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The complete guide to small business payroll
Payroll is one of the more stressful parts of running your own business. The last thing you want is to make a mistake paying the team that works hard to keep your business going—and mistakes can cost you big with the tax department.
Whether you’re paying yourself, hiring your first employee, or confused by contractor payroll, we’ve got the answers to your questions in this guide.
What’s covered in this guide:
- When a payroll system is a good choice
- Types of payroll systems and how to choose
- Setting up your business for payroll
- Understanding payroll costs
- Employees vs. independent contractors
- Common employment and payment terms
- Ending or interrupting employment
- Onboarding new hires to payroll
- When payroll taxes apply
- Different kinds of payroll taxes
- Where and when to pay and report payroll taxes
- Common payroll tax forms
- Why payroll bookkeeping matters
- Types of payroll journal entries
- Recording payroll in a general ledger
- Balancing and reconciling payroll
- Submitting third-party remittances
- Important dates for payroll
- Quarterly and annual actions to take
- End of year actions to take
- Payroll tax thresholds for 2019
Chapter 1: Planning for payroll
When you launch a business, taxes and the other intricacies of payroll probably aren’t the first thing that comes to mind, especially if you’re going into business by and for yourself. But payroll is a big part of the financial and administrative side of entrepreneurship.
Whether employees are the furthest thing from your mind or you’re planning to hire a hundred people tomorrow, it’s good practice to start thinking about and planning for payroll well before it becomes a burden.
In this chapter, we’ll talk about:
- Whether or not you need a payroll system,
- The types of payroll systems available to you,
- Setting up your business for payroll, and
- Understanding the true costs of payroll.
Let’s jump in!
Who needs a payroll system?
Before we get too far, let’s figure out if you actually need a payroll system in the first place. Not every business does.
While it’s rarely a bad idea to use a system to run payroll, it does usually have a cost, so it’s important to weigh whether or not a payroll system is right for your business. Here are a few things to consider:
1. What type of business are you running? And do you have employees?
The first thing to consider when deciding whether or not you need a payroll system is the type of business you’re running and who you’re paying. If you’re paying employees or contractors, a payroll system can provide clear benefits (more on those below).
If you don’t have employees, that’s where it gets a bit trickier. Payroll systems are helpful when you’re paying yourself wages—in that case you need to consider the same things as if you’re paying wages to other employees.
If you’re not paying yourself wages, you won’t need a payroll system.
So how do you know whether or not you should be paying yourself wages? It depends on the type of business you’re running:
- Sole proprietorship
If you’re running a sole proprietorship or partnership, you aren’t supposed to pay yourself wages, so you don’t need a payroll system. On the other hand, if you’re running a corporation or an S corp, you can be a shareholder (or owner) and earn wages. In this case, you might want to pay yourself wages—an accountant can help you decide—and, if you do, a payroll system could benefit you.
For some small business owners, there are benefits to being taxed as an S corporation (or S-corp) including limiting your self-employment tax liability. There also disadvantages and additional costs that vary from state to state, so It’s best to talk this over with your accountant or tax adviser.
If you choose to go the S corp route, you can pay yourself a set salary that incurs all the same payroll taxes as an employee. In that situation, it’s often easier to use a payroll system to pay yourself.
Once other people are involved, though, there’s more riding on a smooth and timely payroll process, plus other factors (like paid time off and benefits) enter the mix. So when you start hiring employees other than yourself, it’s a good idea to formalize and automate a payroll system that can handle all of that.
2. Is your time worth more than the cost of a payroll system?
Most small business owners aren’t human resources professionals or tax accountants. That means running payroll yourself can eat up lots of time that’s better spent on growing your business. New businesses can be tight on time and money, but if you have more wiggle room on the financial side, a payroll system is a good idea.
3. Are you worried about making mistakes?
Some parts of running a business lend themselves to learning as you go. You can afford to make mistakes and learn by trial and error. Payroll really isn’t one of those things.
Last year, the IRS charged over $6 billion in fines and penalties related to employer payroll tax issues, and the largest portion of those went to small businesses. If you aren’t super confident in calculating payroll and paying taxes by yourself, it’s best to err on the side of caution and invest in a system to do it for you.
What types of payroll systems are available?
If you’re still reading, chances are a payroll system is right for your business. But what kind? Most payroll systems fall into three categories:
- In-house payroll,
- Payroll software, and
- Outsourced payroll service.
Outsourcing to a payroll service
An outsourced payroll service is just what it sounds like: a third-party company you pay to handle your payroll system from end to end. Your role would then be to collect information—hours, salary changes, time off—which you’ll hand off to the service provider who will take care of tax withholding, deductions, and all the other intricacies of payroll.
The chief benefits of outsourcing to a payroll service are:
- Saving you, the business owner, time: If you aren’t an HR pro, your time is better spent on other parts of the business. Outsourcing payroll enables you to do just that.
- Worry-free compliance: As your business grows beyond just you, payroll can quickly take on complexity. When you outsource to payroll experts, you can rest assured that your business will comply with all the applicable taxes and processes.
On the flipside, the cost of a third-party payroll service can add up quickly as your business grows. And rigid packaging and offers mean you might end up paying for more than you really need—especially when your business is just getting started.
In-house payroll and payroll software
In-house payroll is what you may have experienced if you’ve worked for a larger company. An internal department dedicated to managing and reporting on payroll—as well as paying applicable federal, state, and local taxes—for the whole company.
Handling payroll in-house can look very different for small businesses, though. By using payroll software, you can manage and run your own payroll (even as your business grows) without eating up your time or adding unnecessary frustration.
There are a lot of benefits to using payroll software to manage payroll within your own company:
- Customize your payroll system: Instead of being locked into a third-party’s rigid system, you can customize your payroll process to whatever your business’ unique needs may be.
- Easy scaling: Software also makes it effortless to scale up (or down) and add more employees as you bring them on.
- Integration with other software: The best payroll software integrates seamlessly with other solutions you have in place, too (like accounting and bookkeeping software.)
One important thing to keep in mind when looking at payroll software is cost. Some payroll solutions can get pricey as your business scales, so it’s important to do your research upfront and find the best software for you.
Choosing the best payroll software for your small business
Speaking of, when it comes to choosing the right payroll software for your business, there’s a lot to consider. After all, jumping from one solution to another isn’t ideal—you want this to be a long-term relationship. You need a solution that works for you now and can grow with your business later.
Here’s what to consider while you evaluate your options for payroll software.
What does your business need?
- Employees: The number of employees you’ll be paying determines which software is best for you and how much it will cost. Don’t forget to consider both how many employees you’re paying now and how many you aspire to in the future.
- Integrations: The best software works seamlessly with your other solutions, so look for a payroll solution that integrates with those you already use.
- Employees versus contractors: Payroll is different depending on whether workers are classified as employees or contractors (more on that in Chapter 2), so look for software that supports both.
What features does the solution include?
- Tax filing support: Not all states make it easy or possible for payroll solutions to do the actual tax filing for you, so if you feel you need tax support that’s something to consider when you’re choosing a provider.
- Direct deposit: Direct deposit is the easiest and fastest way to pay your employees but not every payroll software supports it and some may charge extra for it.
- Vacation and bonuses and benefits: Payroll involves more than just hourly wages. Look for a solution that can account for other things like paid time off (PTO), annual bonuses, and benefit withholding.
- Data storage and security: Your employees’ payroll data doesn’t just disappear after each payroll run. It has to be stored somewhere and kept safe. The best payroll software takes care of both storage and security.
How much can you afford?
- The base monthly or annual cost: Most payroll software starts with a base fee that covers your account or subscription.
- Additional costs: On top of the base fee, you’ll pay an additional set amount per employee and/or per payment run. It’s important to know about any extra features that aren’t included in the base price, and how much they’ll cost, too.
Setting up payroll
Whether you choose to outsource payroll to a third-party provider or handle it in-house with the help of payroll software, there are a few things you need to do in order to set your business up for your first payroll run.
The first step involves getting your business, itself, set up for payroll. Then you’ll need to gather all of the required information that both payroll software and third-party payroll providers will need in order to run your payroll.
Setting up your business so you can run payroll
Setting your business up for payroll includes a lot of steps you may have already done when you originally registered your business. If you’re just launching a business, you’ll need to follow all the steps below. If you’ve already done one, just skip ahead.
Step 1: File a “doing business as” (or DBA)
If you’re planning to use anything other than your own name as the name of your business, you’ll need to file a “doing business as” (or DBA) in order to legally register your business under that name.
The same goes if you’re registering your business as a limited liability company (LLC) or a corporation and you don’t want to include “LLC,” “Inc.” or “Co.” in your business’ name—you’ll need to file a DBA.
Either way, you’ll need your completed DBA in order to run payroll. Start by checking with your local county clerk’s office, your state’s filing office, and the U.S. Patent and Trademark Office’s database to ensure your chosen name isn’t already being used.
If you’re in the clear, head to your town or city clerk’s website to find out how to file your DBA.
Step 2: Register for your federal and state tax IDs
To run payroll, you’ll need to have all the necessary federal, state, and local tax ID numbers. This is how the government identifies your business for tax purposes and verifies you’re paying all the required payroll and other taxes—like a social security number for your business. Depending on your state you might need an EIN in order to run payroll, while in other states running your first payroll is required to get your EIN.
Getting your federal tax ID (also called your employer identification number, EIN, or FEIN) is one of the easiest parts of starting a business. Just head to the IRS website and fill out the application.
Step 3: Get a state unemployment tax account (known as SUTA in most states) number and rate from your state government and a withholding ID
Every state in the U.S. requires you to pay unemployment taxes. Unlike some other payroll taxes, you (the employer) pay a hundred percent of unemployment tax (except in three states where the employee pays a portion: Alaska, New Jersey, and Pennsylvania), and your rate will vary depending on your state and a number of other factors.
The best place to find out how to register for your SUTA number is your state government’s website. While there, check to see if your state requires one tax ID number or two. Once you register for your SUTA number, the state government will determine your SUTA rate.
You also need to get a withholding ID number from the government that administers a withholding tax so that you can make your filings against that number (44 states have a unique withholding number while six don’t: Alaska, Florida, Nevada, South Dakota, Texas, and Washington).
Step 4: File for S corp status (optional)
We touched on the benefits of registering as an S corp above. If you decide an S corp is right for your business, you’ll need to register as one before you run payroll (even if you’re the only employee.)
Luckily, filing for S corp status isn’t too complicated. Just fill out IRS Form 2553 and file it with the IRS.
What information do I need to set up payroll?
Now that your business is registered and right with all the important government agencies, the next step is to simply gather all the information that both a payroll service provider or payroll software will need.
Most of these are self-explanatory, so we’ll keep this one short. Here’s what you need:
- Your company’s legal name, address, and DBA (if you filed one)
- All of your tax ID numbers including:
- Federal employer identification number (EIN)
- State tax withholding ID number
- State unemployment tax ID number (SUTA/SUI)
- Local tax ID numbers (where applicable)
- Your SUTA rate information
- Personal information for all employees, including:
- Social security number (SSN)
- Tax filing status
- Details on deductions and contributions
- Details on pay rate (hourly or salary and the amount) and frequency (how often you run payroll or cut paychecks) for each employee
Understanding payroll costs
When you first start thinking about hiring employees, you know it won’t be cheap. With minimum wages and entry level salaries on the rise across the globe, you go into the hiring process with a certain cost in mind. What many small business owners forget to account for is the additional costs that come with managing and running a payroll system.
What goes into that additional cost?
- Payroll taxes: We’ll cover more on these in Chapter 3.
- Workers compensation: Workers’ comp is a type of insurance that enables employers to pay for medical bills and other expenses that happen as a result of an injury on the job. The amount varies widely from state to state, but most states require employers to carry this insurance. Nationwide, the average rate in the U.S. is 1.85% of the employee’s salary.
- Additional state and local taxes: Your state, or local municipality may charge additional payroll taxes.
- Any software and services: Like we talked about above, a payroll software or third-party service provider will cost your business money. This can be on a monthly or annual basis and will usually go up as you add more employees or frequency to your payroll.
In addition to salaries and wages, it’s important to keep all of these extra costs in mind when planning and budgeting for payroll and new hires.
Planning for payroll
Planning for and setting up a payroll system for the first time can be intimidating for a new business owner. But with the right information and advice, you can make the best decision for your business—and with the best payroll software, it all gets easier from there.
Chapter 2: Paying employees and contractors
Once you have a system in place for managing and running payroll for your business, you’re good to go, right?
The reality is that paying employees and contractors is about a lot more than just setting wages and handing out paychecks every two weeks. In fact, just figuring out whether your current workers are employees or contractors (and which kind of worker is best for your business) is one of the first and most important parts of managing payroll.
In this chapter, we’ll cover everything you need to know about paying employees and contractors, including:
- The difference between an employee and an independent contractor,
- Common employment and payment terms you’ll need to decide on,
- What happens when employment is ended or interrupted, and
- All the requirements and reporting you’re responsible for when a new hire joins the team.
And we’re off!
Employees vs. independent contractors: What’s the difference?
One of the first questions you have to answer when looking for help for your business is whether to work with employees or independent contractors. If that seems like semantics, be assured that it isn’t. How the people you work with are classified has big implications for things like payroll taxes and benefits—and the IRS is pretty strict about who falls into which category.
So how can you tell an employee from an independent contractor? BizFilings had this to say:
Your workers are employees if you have the right to direct and control them in the way they work, both as to the final results and as to the details of when, where, and how their work is done.
Basically, an employee works for you while a contractor does work for you. Contractors are typically brought in when the work to be done is very project-based—when you need a particular task done. Employees, on the other hand, are responsible for myriad, ongoing tasks.
The key factors the IRS uses to differentiate the two are control and independence. They break it down into three main buckets:
- Behavioral control: Do you decide both what and how the worker does their job? For example, do you set working hours or mandate that the worker come into an office?
- Financial control: Are payment terms and methods controlled and decided by you or the worker?
- Type of relationship: Here, the IRS considers things like employment agreements (a contract), if the worker receives benefits, and the length of the working relationship.
If that sounds complicated, it typically isn’t. When you work with a freelancer or independent contractor, their status is usually spelled out from the get-go in your service agreement.
It’s important to note, though, that the IRS considers all workers employees unless you have evidence to the contrary. That’s why it’s always important to use a detailed contract and keep a copy on hand come tax season.
If you’re really unsure whether a worker falls under employee or contractor status, you can submit Form SS-8 to the IRS for an official determination.
Employment and payment terms
Once you’ve decided between working with independent contractors (or freelancers) and hiring employees, there’s more to decide—like whether you’ll pay them a set salary or on an hourly basis, how many hours they’ll work, and how often you’ll run payroll.
Part-time vs. full time vs. contract employees
When the times comes to hire some help, it’s important to take stock of your business’ needs and figure out if part-time, full time, or contract help is what you need right now.
While the difference between part-time and full time work seems pretty self-explanatory, there isn’t a concrete line between the two.
The U.S. Bureau of Labor Statistics defines full-time work as 35 or more hours per week. However, the Affordable Care Act considers anyone who works more than 30 hours per week a full-time employee.
The distinction is important because part-time employees typically don’t receive benefits like health insurance, paid time off, or retirement plans. While you’re still responsible for paying the same payroll taxes on their wages, those benefits can have a big impact on your payroll process.
Contract employees, on the other hand, can work any number of hours per week, but their employment is usually tied to a set time period (say, six months).
At the end of that period, you can either terminate the employee or you may choose to bring them on as a full or part-time employee. During the contract period, workers are most often paid hourly, not eligible for benefits, and you aren’t responsible for payroll or withholding taxes on their wages.
Hiring employees on a contract basis can make sense in some scenarios. If you’re in need of help for a season (like retailers and shipping companies during the holidays) or on a particular short-term project or initiative (like a new product launch), a contract worker can add a much needed extra set of hands without crippling your overhead when things slow down again.
Smaller businesses and startups also use contract-to-hire terms to help feel out new employees before investing in bringing them on full time and providing benefits.
Paying employees a salary or an hourly rate
The next decision you’ll make when hiring someone new is how to pay them: hourly or salaried. First, let’s explain the difference.
Salaried employees make a fixed, annual amount. That number gets divided up between each pay period of the year (more on those later!) Most full time, white-collar jobs are salaried.
The key thing to remember with salaried employees is they make the same amount of money regardless of whether they work 20 hours one week, 60 the next, and exactly 40 the next. Because of this, most salaried employees aren’t eligible for overtime pay, so their paycheck is the same for every run.
Hourly employees, on the flip-side, earn pay for however many hours they actually work—think service workers (like housekeepers), blue-collar workers (like construction), and interns.
When you hire hourly workers, you set an hourly rate, and their pay is simply the rate times how many hours they worked during that pay period. If you choose to pay hourly, it’s important to ensure your chosen rate complies with all federal and state minimum wage requirements.
Hourly workers are usually eligible for overtime and their paychecks can vary any amount from one payroll run to the next.
If you expect to need a new hire to work fewer than 40 hours each week, it’s usually best to pay them hourly. If you’re worried about paying overtime hours, a salary may be the better option.
In today’s competitive job market, hourly pay (and the instability and uncertainty that come with it) can also make it harder to attract talented employees, so it’s important to consider what prospective candidates want and expect with each role, too.
Payment schedules and their benefits
Now that you’ve decided how to pay employees, it’s time to figure out how often to pay them. Your payment schedule simply means how often you run payroll and send out paychecks.
There are four main payment schedules:
The vast majority of today’s businesses pay on either a semi-monthly or bi-weekly schedule, so for our purposes here, we’ll focus on those two. If you’re thinking they sound like the same thing, you’re far from alone. There are a few distinct differences, though, that can mean a lot for both your business and your team.
On a semi-monthly payment schedule, you run payroll twice each month (or 24 times per year). Employees are typically paid on either the 1st and 15th of the month or the 15th and 30th or 31st.
This schedule makes it easy from a bookkeeping and benefits perspective because both of these usually run monthly—so it’s easier to reconcile with payroll. For employees, semi-monthly paychecks also make it easier to plan for bill due dates and expenses, since they’re always paid on the same date.
The main drawback to this schedule is that not every paycheck is exactly the same amount. Some months have more days than others, so the hours included in each pay run can vary somewhat.
A bi-weekly payment schedule means you run payroll every two weeks, usually on the same day of the week (every other Friday, for example).
Bi-weekly payroll always includes 80 hours of work for full time, salaried employees. That means every check is the same—making it easier for both you and your workers to budget for. A stable number of hours in each payroll run makes it simpler to account for overtime hours, too.
The main drawback here is that the date of payroll isn’t consistent from one month to the next. Some months also end up having three pay periods instead of two—making your annual total closer 26 or 27 and sometimes pushing up payroll costs.
Benefits that affect payroll
Earlier, did you decide to work with full time employees over part-time workers or contractors? If so, you’re legally required to provide certain benefits like:
- Health insurance
- Dental insurance
- Vision care
- Life insurance
- Paid time off (including vacation, sick leave, parental leave, and more)
- Retirement plans like a 401(k) or 403(b)
The cost of benefits like health insurance and retirement contributions is most often split between your business and the employee. That’s important come payroll time because those are pre-tax deductions—meaning you take the employee’s portion of the cost out of their gross pay before you take taxes out.
Most payroll software and third-party payroll services can handle benefit deductions and tax withholding for you, but it’s best to have a working understanding just in case.
New hire requirements plus quarterly and annual reporting
Whenever you hire a new employee or start work with a new freelancer, there are several requirements you need to follow to ensure the employment relationship complies with the IRS and state authorities. You’ll also need to create and file certain quarterly and annual reports on that employment.
For employees (by the IRS definition), whether they’re full or part-time, you’ll need to start the working relationship by having them fill out:
- Form W-4, which tells you how much tax to withhold from their paycheck.
- Form I-9, which helps verify the employee’s identity and authorization to work in the United States.
- Any other forms required by your state or local municipality
New employees should also sign an agreement or contract that specifies all of the employment and payment terms we’ve talked about here. Each year, you’re also responsible for creating a W-2 form—which details each worker’s earnings and taxes paid for the year—and delivering it to them by January 31st.
When you begin work with an independent contractor or freelancer, there’s less paperwork involved. Each new contractor needs to fill out a W-9 form. It includes the contractor’s tax ID or SSN, which helps the IRS identify the payments you make to the contractor. You should also have a working contract in place with all independent contractors.
At the beginning of each year, you’re responsible for furnishing a 1099-MISC form for each contractor you worked with in the previous calendar year and paid more than $600 to.
Ending an employment agreement
Very few employees or independent contractors will stay with your business indefinitely. That’s why it’s important to understand what happens and what’s required of you when an employment relationship ends or is interrupted—which can happen for a variety of reasons, each with different implications for you.
Severance is a package of monetary and other benefits paid to an employee when they leave the company. Severance packages are completely optional for employers, but they’re often offered when the termination is a result of layoffs or the elimination of a role—basically, when you terminate an employee for reasons other than their performance or behavior.
Severance pay includes (on top of any wages owed for time already worked):
- Additional payment as a reward for time worked (or loyalty to the company),
- Payout of unused paid time off (PTO), and
- Continuation of health, dental, or life insurance benefits
All the normal payroll taxes (for both the employee and employer) apply to severance pay.
What most of call “firing” an employee is legally termed termination “for cause”—meaning you fired them because of poor performance or inappropriate behavior. When you terminate an employee for cause, you’re obligated to pay out unused vacation time accrued to date and wages owed for time already worked.
Your only other obligation (if you’re in the U.S.) is to extend and communicate COBRA health benefits for an additional 18-36 months, depending on the circumstances of the termination.
If your payroll system is mostly automated, remembering to remove terminated employees is key—so you don’t just keep paying them.
Paying employees and contractors
Managing payroll and paying your employees and contractors involves a lot more than just cutting a check for hours worked. But by getting up to speed on your options and responsibilities as an employer, you can better plan for hiring employees, working with contractions, running payroll, and everything else that comes with it.
Chapter 3: Payroll taxes
Taxes are one of the most important things small business owners need to deal with when it comes to running payroll. The U.S. Internal Revenue Service (or IRS) collected nearly $2.4 trillion in 2017 payroll taxes. A full 70% of all annual federal revenue comes from these payroll taxes.
Despite the big part taxes play in payroll, they’re often one of the last things business owners think about. And because our taxes can be a bit confusing at times, it’s easy to get lost figuring out what you owe and how and when to pay it.
In this chapter, we’ll demystify payroll taxes for you. We’ll talk about everything you need to know, including:
- If you even need to pay payroll taxes,
- Different kinds of payroll taxes,
- Where and when to pay and report your payroll taxes, and
- Common payroll tax forms you should know about.
Without further ado, let’s get to it.
Do I have to pay payroll taxes?
Before we spend any time explaining payroll taxes, let’s make sure you actually need to know about and pay them. At the most basic level, if you have employees, you need to pay and report on payroll taxes to various federal, state, and local tax authorities.
BUT: When we say “employee,” we’re talking about a legal definition—not just anyone who works with you. We talked about the difference between employees and independent contractors back in Chapter 2. If you need a quick refresh, Investopedia had this to say about employees:
Usually, workers are considered employees if you have the right to direct and control the way they do their work, rather than merely the results of the work.
As a business owner and employer, you’re responsible for payroll taxes on all employee wages. You’re not responsible for payroll taxes on money you pay to independent contractors or freelancers.
It’s also important to note whether you’ve incorporated your business (or if you’re taxed as an S corporation). If this is the case, you’re considered an employee of the business in the eyes of IRS—which means you need to pay payroll taxes on your own salary.
Payroll taxes your business needs to pay
Now that we’ve figured out who needs to pay payroll taxes, let’s talk about what those taxes look like. Payroll taxes fall into three main categories:
- Withholding taxes: These are taxes that your employees pay on their income. You’re responsible for withholding them from each of your employees’ paychecks and depositing them with the appropriate tax authorities.
- Employer taxes: You pay the entirety of employer taxes, and they’re typically based on a percentage of your payroll.
- Shared taxes: Shared taxes are split (usually 50/50) between you and your employees. It’s your job to withhold the employee’s share from their pay and deposit it—along with your portion—to the IRS or state tax authority.
You’ll pay taxes to the federal, state, and local governments that fall within each of those buckets. Let’s break down what you’ll pay to each level of government.
Federal taxes are, of course, paid to the United States government—and they’re the same for most businesses that operate in the U.S. Your business will pay and report your federal taxes to the Internal Revenue Service (or IRS).
Here’s the skinny on all the federal payroll taxes you need to pay.
Federal income tax
Federal income tax falls under withholding taxes—meaning it comes entirely out of your employees’ wages.
It’s a certain percentage of each employee’s pay that you take out of their paycheck and pass on to the IRS. The amount of federal income tax you withhold is different for each employee. It’s based on two things:
- How much their wages amount to and
- The employee’s withholding preferences from their W-4 form (more on that later!)
Federal Insurance Contribution Act (FICA) tax
The Federal Insurance Contribution Act tax (often referred to as FICA tax) includes the payroll tax you pay toward Medicare and Social Security. It’s a shared tax, so you and your employees each pay half of it.
For 2018, the Medicare tax rate is 1.45% of taxable employee wages, and the rate for Social Security is 6.2%—making a combined FICA rate of 7.65%.
It’s important to note that you only pay Social Security tax on the first $128,700 an employee makes. And once an employee’s pay exceeds $200,000, the Medicare tax rate increases to 2.35% on the rest of their pay.
Federal Unemployment (FUTA) tax
Federal Unemployment tax (or FUTA) is an employer tax—meaning your business pays the whole tax. For 2018, the standard FUTA tax rate is 6% of your total employee wages. It’s important to note that most employers are eligible for a 5.4% credit against their FUTA tax—bringing down your employment tax liability.
State payroll taxes are paid to your individual state or the state where your employees live and pay their taxes. There are two main payroll taxes at the state level and they’re similar to your federal taxes.
The tax authority you’ll pay and report taxes to varies from state to state, and from one type of tax to another. In most states, you’ll report income and withholding taxes to the state’s Department of Revenue (or DoR) and report your unemployment tax to the Department of Labor (or DoL).
State income tax
State income tax is another type of withholding tax, so it comes entirely from your employees’ pay. The percentage of wages you withhold for state income tax is different from the federal percentage, but it’s also based on the same two factors that you’ll find in the W-4 form each employee completes—the employee’s wages and their withholding preferences.
State Unemployment (SUTA) tax
Just like your FUTA tax, state unemployment tax (or SUTA) is an employer tax in most states—so you pay the entire amount. The key difference between federal and state unemployment tax is the rate. While FUTA tax uses a standard 6% rate, SUTA tax varies (sometimes widely) from one state to the next.
In many states, the government bases your SUTA tax rate on how long you’ve been an employer and your industry, so it can change from year to year. Your state government will let you know what your SUTA rate will be at the beginning of each year.
Similar to FICA taxes, once an employee earns a set amount of wages for the year, you stop paying SUTA taxes on any additional wages. This maximum threshold (called the wage base) is very different across states, so be sure to find out your state’s wage base so you can plan and budget accordingly.
Many local cities, towns, and municipalities also charge their own taxes on your employee payroll. These vary a lot in the type and amount of local tax depending on where you do business and where your employees pay their taxes. For example, large metro areas like Chicago and New York City come with more local taxes, including payroll.
Local payroll taxes can fall into a lot of categories—and most are withholding taxes paid by your employees. Some of the most common include:
- School board,
- Transit, and
- Municipality taxes.
To figure out if your city charges local income and payroll taxes, check out The Balance’s list.
How and when to pay your payroll taxes
Where do I deposit my payroll taxes?
The IRS now requires all tax deposits to be made online through Electronic Federal Tax Payment System (or EFTPS). Luckily, it’s pretty straightforward and convenient to pay this way. Just head to the EFTPS website, enroll, and then select “Make a Payment.”
What frequency should I follow for paying payroll taxes?
Regardless of whether we’re talking about withholding, employer, or shared payroll taxes, it’s your responsibility as the employer to deposit that money to the right agency, at the right time. And when it comes to collecting taxes (including payroll taxes), the IRS can be ruthless.
Small businesses account for the biggest group of noncompliant taxpayers, so it’s important that you prioritize depositing your payroll taxes on time.
What does “on time” mean when it comes to payroll taxes?
When you register your business with the IRS and other tax authorities, they’ll provide a specific schedule based on the size of your company and the amount of your tax liability. Sticking hard and fast to this schedule is the best way to ensure your business is always up to date and avoid IRS penalties.
Following the “Golden Rule”
Some tax experts take it a step further and recommend following the “golden rule” of federal employment tax: deposit taxes on the same day you issue paychecks.
Since paying your federal taxes is a pretty serious matter, it’s a good idea to deposit payroll taxes as you pay employees, so you never have to worry about falling behind or being unable to cover your tax liability when it comes due.
As your payroll tax liability grows to exceed $50,000 over the prior 12 months, your tailored payroll tax schedule from the IRS will likely move to semi-weekly anyway—so it doesn’t hurt to observe that schedule from the beginning.
While FUTA tax payments are typically due on an annual basis, you can also pay them on the same semi-weekly schedule as your FICA and withholding taxes. To keep things simpler, we recommend making your state and local tax deposits on this schedule, too.
Common forms you need to know
As anyone who’s filed any taxes in the U.S. can attest, there’s a lot of paperwork involved. Between the number of forms employers are responsible for and their remarkably similar names, it’s easy to get lost.
These are the most common forms you should know about when it comes to payroll and employment tax. For more information on each or to download PDF versions, follow the links to the IRS website.
The W-4 form tells you, the employer, how much income tax to withhold from each employee’s pay, based on their personal and financial situation and preferences.
Every time you hire a new employee, they should fill out a W-4 form—it’s a standard part of the new hire paperwork we covered back in Chapter 2. If an employee’s situation changes, they can always fill out a new W-4 form to change their withholding amount at the beginning of each year.
The W-9 form is basically the independent contractor version of a W-4—consider it part of the “new hire” paperwork for independent workers.
Whenever you begin work with a new contractor or freelancer, have them fill out this form. It provides you with their name, address, and either social security number (SSN) or federal tax ID (their EIN).
Even though you don’t pay or withhold payroll taxes on independent contractor pay, you’ll need this information to create an annual 1099-MISC for each contractor you work with.
Form 941 details all of the withholding and FICA taxes you’ve paid to the IRS. It’s completed and filed quarterly, and it’s another way to ensure you’re staying up to date and accurate on the federal payroll taxes you need to pay.
If you’ve worked for another company in the U.S., you’ve been on the receiving end of a W-2 form. They’re completed by the employer for each employee. W-2 forms detail all of the employee’s income, taxes paid, and other deductions for the year—and they’re an important part of the employee’s own personal tax return.
They’re filed annually for the previous calendar year, and you’re required to send a copy to the employee by January 31st.
W-3 forms may be a bit less familiar than the W-2. They’re completed and filed annually to the IRS and due by January 31st. The difference is that the W-3 represents the combined information of all the W-2 forms you handed out. It tallies your total federal payroll and withholding taxes paid, and you’ll file it along with a copy of each of your employees’ W-2s.
The 1099-MISC form details all the payments you made to an independent worker throughout the year. Think of it like a W-2 for independent contractors. Anytime you pay a contractor or freelancer $600 or more in a year, you have to file a 1099-MISC with the IRS and send a copy to the contractor on or before January 31st.
Form 940 is how you report all of your federal unemployment taxes (FUTA). It’s similar to Form 941 (which, remember, reports federal income tax withholding and FICA taxes), but you’ll only file this form once per year—instead of every quarter.
Form 944 is reserved for small employers. If your annual FICA and withholding tax liability is less than $1,000, you’ll file Form 944 annually (by January 31st) in place of a quarterly 941 form. As your payroll taxes exceed that $1,000 threshold, you’ll switch to filing Form 941 each quarter instead.
Paying the tax department
Payroll taxes probably aren’t the most exciting part of running your business, but they areimportant.
Taking the time to understand your payroll tax obligations and how to manage them means your business will always be on the up and up with the IRS and other tax agencies—and that means you can sleep better at night and focus more on building your business instead.
Chapter 4: Payroll accounting
For most businesses with employees and contractors, payroll represents a big expenditure. Every payday, you pay out a chunk of money—and it’s important that your books reflect and account for that.
Accounting and maintaining your books has a reputation for being overly complex and tough for non-accountants to decipher, but it doesn’t have to be that way. After all, payroll accounting is really just recording the flow of money from your business to your employees.
To help make it easier, we’re breaking the whole process down. This chapter will help you understand everything you need to know to keep accurate track of your payroll, including:
- Why payroll accounting matters for your business,
- Types of payroll journal entries,
- How to record payroll in your general ledger (with examples),
- Balancing and reconciling payroll, and
- Submitting third-party remittances.
Ready? Let’s do it.
Why it’s important to record payroll
Up to date and accurate payroll accounting does a variety of things for your business. For one, it helps you stay on the right side of the IRS and other tax authorities by ensuring your taxes are always paid on time and accurately.
Payroll accounting also ensures your general ledger and books portray a true picture of your business’ liabilities, expenses, and overall financial health. Not to mention it helps you keep track of budgeting and ensure you aren’t spending more than you can afford.
Types of payroll journal entries
Most of your journal entries for payroll will look more or less the same. At the end of each pay period, you’ll record the money your business owes and pays to your employees, contractors, and any third-parties.
The main type of journal entry you’ll use to record payroll is the initial recording. That’s what you’ll record each time you run payroll, and it accounts for wages paid, withholdings, and your employer taxes accrued. If your employees are salaried, this should look pretty much the same for every pay period.
The examples we’ll share in the next section represent initial recordings.
There are two other types of payroll journal entries:
- Accrued wages
- Manual payments
These are both less frequent, but they do come up, so it’s important to understand what they include and why your business may use them.
Accrued wages entries happen at the end of an accounting period (say, a quarter or your fiscal year). They enable your books to reconcile wages earned by employees (in the same accounting period as they’re earned) but not paid out.
For example: if the quarter ends on a Wednesday and you run payroll on Fridays, you need to account for the wages your employees earned in the previous quarter, even though you won’t pay them until after the quarter ends.
Manual payments are how you’ll record… manual payments. If you cut a check outside of your regular payroll process (for a pay adjustment or employee termination, for example), these transactions are recording separately from your regular payroll entry.
Payroll and your general ledger
Now that you know what types of journal entries you’ll use for payroll, let’s talk about the actual process of adding those entries into your business’ general ledger. Your general ledger is where all accounting entries are recorded—it’s the official record of the comings and goings of your business’ assets, expenses, and liabilities.
The most important part of entering into your general ledger is ensuring everything balances (more on that later!) For now, just ensure the debits and credits in your entry balance each other out.
Every time you run payroll, there are three main entries that should go into your general ledger.
Step 1: Record payroll expenses
The first entry records your payroll expenses, or the money you pay out to employees each payday. The basic payroll expense entry includes (for each employee):
- The employee’s gross wages (the total amount they earned during the pay period),
- The employee’s share of FICA and other shared taxes,
- Federal, state, and local income taxes withheld, and
- Wages payable (or the employee’s net pay)
Step 2: Transitions
The first entry records your payroll expenses before you actually cut employees’ checks. On payday, you’ll enter a separate transaction into the general ledger that accounts for your actual payment of those wage expenses.
This entry records the outflow of cash for each employee’s net pay (their pay after withholding and other deductions), calculated in the first entry above. Since you won’t always deposit withholdings on the same day that you pay employees, it’s important to record the actual amount of the payment—not the employee’s gross pay or total wages.
Step 3: Record payables and liabilities
The next journal entry keeps track of your liabilities and payables—the expenses you incur each pay period, but don’t pay out right away. For example, each pay period, you accrue employer taxes on your employees’ wages, but you won’t pay them to the government until the end of the quarter (or your next designated deposit day).
For that reason, most of the information this entry (and our example below) includes has to do with taxes:
- FICA tax withholdings (your employee’s share of the tax),
- FICA tax payable (your share of the tax),
- Federal, state, and local income tax withholdings (employee’s share), and
- Federal and state unemployment tax (your share and, in some states, your employee’s share).
If you provide benefits like health insurance, you may also accrue liabilities for benefits premiums that you haven’t paid yet.
Recording payroll liabilities in your general ledger is important so you can keep track of what you owe to third parties (like the government or benefits providers). That way, you’ve already budgeted for those payments when they come due.
Balancing and reconciling payroll
If you regularly keep your general ledger up to date with the journal entries above, your payroll should stay balanced. However, whether your accountant is human or machine, mistakes can happen sometimes.
When that happens, you can lose track of payroll expenses and liabilities. That’s why it’s important to double-check that your actual payroll and the payroll on your books match up. Typically, you should reconcile payroll for every pay period. It’s best to reconcile before you cut checks, so any mistakes can be fixed before you actually pay out employees.
So how do you make sure payroll expenses balance? As we said before, if your employees are salaried, most pay periods should look the same in your books. So the first question to ask is does payroll align with the last period? If it doesn’t, double-check that you can account for the difference (a change in personnel, a raise, working with a contractor, etc.).
If you can’t account for a change in payroll with some of the more obvious reasons, your next step is to ensure all of your numbers and calculations are correct. Verify everything including:
- Wages and salaries
- Number of hours worked, overtime calculations, vacation, sick days
- The amount of withholdings and deductions
- Employer taxes
If all of the above are recorded and calculated correctly, then your books should match up perfectly with your payroll expenses—and you can move forward to cutting checks.
Submitting third-party remittances
We talked earlier about recording your payroll liabilities—these are payments that don’t go to employees, but to third-parties instead. Most often, that’s the federal or state government or your benefits providers.
These payments don’t come out of the same account as your employee payroll and they may even be paid on a completely different schedule. That’s why they’re paid and recorded separately.
Third-party remittances typically happen after you run payroll. By recording them promptly and accurately, you ensure those payments don’t fall through the cracks and that your finance and human resources books match up.
When you make these payments, you’ll create a ledger entry similar to the transition entry we covered before. It credits your business’ liabilities for the amount paid and debits it from your cash account.
Keeping track of your payroll
Few business owners get excited at the thought of accounting—but it’s a vital step to ensure and maintain your business’ financial health. By staying on top of your payroll accounting and double-checking your books are accurate, you can keep your business’ cash flow flowing and avoid a sticky situation when it comes to your employer taxes and other liabilities.
Chapter 5: Important times of the year for payroll
There are some aspects of running a business where you, the entrepreneur, have total control and autonomy—after all, that’s one of the reasons people strike out on their own and start a business.
Payroll isn’t one of those things.
No matter who you are or what your business does, there are some important dates, deadlines, and other details that your payroll has to abide by. Keeping your payroll and associated taxes up to date and compliant with all government regulations is mostly just about keeping your information up to date, paying your taxes, and doing it on time.
In this chapter, we’ll cover:
- Important dates for payroll,
- Quarterly and annual deadlines and what you have to do then,
- Things to keep in mind at the end of the year, and
- Payroll tax thresholds for 2019.
Let’s dive in!
Important dates for Payroll
If your business pays employees in the United States, there are some dates you have to keep in mind. Whether banks are closed or you owe taxes or reporting documents to the government, it’s important to know these dates and keep your business on track with the business world around you.
When it comes to payroll, you’ll definitely have some deposits and forms due on a quarterly basis. Most U.S. businesses align their “fiscal quarters” with the calendar year.
- Quarter 1: January 1st – March 31st
- Quarter 2: April 1st – June 30th
- Quarter 3: July 1st – September 30th
- Quarter 4: October 1st – December 31st
2019 federal holidays
As an employer, federal holidays are something to think about. Many professionals expect to have all or most of the main federal holidays off. While you aren’t required to give employees paid holidays, you might be required to pay overtime on those days. It’s also important to keep in mind that all U.S. banks will be closed on these days—meaning you can’t walk into your local bank, and any deposits may not go through until the next business day.
Here’s the list of U.S. federal holidays for 2019:
- January 1st: New Year’s Day
- January 21st: Martin Luther King, Jr. Day
- February 18th: Presidents’ Day
- May 27th: Memorial Day
- July 4th: Independence Day
- September 2nd: Labor Day
- October 14th: Columbus Day (or Indigenous Peoples Day)
- November 11th: Veterans Day
- November 28th: Thanksgiving
- December 25th: Christmas Day
Your individual state may have additional observed holidays throughout the year that you should be aware of. For example, Massachusetts celebrates Patriots Day on the third Monday of each April. Be sure to research local and statewide holidays in your area.
Payroll deadlines by year and quarter
Now that you know all the important dates of the year when it comes to payroll, there are also annual and quarterly deadlines (along with some unique to your business) to keep track of. Let’s go over what’s required of you, the employer, on those important deadlines.
Annual deadlines and what’s due then
Each year, January 31st marks the deadline for furnishing all annual tax paperwork, deposits, and reports to both your employees and the federal government.
On or before this date, you’ll need to:
- Complete all W-2 and 1099-MISC forms for the prior year, and send them to employees and contractors.
- File those 1099-MISC forms, all W-2 forms, and your W-3 form with the Internal Revenue Service (IRS).
- Make your final deposit of Federal Unemployment tax (FUTA) for either the prior year or the just the fourth quarter (depending on your tax liability and your business’ deposit schedule), and file Form 940 with the IRS.
- If your total federal withholding and FICA tax liability is less than $1,000 for the year, you’ll also need to file Form 944 annually.
For many businesses, March 15th isn’t a particularly important date. However, if you’re filing your business taxes as an S corporation, your annual tax return is due on March 15th. This is before the general tax return deadline in April, so don’t let it sneak up on you.
If you aren’t filing your taxes as an S corporation, all personal and business tax returns are due on April 15th (or the next nearest business day—in 2019, that’s Tuesday, April 17th). Those who need more time to compile their tax return can file for an extension, but the application and all payments owed are still due by the deadline.
Quarterly deadlines and what you need to do
On top of your annual requirements, you also have responsibilities to report on and pay taxes throughout the year—typically at the end of each quarter. Your main requirements are to:
- File Form 941 for the previous quarter and
- Make your Federal Unemployment tax (FUTA) deposit for the prior quarter (if your total FUTA liability is $500 or more).
These are both things you’ll have to do every quarter, and they’re typically due by the end of the next month. If your business uses the standard calendar quarters, both of these are due on:
- January 31st,
- April 30th,
- July 31st, and
- October 31st.
Deadlines for your business
Quarterly and annual deadlines aren’t the only important dates you need to remember. There will also be key deadlines that are unique to your business
When you register for an Employer Identification Number (EIN) with the IRS, they’ll give you a specific payment schedule for when your FICA and federal income withholding deposits are due.
This schedule can change as your business and tax liability grow, so it’s important to stay on top of your due dates. When this happens, the IRS will send your business a new schedule at the beginning of the calendar year.
Other things to keep in mind at the end of the year
The end of the year is a busy time for businesses. On top of holiday planning and setting goals for the upcoming year, there’s also a lot going on with taxes, preparing for new labor and payroll changes, and closing the books on the year.
With all of that, it’s easy for things to fall through the cracks. Here are a few things to remember at the end of the year:
- Remind your employees to submit a new W-4 form if their withholding amount or deductions have changed since last year.
- Open enrollment for Marketplace and employer-provided health insurance spans the last two months of the year. For 2018, it runs from November 1st to December 15th. Remind your employees to select their coverage and make any necessary changes to dependents before the end of the period.
- Remember to pay out any year-end bonuses—typically during the last payroll run of the year.
- Account for any paid time off (PTO) your employees have. If their PTO expires at the end of the year, you’ll need to pay it out in their final paycheck. If it carries over, you’ll need to reconcile that in your payroll system.
- Update your payroll system for wage increases (including raises and new minimum wage requirements) and any other changes (like new PTO accrual rates) that will take effect after the New Year.
2019 payroll tax thresholds
Payroll tax thresholds sound complicated, but they’re really a simple concept. For certain payroll and employer taxes, the government sets a maximum threshold. After an employee’s wages exceed that maximum, the tax may stop accruing or another tax could be added.
- Social Security sometimes also called OASDI) tax: You and your employees only pay tax on up to $132,900 in taxable wages. This threshold is up from 2018’s, which was $128,400. Once an employee earns more than that amount, you don’t pay any more Social Security Tax.
- Medicare: On the flipside, Medicare tax has the opposite kind of threshold. Once your employee’s wages exceed $200,000 for the year, an Additional Medicare Tax of 0.9% is added (on top of the existing 1.45% Medicare tax on all wages).
- Federal Unemployment (FUTA) Tax: As the employer, you’re responsible for the entirety of FUTA tax—but you’ll only pay it on the first $7,000 each employees earns in a year.
- State Unemployment (SUTA) Tax: You may remember from Chapter 3 that SUTA taxes vary widely from state to state. The tax threshold does, too, ranging from $7,000 to $49,900. The American Payroll Association has a handy guide to help you find out your state’s SUTA tax threshold.
While not technically a tax threshold, you should also be aware of minimum wage laws. At the federal level, minimum wage stands at $7.25* per hour. But you’ll also need to comply with your state.
As usual, the state minimum wage varies widely—ranging from the federal $7.25 all the way up to $14 an hour. Several cities and local municipalities (like San Francisco and New York City) also choose to set higher minimum wages than their state. For a full list of state and city minimum wages, check out the Labor Law Center’s list.
*As of November 2018
Stay up to date on your deposit and reporting deadlines
Hiring and paying your employees comes with its own host of new responsibilities and challenges for your business. But above all, your most important job is to pay and report your payroll and taxes on time throughout the year.
Once you’re a seasoned employer, you’ll have these dates and details down pat—and you can spend more time focused on growing your business instead.