How to Process Payroll - DIY Payroll: A Step-by-Step Guide

Entrepreneurs start businesses because they love what they do. If you’re a small business owner, you probably started your business because you were passionate about your craft and wanted to make a living from it. 

However, as you know, practicing your craft is just one part of running a small business. You also have to perform tedious administrative tasks in order to keep the company running. 

One of these crucial tasks is payroll processing. 

Without payroll, you can’t pay your employees. If you don’t pay your employees, they won’t come to work — and you won’t have a business.

The good news?

Payroll processing for small businesses doesn’t have to be a struggle. 

Here’s what you’ll learn in this guide to payroll:

• What payroll processing is
• How to do payroll
• Why you should outsource payroll

What Is Payroll Processing?

Payroll processing calculates how much money you owe your employees at the end of a pay period.

Below you can find an example of a company’s payroll. 

In addition to a list of the company’s employees, you can see the hourly employees’ time cards for the pay period. Their time cards determine how much they are paid. This won’t apply to salaried employees, whose paychecks are consistent over each pay period.

This company uses a weekly payroll schedule. Bi-weekly and semi-monthly are also popular payroll schedules.

How to Process Payroll

There are four ways to do payroll: 

• Use payroll software
• Outsource to a payroll service provider
• Hire an in-house payroll specialist
• Do it yourself (DIY)

The best payroll processing options for a small business are payroll software or outsourcing it to a payroll service provider. These methods are cost-effective and ensure legal compliance.

The second best option is to hire an in-house payroll specialist. Unfortunately, this choice can be too cost-prohibitive for many small businesses. In California, hiring a payroll clerk will add $50,454 to your annual payroll, on average.

That leaves the DIY method. Frankly, unless you were a payroll professional in a previous career, you shouldn’t take your company’s payroll processing into your own hands. 

Why? 

Payroll processing is a time-consuming task that takes you away from projects that can grow the business. More importantly, payroll processing requires familiarity with tax codes and labor laws. 

Leave your payroll to the professionals — or good payroll software.

Still not convinced you should avoid processing payroll manually? Maybe an inside look into this tedious undertaking will change your mind. 

Here is how to do payroll:

1. Gather Paperwork From Your Staff

The first step in payroll processing is to collect important employee information. 

Ask current employees and new hires to fill out the following tax forms, if they haven’t done so already:

• IRS W-4 form to determine federal tax withholding
• State W-4 form to determine state tax withholding
• USCIS 1-9 form to verify their eligibility to work in the United States
• Any additional forms required by your state

2. Calculate Gross Pay

Calculate each employee’s pre-tax earnings for the pay period. 

To determine gross pay for hourly workers, multiply their hourly rate by the number of hours they worked during the pay period.

For example, let’s say that your employee Tony worked 38 hours during the pay period in question. He is paid $23 per hour. So his gross wages are 38 x $23, or $874. 

A salaried employee’s gross is the same during each pay period. To determine what this figure is, divide their annual salary by the number of pay periods your company has.

For example, Greta’s annual salary is $60,000. Her company follows a bi-weekly pay schedule, so there are 26 pay periods in the year. Her gross pay each pay period is $60,000 / 26, or $2,307.69

3. Calculate Tax Withholding

The next step in payroll processing is to calculate your employees’ pay after payroll taxes are withheld and calculate your employees’ pay after payroll taxes are withheld and deductions are made.

Use the paperwork that your staff gave you in step one to determine how much of your employees’ gross pay needs to be set aside for:

• Federal income taxes
• State income taxes
• Local taxes
• FICA (Federal Insurance Contributions Act), a.k.a. payroll taxes: Social Security and Medicare
• Pre-tax deductions including retirement savings, commuter benefits, and health insurance

Note that FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) are paid by you as the employer — not taken from employee’s pay. In California, employers do not pay SUTA.

Let’s revisit our previous example, featuring Greta. 

She’s a salaried employee who lives in Los Angeles, is single, contributes five percent of her pre-tax pay into a 401(k), and pays $100 bi-weekly for health insurance. Her company follows a bi-weekly payroll schedule. 

Her post-tax paycheck amounts to $1,589.

4. Pay Your Employees

After you’ve calculated how much to deduct from your employees’ paychecks, you are ready to pay them. Cut checks or initiate a direct deposit to pay employees what they are owed.

5. File Taxes

Tax filing is the next step you have to take to process payroll. File the taxes you withheld from your employees’ paychecks with the government. You will need to file taxes with the IRS, your state’s department of revenue, and if applicable, your city’s department of revenue. 

6. Pay Into Benefits

Then, you need to divert a part of your employees’ pre-tax earnings into the benefits and retirement plans that they have chosen to pay into. 

These plans may include:

• Healthcare plans
• Retirement plans
• Commuter benefit accounts
• Health savings accounts
• Flexible spending accounts

7. Update Your Payroll Records

The last step in payroll processing is to update your payroll records to reflect the latest payroll run. You’ll need to keep information about employee wages and salaries, tax forms, overtime records, pay stubs, and more in case of an audit.

As you can see, it is difficult to learn all of the ins and outs associated with payroll. Payroll processing is complicated. 

But, you can avoid the learning curve by outsourcing your payroll processing to a payroll service provider or using payroll software.

The Benefits of Outsourcing Payroll Processing Services and How to Do It

Companies choose to outsource payroll because they either don’t know how to do it or it takes up too much of their time. 

These are just some of the benefits of outsourcing payroll to a payroll service provider:

• Save time: As a small business owner, you should dedicate yourself to projects that are critical to the growth of your business. Don’t waste your limited time and energy on calculating wages and tax withholding.
• Decrease your liability: If you’re not a payroll professional, you’ll likely make a mistake on your payroll, at some point. Working with a professional payroll service provider or payroll software creates safeguards against expensive mistakes or human error.
• Ensure compliance: Outsourced payroll service providers can take labor laws, tax withholding, and workers’ compensation compliance off of your plate.
• Spend less: Outsourcing payroll is more affordable than hiring someone in-house. Payroll software and payroll service providers cost a fraction of what it costs to hire a full-time payroll specialist.

By now, you should be convinced that it’s wise to get help with your payroll processing. 

Here’s how to find the assistance you need: 

There are two recommended ways to outsource your payroll processing. 

First, you can hire a payroll service provider to handle it for you. This option typically involves working with an account manager at a payroll company or payroll agency. They will do payroll processing for you. 

Outsourcing payroll to a payroll service provider typically costs $25-$200 per month.

The other option is to do your payroll with the help of payroll processing software. This method is a hybrid between doing it on your own and outsourcing it. 

Payroll software automates tedious tasks, like timekeeping. It also has compliance and built-in withholding calculations. Additionally, online payroll processing software lets you manage payroll through a mobile app. 

Payroll software is even more affordable than outsourcing to a payroll service provider. Payroll software starts at only $10 per month.

Final Thoughts: Everything You’ve Ever Wanted to Know About Payroll Processing

Processing payroll is a necessary part of running a business. 

Handling human resources isn’t the most thrilling part of entrepreneurship—but, it’s crucial to keep the operation running smoothly. 

Payroll means keeping track of how much money you owe your employees at the end of a pay period. It also involves calculating taxes and withholdings. 

While you could do payroll manually, you’re better off equipping yourself with payroll software. Payroll software automates tedious tasks, ensures compliance, and frees up your time so you can focus on growing your business.