually

At long last, it’s finally time to run payroll. When it comes to manual payroll, there are three main phases: 

  • Run payroll
  • Pay payroll taxes
  • File quarterly and annual tax forms 

Each phase has its own set of steps. While it may seem overwhelming at first, just focus on following the instructions one step at a time. 

Run payroll 

1. Calculate your employees’ gross wages

Gross wages are the total amount of wages that your employee earns, before payroll deductions like retirement contributions, health benefits, and payroll tax withholdings. 

How you calculate your employee’s gross wages depends on if your employee is an hourly or salaried employee. 

For hourly employees, multiply the total hours they worked in the pay period by their hourly wage. For example, if you pay Riley $15 per hour and they worked 64 hours in the bi-weekly pay period, here’s how you would calculate their gross wages:

$15 x 64 = $960

For salaried employees, divide their total annual salary by the number of pay periods you have throughout the year. For example, Riley’s yearly salary is $60,000 and you have 24 payrolls in the year. Their gross wage each pay period is $2,500.

$60,000/ 24 = $2,500

Gross wages also include:

  • Overtime pay
  • Sick and vacation pay
  • Bonuses
  • Commissions
  • Tips

If your employee has any of these during a pay period, you’ll need to add it to their base wages. 

2. Calculate your employees’ pre-tax deductions and subtract them from gross wages

Pre-tax deductions are payroll deductions that your employee volunteers to withhold from their paycheck. Common examples are:

  • Retirement contributions
  • Health benefits
  • Disability insurance
  • Commuter benefits

These deductions are subtracted from your employee’s gross wages before payroll taxes are calculated. That means they lower your employee’s taxable income. 

Let’s say Riley contributes $200 per pay period to their retirement plan and $100 per pay period to their health insurance premium. You would deduct these contributions from their gross pay:

Gross pay$2,500
Retirement contribution– $200
Health insurance – $100
Taxable gross wages*$2,200

*This number could be different depending on the type of tax because not all pre-tax deductions are exempt from all taxes. For example, health benefits are excluded from FICA payroll tax (more on that next) and federal income tax but retirement contributions are not excluded from FICA payroll tax. Be sure to double check what taxes your employee deductions are subject to. 

3. Calculate your employees’ federal tax withholdings and subtract it from their paycheck

Now that you know your employee’s taxable gross wages, the next step is to calculate and withhold mandatory payroll taxes. These are the employee’s portion of payroll taxes. Later, you’ll figure out your share. 

There are two types of federal payroll taxes:

  • FICA payroll tax (FICA)
  • Federal income tax (FIT)

FICA payroll taxes

FICA payroll taxes go towards your employee’s Social Security and Medicare. The total tax is 15.3% of the employee’s taxable gross wages. Employees are responsible for paying half (7.65%) of the tax, and you, the employer, are responsible for the other half (7.65%). 

Here’s how your employee’s portion is allocated:

  • Social Security tax: 6.2%
  • Medicare tax: 1.45%

Even though employees pay half of their FICA payroll taxes, you’re responsible for subtracting their payment from their paychecks and sending it to the government. 

Here’s how you would calculate FICA payroll taxes from Riley’s paycheck:

Gross pay$2,500
Health insurance – $100
Taxable gross wages (FICA)$2,400*
Social security tax (6.2%)– $148.80
Medicare tax (1.45%)– $34.80
Net pay after FICA payroll taxes$2016.40

* Wait! What happened to the retirement contribution deduction? Retirement contributions are taxable for FICA payroll tax, which is why we haven’t deducted it from Riley’s gross pay. 

Seems easy enough, right? Well, there are two important things to be aware of: 

  • The Social Security wage base: There’s a cap on the number of wages subject to Social Security tax, which is called the Social Security wage base. In 2020, the wage base is $137,700. If your employee earns more than $137,700, then you won’t withhold Social Security tax on wages over $137,700.
  • Additional Medicare tax: If your employee earns more than $200,000 in taxable gross wages, they’re required to pay an additional tax of 0.9% on wages over $200,000. 

These special cases mean that you need to keep careful track of how much you pay your employees throughout the year.

Federal income tax

Fall in love with modern payroll

There are two methods for calculating your employee’s federal income tax withholding:

  • Wage bracket method
  • Percentage method

If your employee earns more than $100,000 annually, then you can’t use the wage bracket method and instead, need to use the percentage method. If your employee earns less than $100,000 per year, then you can use either method. The wage bracket method is simpler than a percentage method, so if you have a choice, this will be the easier option. 

In 2020, the IRS released a new W-4 form for employees. How you calculate employee withholdings will vary based on the type of W-4 your employee uses. There are three different ways to calculate an employee’s withholding:

  • Wage bracket method for employees with a W-4 from 2020 or later
  • Percentage method for employees with a W-4 from 2020 or later
  • Percentage method for employees with a W-4 from 2019 or earlier

Refer to IRS Publication 15-T for detailed instructions for each method. We’ll be doing our example based on the Wage bracket method for employees with a W-4 from 2020 or later.

Step 1: In this step you’ll adjust the employee’s wage based on the information on their W-4. You’ll account for any additional income or deductions that your employee has listed on their W-4. After you take all of these factors into account, you’ll have your employee’s adjusted wage amount. 

Let’s say Riley expects to make $12,000 in dividend income during the year. They don’t plan to claim any additional deductions. The process looks like this:

Taxable gross wages$2,200
Number of pay periods24
Other non-employee income (annual amount is listed on Riley’s W-4, under Step 4, line 4a)$12,000
Other income accounted for during current pay period (divide the total annual income by the number of pay periods)$500
Adjusted Wage Amount (add their taxable wages to their other income)$2,700

Step 2: Now that you know your employee’s adjusted wage amount it’s time to figure out their tentative withholding amount. To do this you’ll need to know:

  • Your pay frequency 
  • The employee’s filing status 
  • If your employee checked the box in Step 2 of Form W-4
Step 2: Multiple Jobs or Spouse 
Works (IRS Form W-4)

Then, open IRS Publication 15-T and find the wage bracket table that corresponds with your pay schedule, the employee’s filing status, and their adjusted wage amount. 

For example, you file payroll on a semi-monthly basis and Riley is a single filer and didn’t check a box in Step 2. According to the wage bracket table, the tentative withholding amount is $304. 

IRS Wage Bracket Table

Step 3: Next you’ll account for additional tax credits, like your employee’s dependents. Look at your employee’s W-4 and line 3 of Step 3. This is where your employee claims their dependents. 

Step 3: Claim Dependents (IRS Form W-4)

Divide the number on line 3 by the number of pay periods. Then, subtract that total from your employee’s tentative withholding amount from Step 2. 

Here’s how it works for Riley, who has one child under 17.

Amount from Step 3 on Form W-4$2,000
Number of pay periods24
Tax credit for current pay period (divide the amount from Step 3 by number of pay periods)$83.33
Adjusted withholding amount (Tentative withholding amount from Step 2 less the tax credit)$220.67

Step 4: You’re almost there! The last step is to add additional withholdings that your employee requested on their W-4. To find this information, go to Step 4, line c of your employee’s W-4.

Step 4 (optional): Other Adjustments (IRS Form W-4)

Add that number to the adjusted withholding amount from Step 3. The total is the final withholding amount. 

For example, Riley has requested that an additional $50 is withheld from their paycheck every pay period. Step 4 looks like this. 

Additional withholding from W-4$50
Adjusted withholding (from Step 3)+ $220.67
Employee’s withholding for the period$270.67

Now let’s put that all together to calculate Riley’s net pay after their federal income tax withholdings.

Gross pay$2,500
Retirement contribution– $200
Health insurance – $100
Taxable gross wages (FICA)$2,400
Taxable gross wages (FIT)$2,200
Social security tax (6.2%)– $148.80
Medicare tax (1.45%)– $34.80
Net pay after FICA payroll taxes$2,016.40
Federal income tax withholdings– $270.67
Net pay$1745.73

4. State income tax and other state taxes

Depending on your state, you may also need to withhold state or local income taxes from your employees’ paychecks. Some states even require that you withhold additional state taxes. 

Check with your state’s labor department to learn what you need to withhold. 

5. Calculate other voluntary and mandatory payroll deductions and subtract from paycheck

There are other voluntary and mandatory payroll deductions you may withhold after taxes. An example of a voluntary post-tax payroll deduction are the employee’s union dues, which they are electing to pay. 

Mandatory payroll deductions are deductions you’re  required to withhold and that the employee doesn’t opt-in to. These are called wage garnishments and they’re deducted from your employees’ paychecks.

Garnishments can be for unpaid child support, delinquent student loans, unpaid taxes, credit card debt, and unpaid medical bills.

The government will notify you if your employee has a wage garnishment. The notification will tell you when to start and end the garnishments, how much to withhold, and where to send the funds. 

Then you’ll subtract the wage garnishment from your employee’s “disposable earnings.” Disposable earnings are your employee’s earnings after mandatory payroll deductions but before their voluntary deductions, like retirement contributions and health insurance. The definition of disposable earnings varies by state. In some states, health insurance is part of disposable earnings. Check with your state’s payroll department for their definition of disposable earnings.

Let’s say you’re required to garnish 15% of Riley’s earnings. Here’s how you would calculate Riley’s paycheck:

Gross pay$2,500
Social Security tax (6.2%)– $148.80
Medicare tax (1.45%)– $34.80
Federal income tax withholding– $270.67
Disposable earnings$2,045.73
Wage garnishment (15%)– $306.86
Net pay after taxes and garnishment$1,738.87
Retirement contribution– $200
Health insurance – $100
Net pay$1,438.87

6. Pay employees and record payroll totals

After you’ve calculated each employee’s paycheck, it’s time to pay them. 

If your state requires that you provide a pay stub (which most states do), be sure to include a pay stub with their paycheck.  Also, be sure to check on your state’s pay stub requirements. Some states have strict pay stub requirements.

Here’s an example of a pay stub:

Example of a Gusto Earnings Statement

This is also an excellent time to record the payroll totals for each employee. This comes in handy later when you’re paying payroll taxes and filing out your quarterly and annual forms. 

For each employee record their:

  • Gross pay
  • Voluntary deductions
  • FICA payroll taxes
  • Federal, state, and local withholdings
  • Wage garnishment totals

7. Calculate federal employer payroll taxes

As an employer, you pay two types of federal employer taxes:

  • FICA payroll taxes
  • FUTA payroll tax

You pay half of FICA payroll taxes, which is 7.65% of their gross pay. 

The Social Security wage base applies to both employees and employers. Once your employee’s wages exceed the wage base, you don’t need to pay Social Security tax. 

The Additional Medicare tax is only imposed on employees. That means you’re not responsible for paying more Medicare tax after their wages exceed $200,000. Instead, you’ll continue to pay 1.45%. 

The other employer tax is FUTA tax, which goes towards federal unemployment insurance. FUTA tax is 6% on each employee’s first $7,000 in wages. After your employee earns $7,000, you no longer pay FUTA tax. 

If you pay your state unemployment taxes on time, you’ll receive a 5.4% federal tax credit. This lowers the effective FUTA tax rate to 0.6%. Some employers may have to pay more in FUTA tax is they are in a state with an outstanding federal loan balance. These employers will not receive the full 5.4% credit. Check with your state’s payroll agency to find out your FUTA tax rate. 

Here’s how you’ll calculate your federal employer taxes for Riley (our example from above):

Taxable gross wages$2,400
Employer portion Social Security tax (6.2%)– $148.80
Employer portion Medicare Tax (1.45%)-$34.80
FUTA tax (0.6% on first $7,000 wages)– $14.40
Total federal employer taxes$198.00

8. Calculate state employer taxes

All states require that you pay state unemployment tax (SUTA). This tax goes towards funding public unemployment programs. 

Each state has its own SUTA tax rate. In most states, the SUTA tax varies based on your employee’s total wages and how many employees you’ve laid off in the past. 

Usually, when you register as a new employer in your state, you’ll receive your SUTA tax rate. 

Some states require that you pay additional employer taxes. Be sure to check with your state’s labor department to find out what taxes are required. 

9. Put money aside to pay the government 

After you’ve calculated the employee’s and employer’s portion of payroll taxes, it’s time to put those funds aside. 

Later, you’ll send the money to the IRS and state government, but for now, transfer it to a savings or payroll account for safekeeping. 

Pay payroll tax 

Payroll doesn’t end when you hand your employees their paychecks. Remember that money you put aside for safekeeping? Now it’s time to send those funds to the government.

1. Pay federal payroll taxes

As an employer, you’re required to send both your employee’s tax withholdings and your employer taxes to the IRS. 

Exactly when you pay your federal payroll taxes depends on your deposit schedule. There are four types of deposit schedules:

  • Quarterly
  • Monthly
  • Semi-weekly 
  • Next-day

Your deposit schedule is based on your payroll tax liability for the previous quarter or look-back period. A look-back period is a 12-month period that ends on June 30. 

For example, to determine your deposit schedule in January 2020, the look-back period is July 1, 2018 – June 30, 2019. You’ll need to know the total payroll taxes you paid during the look-back period. 

Here’s how to know which deposit schedule you’ll follow and when your deposits are due:

Deposit scheduleQualificationWhen deposits are due
QuarterlyYour total payroll taxes are less than $2,500 in a quarterDue with Form 941: April 30, July 31, October 31, January 31
MonthlyYour payroll taxes for the look-back period were $50,000 or less
You’re a new employer and didn’t have employee’s during the look-back period
By the 15th of the following month
Semi-weeklyYour payroll taxes for the look- back period were more than $50,000For payrolls paid on Saturday, Sunday, Monday, or Tuesday, deposits are due by the following Friday
For payrolls paid on Wednesday, Thursday, or Friday, deposits are due by the following Wednesday
Next dayYou accumulate  $100,000 or more in payroll taxes during a monthly or semiweekly deposit periodNext business day deposit and you must make deposits based on the semi-weekly schedule for the remainder of the year and for the following year

To pay your taxes, you must pay through EFT that you initiate through your bank or pay via Electronic Federal Tax Payment System (EFTPS). Monthly and semi-monthly depositors are no longer allowed to mail in their tax payments. 

2. Pay FUTA tax

Fortunately, the FUTA tax payment schedule is more straightforward. If your FUTA tax is more than $500 in a quarter, then you’ll deposit the tax on the last day of the month after the quarter ends. 

QuarterDeposit tax by
January 1 – March 31April 30
April 1 – June 30July 31
July 1 – September 30October 31
October 1- December 31January 31

If your FUTA tax is less than $500 in a quarter, then you’re not required to make a tax deposit. Instead, your unpaid tax liability rolls over to the next quarter. Once your total unpaid FUTA tax exceeds $500, you’ll make a deposit for that quarter.  

If your FUTA tax never exceeds $500, then you must pay the total amount due by January 31 of each year. 

3. Pay state, city, and local taxes

Just like the IRS, each state has its own deposit schedule for payroll taxes. Check with the appropriate state or local agency in your city and state to find out when and how you’re required to deposit your state and local taxes.

File quarterly and annual tax forms

The final step to running payroll manually is to file the required tax forms with the federal and state government. 

1. File Form 941

As an employer, every quarter you’re required to complete IRS Form 941, Employer’s Quarterly Federal Tax Return. This form tells the IRS how much money you withheld from your team’s paychecks and the amount of employer taxes you paid for the quarter. 

Most employers are required to file Form 941. The only exceptions are:

  • Businesses with seasonal employees 
  • People with household employees
  • Businesses with farm employees
  • People who have received a notification that they’re required to file Form 944 instead of Form 941

Form 941 is due on the last day of the month following the end of the quarter. If you make timely online payroll tax deposits in full throughout the quarter, then you have an additional 10 days to file the form. This changes the due date to the 10th of the second month following the end of the quarter. 

You can submit Form 941 online or download the form, fill it out digitally, and mail it to the IRS.

2. File Form 940 

Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return is an annual form that you use to report your FUTA tax payments to the IRS. 

You’re required to file Form 940 if either of these statements is true:

  • You paid at least $1,500 in employee wages during the year
  • You had an employee work for 20 or more weeks during the year. (The 20 weeks don’t need to be consecutive.)  

Form 940 is due on January 31 and covers the previous tax year. If you made on-time FUTA tax payments, then you have until February 10 to file the form. 

You can file Form 940 online or download the form and mail it to the appropriate address (see Form 940 instructions for a list of mailing addresses). 

3. File Form W-2

The Form W-2 Wage and Tax Statement is an annual form that you’ll complete for each employee. 

It reports your employee’s yearly wages, deductions, and tax withholdings. You send the copies to your employees, the Social Security Agency, and your state, city, or local tax department. Your W-2s must be submitted by January 31 every year. 

There are several options when it comes to preparing and filing your W-2s. You can purchase the forms from an office supply store and complete, print, and mail them yourself. Or you can use an online filing service, which electronically files the forms with the right agencies and sends copies to your employees. 

4. File state tax forms

Depending on your state, you might also need to file quarterly or annual tax forms reporting your payroll tax withholdings and payments. Again, check with the appropriate state/local agency for the details.

Other options if you don’t want to do payroll by hand

Whew! That was a lot of steps. Does payroll get easier? With practice, yes, but most of these steps will be repeated on an ongoing basis. So while it might get easier, it will still take a chunk of your time.

Is there a way to run payroll that doesn’t involve lengthy calculations and piles of paperwork? Yes! 

Here’s how to do payroll in a more time-efficient way:

1. Use online payroll

How does payroll software work? Online payroll services, like Gusto, take care of tax calculations, tax payments, and filing quarterly and annual forms for you. 

Instead of putting money aside for your tax payments every time you run payroll, payroll software debits your tax liability from your account and makes state and federal tax payments on your behalf.  

Every quarter and year, payroll software like Gusto completes and submits your tax forms and even sends W-2s to your employees. 

Your only job is to enter the time each employee worked and approve payroll. The automated payroll service takes care of the rest. 

Most payroll software offers the following features, which simplify the payroll process:

  • Calculates employee and employer federal and state tax withholdings 
  • Automatically files payroll taxes and returns
  • Tracks employee’s paid time off and benefits
  • Sends new hire paperwork digitally and reports new hires on your behalf
  • Generate annual tax forms, like your employee’s W-2, and submits copies to employees and appropriate government agencies

2. Hire an accountant to take it off your plate completely

If you want absolutely nothing to do with payroll after reading this article, hiring an accountant or payroll specialist is the way to go. 

When you hire an accountant, someone trained to process payroll takes over. 

The drawback to hiring an accountant is that it often costs more than using a payroll service. Also, because payroll is outsourced, it may take longer to get your payroll questions answered. 

3. Hire someone to do it at your business

If you’d rather keep payroll in-house, but don’t want to do it yourself, you can hire someone to do it at your company or delegate payroll to an existing employee

Ideally, you would hire someone with payroll experience, but you could also train an in-house bookkeeper or administrative person to take it over for you. 


And that’s what you need to know about how to do payroll for your small business! And if it’s too complicated to do payroll yourself (we get you), know that you have plenty of options to help you take it off your plate.

Andi Smiles
Andi Smiles Andi is a small business financial consultant and coach who teaches business owners to take control of their finances. She’s helped hundreds of self-employed folx organize and understand their business finances, while also uncovering their emotional relationship with money.

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