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Payroll Setup Basics

The idea behind this topic is to assist those who are setting up a payroll system from scratch. This topic may also be helpful for those who are in the early stages of managing payroll and wish to get on the right track.

This particular help topic does not tell you how to use Total Office Manager payroll specifically. It is designed to help people setup a payroll system.

Any small business owner can tell you that paying employees involves a lot more than writing a check every week or two. There are a number of laws governing employee compensation and they change all of the time. If you don’t want to have trouble with any of the various government agencies, you have to be well organized and stay up to date on federal and state guidelines.

The key to staying on top of things is setting up a good system that complies with all the applicable state and federal laws. To get started, try this step-by-step approach to setting up a simple payroll system:

Step One

Get an Employer Identification Number (EIN). You can apply for a number by filling out IRS Form SS-4.

Step Two

Get state and local identification numbers if they are required in the area or areas where your business operates.

Step Three

Separate your independent contractors and full-time employees. You don’t have to withhold taxes from an independent contractor’s pay. Don’t think that you can save time by classifying all of your employees as independent contractors, however: The IRS may penalize your business heavily if you designate regular workers as independent contractors. For details, see the IRS Publication 15 Circular E, The Employer’s Tax Guide.

Step Four

Have each employee fill out and sign IRS Form W-4. The form provides two critical pieces of information: the employee’s Social Security Number and the allowances the employee is claiming for income tax withholding purposes.

New workers should fill out a W-4 as soon as possible. Employees who marry or divorce, have children, gain or lose a dependent or want to change withholding amounts for any other reasons should also complete and sign a new W-4.

If you do not have an employee’s W-4 on file, you are required by law to treat the employee as a single person with no exemptions for withholding purposes.

Step Five

Establish a pay period. Most states require that employers pay workers on regular paydays. A few states allow some employees to be paid once a month, but most require that you pay your employees at least twice a month. Check with your state department of labor for your state’s specific guidelines.

Step Six

Establish payroll records . For federal tax purposes, you must keep the following information on file:

  • The name, address and Social Security Number of each employee

  • The total amount and date of each payment

  • The portion of each payment that constituted taxable wages

  • Obtain copies of each employee’s W-4

  • Dates and amounts of tax deposits

  • Copies of returns you filed

  • Copies of any undeliverable W-2 forms

Step Seven

Decide if you will pay workers for time spent in orientation, sick days, meals or working from home. Your state department of labor can tell you if you are required to pay for this time.

Step Eight

Check your local overtime rules. According to most state laws, any work that exceeds 40 hours per week must be compensated with at least one and a half times the employee’s hourly wage.

Step Nine

Figure out what you need to withhold. The IRS expects you to withhold a portion of every employee’s paycheck. Chances are your state and even local governments require withholding as well. The government provides tax tables that calculate the amount you must withhold once you have established the appropriate amount of taxable wages. All states except Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming impose a personal income tax. Like the federal government, most states provide tables to help you compute withholding amounts.

Many business owners save time and reduce the risk of errors by hiring a bookkeeper or payroll service. An outside payroll person or service can perform basic payroll-related tasks, deposit tax payments, prepare W-2s and take care of insurance and retirement plans.