How to do payroll yourself: Considerations for employers

Setting up payroll is one of the most important tasks employers have on their plate. Payroll is how you make sure your employees get paid—accurately and on time—which directly impacts their satisfaction and your company's overall performance. For small businesses, handling payroll internally can save costs and give you greater control over your financial operations. However, it requires a thorough understanding of tax laws, meticulous record-keeping, and a commitment to staying compliant with ever-changing regulations.

This guide is for every small business owner who’s ever Googled, “How to do my own payroll” (or, at least, thought about it). We’ll walk you through how to do payroll yourself, from calculating gross pay to tallying and withholding payroll taxes—plus other considerations employers need to know to accurately calculate payroll and get their employees paid. From understanding the core components of payroll to step-by-step instructions, tips for reducing expenses, and how payroll software like Rippling can streamline the process, read on for actionable insights to effectively manage payroll for your small business.

How do you do payroll?

Ever found yourself wondering, “How does payroll work?” 

Payroll isn't just about issuing paychecks; it's a multifaceted process that involves adding up wages, withholding taxes, calculating net pay, and ensuring compliance with federal and state laws. Understanding the components of payroll is the first step toward managing it effectively.

Calculating wages

Calculating wages accurately helps ensure your employees get compensated fairly. This involves determining gross pay based on the number of hours worked for hourly employees or the agreed-upon salary for salaried employees. You also need to factor in overtime, bonuses, commissions, and other forms of compensation.

To calculate gross pay:

• For hourly employees: multiply the number of hours worked by the hourly rate
• For salaried employees: divide the annual salary by the number of pay periods in the year

Always make sure overtime is calculated according to federal and state laws. Under the Fair Labor Standards Act (FLSA), overtime is typically paid at a rate of 1.5 times the regular hourly rate for hours worked over 40 in a week—but some states have their own overtime rules, so be sure you know the laws that apply depending on your local jurisdiction.

Deducting taxes

Once you have your employees’ gross pay, the next step is to calculate deductions. These typically include federal income tax, Social Security, Medicare, and any applicable state and local taxes. Employers are responsible for withholding payroll tax deductions from employees' paychecks and remitting tax payments to the appropriate government agencies on their employees’ behalf.

Federal income tax withholding is determined by the employee's W-4 form and the IRS tax withholding tables. 

Social Security and Medicare taxes, collectively known as FICA taxes, are withheld at rates of 6.2% and 1.45% respectively (and as the employer, you pay a matching amount). 

State and local taxes often include state income tax, unemployment tax, and sometimes county or city taxes. These vary by location, so it's important to stay informed about your specific obligations.

Distributing payments

After calculating deductions, you'll arrive at your employees’ net pay, which is the amount each employee takes home. Distributing payments can be done through various methods, such as direct deposit, paper paychecks, or payroll cards. Direct deposit is one of the most common ways to distribute compensation to employees because of how efficient and convenient it is, but offering multiple payment options can accommodate different employee preferences.

Make sure payments are made promptly and securely. Delayed or incorrect payments can lead to employee dissatisfaction and legal issues.

Payment schedule

Establishing a consistent payment schedule is important for both budgeting and meeting legal requirements. Common frequencies for pay periods include weekly, bi-weekly, semi-monthly, and monthly. The choice depends on your business's cash flow and state laws governing pay periods.

Communicate your choice of pay periods clearly to your employees and stick to it consistently. This builds trust and helps employees manage their personal finances more effectively.

Maintaining accurate records

Accurate record-keeping will prove essential if you ever face an audit or a payment dispute. You also need consistent, accurate records for payroll tax compliance. Records should include employee information, hours worked each pay period, gross pay (including wages, overtime, commissions, bonuses, and other payments), deductions, and payroll tax filings. The IRS requires employers to keep compensation and payroll records for at least four years.

How to do payroll yourself in 7 steps

Now that you have an idea of how to set up payments, let’s discuss how to manage payroll for a small business. Handling payroll yourself can be complicated, but by following this step-by-step guide, you can navigate the process with greater confidence and accuracy.

Step 1: Obtain an EIN and register for state tax accounts

Before you can run payroll, you need to obtain an Employer Identification Number (EIN) from the IRS. Your EIN is a unique number used to identify your business for tax purposes. You can apply for an EIN online through the IRS website.

In addition to the EIN, you'll need to register for state tax accounts. This includes setting up accounts for state income tax withholding, unemployment insurance, and any other state-specific payroll taxes. Visit your state's Department of Revenue or equivalent agency to register.

Step 2: Classify your employees and independent contractors

When you hire workers, classifying them correctly is a crucial part of tax and legal compliance. Employees and independent contractors are treated differently under tax laws, and misclassifying an employee as an independent contractor can result in fines, penalties, back taxes, and legal issues. 

Employees are protected by labor and employment laws, receive employee benefits, and are subject to withholding of FICA taxes (Medicaid and Social Security tax) and other payroll taxes. Independent contractors, on the other hand, are responsible for paying their own taxes and don’t receive benefits. Check if you’re accurately classifying your workers with our free Employee Misclassification Analyzer Tool.

Step 3: Gather employee information (W-4 forms, direct deposit details)

To accurately calculate payroll, collect the following forms for every employee: 

• Form W-4: Collected from new hires to determine their federal income tax withholding based on their filing status and allowances
• Form I-9: Verifies a new hire’s eligibility to work in the US
• Direct deposit authorization: Allows you to deposit paychecks directly into the employee's bank account, if applicable
• State tax withholding forms: Some states require additional forms for state income tax withholding

Make sure all information is kept confidential and stored securely, complying with data protection regulations for your jurisdiction.

Step 4: Choose a payroll schedule and track employee hours

Selecting an appropriate payroll schedule is important for compliance and financial planning. Common options include weekly, bi-weekly, semi-monthly, and monthly pay periods. Check your state's laws to ensure your chosen pay periods meet legal requirements.

Then, you need a reliable system for tracking employee hours. This can be as simple as paper timesheets or as sophisticated as digital time-tracking software. But accurate time records are essential for calculating wages, especially for hourly employees and those eligible for overtime, so make sure the system you put in place can keep track of all your employees’ time. And keep an eye out for solutions that can sync with your accounting or payroll system to save you from manual, potentially error-prone data entry.

Step 5: Calculate gross pay, deductions, and net pay

With the necessary information and systems in place, you can now calculate each employee's pay:

1. Gross pay: Calculate based on hours worked or salary, including any overtime, bonuses, or commissions for the pay period.
2. Deductions: Determine federal and state tax withholdings, FICA (Medicare and Social Security tax), and any voluntary deductions like health insurance premiums or retirement contributions.
3. Net pay: Subtract total deductions from gross pay to arrive at the amount the employee will receive.

Use current tax tables and rates for accuracy. Double-check your calculations to prevent errors that could lead to compliance issues or employee dissatisfaction.

Step 6: File payroll taxes and issue payments

Employers are responsible for depositing withheld taxes with the IRS and state tax agencies. Federal tax deposits are typically made through the Electronic Federal Tax Payment System (EFTPS). You must also file quarterly and annual tax forms, such as:

• Form 941: Employer’s Quarterly Federal Tax Return
• Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return

Issue paychecks or direct deposits to employees according to your payroll schedule. Make sure payments are accurate and delivered on time to maintain compliance and employee trust.

Step 7: Keep payroll records and prepare for year-end taxes

Maintaining detailed payroll records is not only a legal requirement but also aids in year-end tax preparation. Your records should include:

• Employee, wage, and payroll data
• Tax filings and deposit confirmations
• Records of any adjustments or corrections

At the end of the year, you'll need to:

• Provide Form W-2 to each employee, summarizing their annual earnings and withholdings
• File Form W-3 with the Social Security Administration, summarizing all W-2 forms
• Issue Form 1099-NEC to independent contractors paid $600 or more

Starting early and keeping records organized throughout the year can simplify this process significantly.

3 tips to reduce payroll expenses

Running payroll manually isn’t the only way for small business owners to keep their costs low. These five tips can help employers reduce expenses and improve their business’ financial health—everytime they calculate payroll.

Using automated tools

Many modern payroll solutions can automate some of the time-consuming tasks that come with running payroll, such as calculating net pay, withholding taxes, and generating reports. Automation reduces the likelihood of errors and frees up time to focus on other aspects of your business.

Research and choose a payroll system that fits your needs and budget. Many payroll providers offer convenient features like direct deposit, electronic tax filing, and employee self-service portals.

Staying compliant with tax regulations

Keeping up-to-date with tax laws and regulations helps avoid costly penalties and interest charges. Regularly review IRS updates, subscribe to newsletters, and consider consulting with an accountant or tax professional to help you stay compliant.

It’s also a good idea to implement a system to track filing deadlines and tax payment schedules. Some payroll providers offer automatic updates to tax rates and regulations, saving you from having to track deadlines and regulation changes manually and reducing your risk of noncompliance.

Reviewing payroll data regularly

Regularly auditing your payroll data can identify discrepancies, overpayments, or areas where you can save money. Analyze overtime expenses, benefit costs, and employee classifications to find opportunities for optimization.

Schedule periodic reviews of payroll and wage reports and compare them against your business’ budgets and forecasts. Making adjustments based on these insights can lead to significant cost savings over time.

How to do payroll taxes yourself

Handling payroll taxes is one of the most complex aspects of payroll management. But you don’t need payroll software or other high-tech tools to run payroll. Even though the calculations can be complicated, they can be done manually if you know where to find the formulas and tables you need. Here's how to navigate federal, state, and local tax requirements effectively.

Federal income tax withholding

To determine the correct amount of federal income tax to withhold from each employee's paycheck:

1. Collect Form W-4: Make sure every new hire completes the latest version of the W-4 form.
2. Use IRS tax tables: Refer to the IRS Publication 15-T, which provides tax tables based on the employee's filing status and income.
3. Calculate withholding: Apply the information from the W-4 and the tax tables to calculate the withholding amount.

Make sure to update your calculations if an employee submits a new W-4 form or if there are changes in tax laws.

Social Security and Medicare Taxes (FICA)

Employers must withhold FICA taxes from employees' wages and contribute a matching amount:

• Social Security Tax: Withhold 6.2% of wages up to the annual wage limit ($160,200 for 2023).
• Medicare Tax: Withhold 1.45% of all wages, with no wage limit.

For high-income earners, an additional Medicare tax of 0.9% applies to wages exceeding $200,000. Use the EFTPS to ensure timely deposit of FICA taxes, and make sure to include them in your quarterly filings.

Federal Unemployment Tax Act (FUTA)

FUTA taxes fund unemployment benefits and are paid solely by the employer, not by employees:

• Tax rate: Generally 6% on the first $7,000 of each employee's wages
• You may be eligible for a credit of up to 5.4% if you pay state unemployment taxes, reducing the effective FUTA rate to 0.6%.

FUTA taxes are reported annually on Form 940 and deposited at least quarterly, depending on the amount you owe.

State and local taxes

State and local tax obligations vary widely:

• State income tax: Withheld based on state-specific tax tables and employee withholding forms
• State Unemployment Tax (SUTA): Employers pay this tax to fund state unemployment programs
• Local taxes: Some municipalities impose additional taxes, such as school district or city income taxes

It’s up to business owners to register with their state's tax agency to understand their obligations and stay informed about rate changes. Some payroll services and providers can also track state and local taxes automatically, helping businesses stay compliant, even as local taxes and regulations change over time.

Filing and depositing taxes

To avoid penalties, you need to calculate your taxes accurately and file and pay them on time. Here are some best practices to keep in mind:

• Double check all your calculations: Regularly review your calculations or consider using a payroll solution with built-in tax compliance features.
• Keep up with changes: Tax laws and rates can change annually (or even more often). Stay informed to adjust your processes accordingly.
• Maintain accurate records: Keep detailed records of all tax deposits and filings for at least four years.
• Know your deposit schedule: The IRS determines your deposit frequency (monthly or semi-weekly) based on your total tax liability.
• File the right forms: Form 941 is filed quarterly to report federal income tax, Social Security, and Medicare taxes withheld. Form 940 is filed annually to report FUTA taxes. State forms vary; check with your state's tax agency.
• File electronically: Use the EFTPS for federal tax deposits and ensure you meet all filing deadlines.
• Consult with a pro: Consider consulting with a tax professional or accountant to review your processes and provide guidance.

Pros and cons of doing payroll yourself

Knowing how payroll works is only part of the calculation. Before deciding to run payroll manually, it's important to weigh the advantages and disadvantages.

Pros

• Cost savings: Handling payroll yourself can save money on outsourcing fees or payroll service subscriptions. For small businesses with tight budgets, this can be a significant advantage.
• Control: Managing payroll in-house gives you direct oversight of all payroll systems and data. You can customize payroll procedures to fit your business' unique needs and maintain confidentiality of sensitive employee information.
• Data security: Keeping payroll data within your organization can reduce the risk of data breaches associated with third-party providers. Implementing robust security measures means that employee information remains confidential.

Cons

• Compliance risks: Payroll processing laws and tax regulations are complex and frequently change. Mistakes can lead to penalties, fines, and legal issues. Staying compliant requires ongoing education and attention to detail.
• Time commitment: Processing payroll is time-consuming, especially as your business grows. It can divert your attention from core business activities that drive growth and revenue.
• Lack of scalability: Manual payroll systems may become inefficient as your business expands. Increased employee numbers, multiple pay rates, and diverse tax obligations can overwhelm your existing processes, especially as a small business.

Streamlined Payroll Management with Rippling

If you want payroll so powerful it runs itself, you want Rippling. 

Rippling offers full-service payroll that’s intuitive, easy to use, and has a 100% error-free guarantee on every pay run. It also offers 500+ integrations, automatic and accurate tax registration and filing, and a dedicated mobile app where your employees can view their W-2s and paystubs, submit expenses directly, and more.

With Rippling, you can: 

• Pay employees and contractors in the same platform
•  Manage time and attendance natively 
• Run unlimited off-cycle pay runs at no extra cost 
• Set up multiple pay schedules, pay rates, and pay types in just a few clicks 
• Add recurring reimbursements (like cell phone payments, gym memberships, etc.) that are automatically paid out every pay period, monthly, or at whatever interval you choose
• Automatically calculate prorated pay runs for new or promoted employees 
• Manage all currency conversions, including payroll adjustments 
• Automatically calculate overtime for every country 
• Make changes after submitting payroll

How to do payroll yourself FAQs

Can I do payroll by myself?

Yes, you can run payroll manually yourself. Many small business owners choose this route to save on costs and maintain control. However, it requires a thorough understanding of payroll laws, tax filing, and other regulations. Be prepared to invest time in learning and staying updated on changes in legislation.

Consider starting with a few employees to get accustomed to the process. As your business grows, you may want to reassess whether manual payroll processing still makes sense—or if moving to an automated payroll provider or even full-service payroll software makes more sense as your small business scales.

What is the easiest way to do payroll?

Using payroll software is the easiest way to handle payroll yourself. Full-service software solutions can automate many of the complex tasks involved in payroll processing, such as calculating net pay, tallying deductions, generating paychecks and pay stubs, and filing tax forms.

When choosing payroll software, look for features like ease of use, compliance updates, customer support, scalability, and employee self-service.

What documents are required for payroll compliance?

To ensure compliance, you need to maintain several key documents:

• Employee forms: W-4, I-9, and any state-specific withholding forms
• Payroll records: Detailed records of hours worked, total wage payments, deductions, paychecks, and net pay
• Tax filings: Copies of all filed FICA, FUTA, state, and local tax forms and deposit confirmations
• Benefit records: Documentation of any benefits provided, such as retirement plans or health insurance

Keep these records organized and securely stored, as they may be required for audits or legal inquiries.

Can I switch from DIY payroll to payroll software later?

Absolutely. Many businesses start by processing payroll manually and switch to payroll software as their needs become more complex. Transitioning to a payroll provider can improve efficiency, accuracy, and compliance.

When making the switch to a payroll service, make sure you transfer all existing payroll data accurately. Most payroll software providers offer support during the onboarding process to facilitate a smooth transition.

This blog is based on information available to Rippling as of October 18, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.