The Basics of Small Business Payroll: A Guide for Entrepreneurs

The Basics of Small Business Payroll A Guide for Entrepreneurs

Payroll is more than just paying employees. It involves navigating complex regulations, ensuring accurate tax withholding, and maintaining detailed records. As an entrepreneur, you may face challenges like staying compliant with evolving laws and accurately calculating taxes. Overcoming these obstacles is essential to avoid legal issues and satisfy and motivate employees. Let’s explore how to set up your payroll, explain the taxes you need to account for, and how to choose the right software for small business payroll.

Setting Up Payroll for the First Time

When you’re setting up payroll for the first time, it might seem daunting. However, following these simple steps can make the process manageable.

Obtaining an Employer Identification Number (EIN)

The first step in setting up payroll is to obtain an Employer Identification Number (EIN) from the Internal Revenue Service. This is essentially your business’s social security number, and you will need it for tax filings and other documentation. The quickest way to get your EIN is to apply for one online at the IRS website. Once your EIN has been issued, you’ll receive a confirmation letter from the IRS. Keep this document as it’s often required to open business bank accounts and other official business purposes.

Setting up records for hiring employees

Before you can run payroll, you must set up records for each employee. This includes basic information like name, address, and social security number. Additionally, you must keep track of their salary or wage information, tax withholdings, and benefits. Ensure employees complete the necessary tax forms, such as the W-4, I-9, and state withholding forms.

Choosing a payroll schedule

Finally, you’ll need to decide how often you want to pay your employees. This could be weekly, bi-weekly, semi-monthly, or monthly. The choice depends on your business needs, cash flow, and state laws. Keep in mind that more frequent pay periods may mean more administrative work.

Understanding Payroll Taxes

Navigating payroll taxes can be challenging, but every small business owner must understand how to manage these taxes effectively.

Federal income tax

Federal income tax must be withheld from your employees’ wages. The amount to withhold varies based on the employee’s earnings, filing status, and the information they provide on Form W-4.

Steps to manage federal income tax withholding:

  • Review each employee’s Form W-4: This form will guide you on how much federal income tax to withhold from their paycheck.
  • Use IRS tax tables: These tables, provided in the IRS Publication 15-T, help you calculate the exact amount to withhold based on the W-4 information and the employee’s pay period earnings.
  • Report and pay taxes: You must regularly deposit these withholdings to the IRS and report them using Form 941 (quarterly) or Form 944 (annually).

State and local taxes

State and local tax requirements vary widely depending on where your business is located and where your employees live. Like federal taxes, you must withhold these taxes from each paycheck.

How to handle state and local taxes:

  • Check local regulations: Each state and locality will have its own tax withholding requirements and forms similar to the W-4.
  • Withhold taxes accordingly: Use the state’s withholding tables to calculate the correct amount to withhold from each paycheck.
  • Report and pay these taxes: Typically, you will report and pay these taxes every quarter, though requirements can vary.

FICA taxes (Social Security and Medicare)

FICA taxes fund Social Security and Medicare and require contributions from both the employer and the employee.

Managing FICA taxes involves:

  • Calculate the correct amount: The current rate for Social Security is 6.2% for both employer and employee (on earnings up to the applicable wage base), and Medicare is 1.45% for both, with an additional 0.9% for employees earning more than a certain threshold.
  • Withhold and match: You need to withhold the correct amounts from your employees’ wages and contribute an equal amount as the employer.
  • Submit payments: These are typically paid alongside your federal income tax deposits and reported on Form 941 or Form 944.

Federal and state unemployment taxes

Unemployment taxes fund the unemployment benefits provided to workers who have lost their jobs.

Here’s how to manage these taxes:

  • Federal Unemployment Tax Act (FUTA): Employers solely pay FUTA without any deductions from employees, usually at a rate of 6.0% on the first $7,000 of each employee’s earnings.
  • State Unemployment Taxes (SUTA): These rates vary by state and are also employer-paid. Your SUTA rate can change based on factors like your industry and claim history with former employees.
  • Regular contributions: You must pay these taxes at state-determined intervals and report them annually using Form 940 for FUTA.

Calculating Gross to Net Pay

Calculating an employee’s net pay starts with determining their gross pay, which is either a fixed salary or the total hours worked multiplied by their hourly rate. From gross pay, you’ll subtract various deductions such as federal and state taxes, FICA taxes, and other withholdings like retirement contributions and health insurance premiums.

Example Calculation:

  • Gross Pay: $2,000
  • Deductions:
    • Federal Tax: $300
    • State Tax: $100
    • FICA Taxes: $153
    • Health Insurance: $200
  • Net Pay: $2,000 – ($300 + $100 + $153 + $200) = $1,247

Avoid common mistakes such as incorrect tax withholding amounts and not updating deduction amounts when employee benefits change. Accurate calculations ensure compliance and employee satisfaction.

How to Choose Software for Small Business Payroll

Handling these payroll tasks manually can be a nightmare. Luckily, choosing the right payroll software can streamline operations and ensure accuracy. Here’s what you should consider:

  • Ease of use: The software should be user-friendly, with an intuitive interface that simplifies payroll processing.
  • Cost: Look for solutions that fit your budget but also offer essential features like tax calculations and direct deposit.
  • Integration capabilities: Ensure the software can integrate seamlessly with your existing HR and accounting systems.
  • Scalability: The software should grow with your business, accommodating new employees and changing needs without difficulty.
  • Reporting features: Comprehensive reporting capabilities are vital for tracking payroll expenses and managing employee data effectively.


Setting up and managing payroll effectively is essential for the smooth operation of any small business. From obtaining your EIN to choosing the right payroll software, each step requires careful consideration to ensure compliance and efficiency.