Most small businesses run payroll on one of the following schedules:
Weekly. Employees receive paychecks every week on a specific day of the week (52 payrolls per year). For example, you pay your employees every Friday.
Bi-Weekly. Employees receive paychecks every two weeks on a specific day of the week (26 payrolls per year). For example, you pay your employees every other Friday.
Semi-Monthly. You pay your employees twice per month on two specific dates of the month (24 payrolls per year). For example, you pay your employees on the 15th and last day of the month.
Payroll processing is crucial, and kind of complicated. It requires an understanding of federal and state regulations, and some tax knowledge to make sure you’re withholding and filing the right amounts (and paying everyone the right amount of money!).
While it’s possible to do payroll by hand, it’s very time-consuming. For that reason, most small businesses use payroll software or outsource their payroll to reduce stress and minimize errors.
What is payroll tax?
Employers are required to deduct payroll taxes from the wages of every employee.
Payroll taxes include:
Federal income tax
There is no standard federal payroll tax rate for federal income taxes. The amount of federal income tax you withhold and remit to the IRS depends on the employee’s salary or wages, and the information the employee provided on Form W-4.
IRS Publication 15-T includes several tables that can help you calculate federal income tax withholding, depending on the employee’s adjusted wages and tax filing status. However, take one look at the instructions and tables included in that publication, and you’ll see why few companies are doing payroll by hand.
State and local income taxes
Most states in the United States. have a state income tax. The only states that don’t assess a state income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Some cities and counties also impose a local income tax. According to the Tax Foundation, as of 2019, 4,964 jurisdictions in 17 states imposed some sort of local income tax. Those 17 states are Alabama, California, Colorado, Delaware, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, Pennsylvania, and West Virginia.
State and local income taxes generally apply to people who live or work in the state or locality, regardless of where the employer is located. If your business employs people who live or work in a location that imposes state or local taxes, you’ll need to withhold those taxes from their wages.
Each state and locality has its own income tax rules and rates. Check with the department of revenue or talk to your accountant to ensure you’re withholding the right state and local income taxes for your employees.
Federal and state unemployment tax
Unemployment benefits are funded by unemployment taxes that are based on employee wages.
Only employers pay federal unemployment taxes (FUTA)—they aren’t withheld from the employee’s wages. The FUTA tax rate is 6% of the first $7,000 per year that you pay each employee. However, most employers qualify for a tax credit of 5.4%, which lowers your FUTA tax rate to 0.6%.
In most states, employers also pay 100% of state unemployment (SUTA) taxes. However, if you have employees in Alaska, New Jersey, and Pennsylvania, you may have to withhold SUTA tax from your employee’s wages. SUTA taxes don’t have a standard rate. Each state sets its own rates.
To read more about the FUTA tax credit and SUTA tax rates, check out our Employer’s Guide to Unemployment Taxes.
Social Security and Medicare taxes
The taxes that help fund Social Security and Medicare are collectively known as FICA, which stands for the Federal Insurance Contributions Act.
Currently, the FICA tax rate is 15.3% of the employee’s gross wages: 12.4% for Social Security tax and 2.9% for Medicare tax. An employer withholds half of that FICA rate from the employee’s wages and pays the remainder out of their own pocket.
For more information on FICA taxes and how to calculate them, check out FICA Tax: Everything You Need to Know.
What is a payroll deduction?
Payroll deductions are the amounts taken out of your employee’s paychecks each pay period.
Payroll deductions include the payroll taxes listed above, but they can also include other items, such as:
Garnishments. Wage garnishments happen when a court orders you to withhold a specific portion of your employee’s gross pay for child support or other debts. Employers are required to send the amount withheld directly to a creditor or other person to whom the employee owes money.
Health insurance premiums. If you offer employee benefits, such as health, dental, and vision insurance, you may deduct a portion of the premiums from the employee’s wages.
Retirement contributions. If you offer a retirement plan, such as a 401(k) or SIMPLE IRA, your employees can choose to have a portion of their wages withheld for retirement savings.
What is a payroll register?
A payroll register summarizes payroll information for a specific pay period. It includes many of the details normally found on an employee’s pay stub, including the number of hours each employee worked, gross pay, net pay, and payroll deductions. At the end of the payroll register, there is usually a totals section that summarizes all of the employee information.
You can use the payroll register to see how much money you need to set aside for certain payments, such as the employer-portion of FICA taxes. It also comes in handy when filing payroll tax reports.
What is payroll withholding?
Payroll withholding refers to the mandatory payroll deductions. Employers are required by law to withhold income taxes, FICA taxes, and garnishments from an employee’s wages. Employers who don’t withhold these mandatory amounts can face fines and even jail time.
Other types of withholding, such as health insurance premiums and retirement plan contributions, are voluntary because small business owners aren’t required to offer them to employees.
What are payroll liabilities?
Payroll liabilities are any type of payment related to payroll that a business owes but has not yet paid. These typically appear on the company’s balance sheet as Accrued Payroll.
These can include:
Wages employees have earned but not yet received
Taxes, garnishments, and other withholdings from employee pay that haven’t been remitted to the proper authority
The employer portion of FICA and unemployment taxes that haven’t been submitted to the IRS
Payroll liabilities come with every payroll a business runs, but don’t stay on the company’s balance sheet for long. Accrued wages will be paid out to employees according to your regular payroll schedule and payment method (i.e., paper checks or direct deposit). Payroll taxes, premiums, contributions, and garnishments need to be sent to the proper authority.
Working with payroll software or a payroll service provider to automate running payroll can ensure that you withhold the proper payroll deductions and send amounts to the appropriate agency on time.
How to actually run payroll (with software)
If you’re doing payroll yourself, you’ll need a payroll system. We’ve outlined the top five payroll solutions here.
Payroll software will give you the ability to:
- Run payroll (and produce pay stubs) on the cadence you need (usually biweekly)
- Calculate how much each employee gets
- Make payroll tax payments
- Facilitate pay checks and direct deposits
- Fill out w-4 forms
- Onboard new hires
- Manage workers’ compensation
Can I make this easier?
If this is all sounding a bit complicated, you’ll be relieved to know there are easier options than the DIY route. You can hire a payroll provider to take care of the bulk of the work for you. We recommend Gusto, a software application that guides you through the payroll process. Even better, it automatically files and pays your payroll taxes, so you don’t have to worry. Gusto is to payroll as Bench is to bookkeeping. By outsourcing your payroll, you can be free to focus on what your business does best, and enjoy the peace of mind that comes with accurate tax filings.