Setting up a payroll system involves several steps including obtaining an employer's identification number (EIN), taking care of employee paperwork, choosing a payroll system and running the payroll. Having an organized payroll system makes it easier for employers to stay on top of their regulatory and legal obligations. It also serves as protection from Internal Revenue Service (IRS) penalties, according to the U.S. Small Business Association or SBA.
The following shows the steps to setting up a payroll system as recommended by the SBA.
- Obtain an EIN
- Check state ID requirements
- Define worker status
- Have employees accomplish W4 forms
- Establish pay periods
- Document employee compensation terms
- Choose a payroll system
- Run the payroll
- Record and report
Employers should obtain an Employer's ID Number from the IRS before hiring employees. An EIN is necessary for processing taxes, as well as in reporting employee information to state agencies.
Businesses may also need to obtain ID numbers in some states and local governments for tax processing.
Know the difference between a regular employee and an independent contractor as the distinction will affect how to pay taxes, and how Social Security and Medicare are withheld.
New employees should accomplish Federal Income Tax Form W-4.
Pay periods should be set, whether it is monthly or twice a month. Some states sometimes decide on pay periods.
Employee compensation terms such as tracking working hours, paid leaves, and overtime pay should be carefully documented.
Decide whether to conduct an in-house payroll system or to outsource it.
Run the payroll according to the chosen system.
Keep certain employee records as required by the IRS and some states. Submit payroll reports to the IRS either on an annual or quarterly basis.