If you’re looking to set up a payroll system, chances are, you’re ready to hire your first employee. Your business is finally getting off the ground and getting ready to open it’s doors to the world at large. For any new business owner, that’s refreshing news. After countless hours of hammering out a viable business plan, filling out and filing appropriate paperwork, and stressing out over just about every excruciating detail, it’s finally time to sit back, relax, and reap the rewards. Right?
Well, not exactly. There’s still one more not-so-tiny hurdle that must be handled with great care and precision: setting up payroll.
Unless you plan on running a business with no employees (or no income), you’ll still need to hire workers to actually handle day to day operations and other key tasks who, at the end of the day (or week, month, or compensation period) will probably need to be paid: regularly, on time, and in accordance with rigorous record keeping standards. Payroll is by far the largest expense most businesses face, and mishandling the associated tax burden can certainly result in some large fines and penalties. Therefore, it would behoove the aspiring business proprietor to take both the time and effort, and make the appropriate financial investment if necessary, to ensure that this critical component is implemented smoothly and precisely.
7 Steps to Set Up a Payroll System
1. Get the Bureaucratic Ball Rolling
As un-fun as it may sound, every aspiring entrepreneur will at some point need to roll up their sleeves and lay the necessary bureaucratic groundwork. First, you’ll need an Employer Identification Number (EIN), often referred to as an Employer Tax ID, or from the Internal Revenue Service (IRS). Some states and local municipalities also require businesses to get a separate Tax ID from them in order to process taxes. Texas, for example, is one of those states.
While it may at times feel like hacking at a jungle of paperwork and government red tape, think of it as a path-clearing exercise that will help your business run much more smoothly down the road.
2. Worker Classification – Employee or Contractor
Figure out which of the two categories, either employee or contractor, that your current or future workers fall under. The distinction between the two is critical as it determines how you withhold income, pay Medicare and Social Security taxes, and pay unemployment taxes. The temptation, of course, may be to intentionally misclassify employees as contractors in an effort to reduce tax liabilities. However, these types of fraudulent schemes are illegal and invite expensive IRS audits and financial penalties. As a rule of thumb, if a business controls not only what their workers do, but also how that work is to be done, they are employees. Most workers fall under this category. If the employer does not control how the work is accomplished, then the workers in question are contractors. Be extra careful to distinguish correctly between the two.
3. Worker Paperwork – W-4 & I-9
All new hires must complete the Federal Income Tax Withholding Form W-4 and return it to you (the employer) so that the correct amount of federal income tax is withheld from their pay.
You will also need to fill out Employment Eligibility Verification I-9 forms for new employees in order to verify their legal status.
4. Pick a Pay Period
A pay period is simply a recurring length of time over which employee time is recorded and appropriated compensated. Typically, this would be bi-monthly, or every two weeks, although other common pay periods are weekly, semi-monthly, and monthly. Some states have laws regarding pay periods – for instance, Texas law requires employers to pay non-exempt employees a minimum of at least twice per month.
5. Choose a Payroll System That’s Right For You
There are a number of payroll systems that could work depending on your business needs and capabilities: do-it-yourself by hand, do-it-yourself with software, hire an accountant, or outsource to a Human Resources Outsourcing (HRO) firm that specializes in or offers payroll services.
The first two options are, for obvious reasons, the cheapest method, but also consume the most time and energy, and are error-prone. Businesses that choose to go this route are often sole proprietorships or small firms employing one or two employees for whom the appropriate paperwork is largely manageable.
Businesses could also hire an accountant or tax professional to take care of relevant tasks, which greatly reduces bookkeeping errors and other potentially expensive, penalty-inducing mistakes. Unfortunately for small businesses, this is a very expensive solution since you are essentially hiring your own payroll personnel (i.e. HR department) who will demand competitive salaries. As a business grows and the amount of paperwork, regulatory compliance functions, and HR tasks build up, hiring an entire HR department could quickly become financially untenable.
Of course, small to medium-sized businesses expecting growth, but not quite large enough to justify hiring their own HR personnel and tax specialists, can consider outsourcing the handling of payroll completely to an outside provider. These HRO’s take on all or part of a client company’s tax liabilities – for a small fee of course – freeing up client firms to focus on core business rather than bureaucratic compliance and red tape. Small to medium-sized businesses should seriously consider this option.
6. Pay Your Employees Properly
Once you’ve chosen the best payroll system for your business, it’s time to run payroll and start sending out checks to your employees. You’ll either enter in all the data yourself, hand it over to an accountant, or let a payroll outsourcing firm take care of everything for you.
As a side note, don’t forget to keep all your records for the amount of time as required by law. For example, some states require that W-4 forms be kept on file for all current employees, and for up to three years after an employee is terminated or leaves. Keep all W-2’s, copies of filed tax forms, and dates and amounts of all tax deposits.
7. Pay Payroll Taxes and File Forms
Finally, it’s time to pay Uncle Sam. There is a whole host of tax reports that will need to be filled out and submitted to local, state, and federal authorities. Information on Federal requirements can be found in the IRS’s Employer Tax Guide which details each tax obligation in full. Remember to also visit state and local government websites for information on state and local taxes.
With that, you’ve completed all the steps in payroll. Now it’s time to stay on top of all the changes and updates that come along with the territory.
Hiring employees is an exciting time for any business. After all, that means your business is growing! But, remember the number of things to consider, and all of the potential pitfalls to avoid, before handing out paychecks. Centripetal Consulting Group is here to help your business navigate the HR landscape with confidence and success.