Employer's guide to managing payroll: A step-by-step approach

Managing payroll is a must-do for businesses of all sizes that have employees, and it’s even a consideration for those who work with freelancers or independent contractors. It can mean wading into a world of payroll terms and tax obligations you may be getting familiar with for the first time. From learning acronyms like FICA and FUTA to wrapping your head around withholding taxes, some employers may feel a little uneasy when getting started.

Key takeaways about managing payroll

It’s a method that is repeatable, so employers can accurately calculate employee wages, including regular pay, overtime, bonuses, and required withholding taxes
It typically includes a plan to maintain detailed payroll records and ensure compliance with federal, state, and local laws
Companies must decide who will manage payroll — yourself, an in-house team, or outsource those tasks to a provider
It’s important to establish a consistent pay schedule and method for distributing wages (direct deposit, checks, etc.)

However, with some planning, you can manage this process yourself, hire an outside company, or hire a team to do it for you. Even if you have payroll specialists on staff or plan to outsource this task, it’s still a good idea to know what it means to manage payroll, how this affects your employees, and how it can tie into other facets of your organization (such as offering employee benefits).

In this overview, we’ll discuss some payroll basics,relevant federal and state taxes, and point you in the direction of other resources to help you tackle this topic.

Why is managing payroll a must-do for most businesses?

If you are first becoming familiar with how paying employees works, let’s briefly touch on some reasons why having a system in place is a good idea.

Reduce risks and errors

Keep employees happy and paid on time. Many companies use payroll software as part of the management process. Because many of the calculations are automated, it lessens the chance of wages being miscalculated or employee payments not getting made. Some providers can also help make sure that important payroll forms, such as Form 941 which are filed each quarter, and Form 940 which is filed on time at the end of each year.

Reputation

The reality is that with the advent of review sites such as Indeed and Glassdoor, with a few clicks, current (and former) employees can easily post about their experience working for a company. Making errors (even if they are unintentional) with deductions for benefits or paying employees late can lead to online postings that are easily avoided with some systems in place.

Reporting you can rely on

What is one of the other benefits of buttoning up a process? You can take care of getting records under control in the event that Uncle Sam ever comes knocking on your door for an audit. Though unlikely, you’ll need to have wage information available, the taxes you paid and withheld. Part of getting management in place is getting a records system in place. Many tools or software platforms automatically record and keep track of when people are getting paid.

Tax compliance
When you manage payroll, paying employees comes with certain tax obligations, and it’s important to keep up with them all.

FICA familiarity

Both the employer and the employee are responsible for paying FICA taxes. These taxes are under the Federal Insurance Contributions Act (FICA) and consist of old-age, survivors, and disability insurance taxes, commonly known as Social Security taxes.
It also includes hospital insurance taxes, though most employees will be more familiar with the term Medicare taxes. Here is how the numbers work out:
The current tax rate for Social Security is 6.2% each for employer and employee, up to the annual wage base limit.
For Medicare, it is 1.45% each for employer and employee, which has no wage base limit.

Employees contribute a percentage of their gross wages to these taxes, and employers then match the FICA taxes that are paid by their employees.

Foundations of FUTA

The Federal Unemployment Tax Act (FUTA) payments help fund unemployment for workers who have lost their jobs — it is a tax paid solely by employers.
Employers pay 6% of the first $7,000 of each employee’s wages. However, employers typically receive a credit for paying state unemployment taxes, commonly reducing the effective FUTA rate to 0.6% most of the time. To learn more about the purpose of this tax, here is our FUTA guide.

State and local taxes

What does it mean to manage payroll?

Simply put, payroll management is a process that employers use to ensure that employees are paid the correct wages while also complying with various legal and tax obligations. This includes everything from calculating wages and withholding taxes, to maintaining accurate records and submitting required filings.

Managing payroll primer: these are the essentials

Managing payroll covers a lot of territory, but here are the minimum main tenets that most employers have in place.

Calculating employee wages: Including regular pay, overtime, bonuses, and other compensation. At this point we’re adding up all the gross wages — all the dollars people have earned before deducting anything — meaning the money that typically goes into payroll taxes.
Withholding taxes: As an employer you’re responsible for making sure federal, state, local, and other deductions like Social Security and Medicare are withheld during each pay cycle.
Maintaining records: Keeping detailed records of every payroll transaction. You can keep these records as hard copies or digitally, but you should have a process. There are federal agencies such as the Internal Revenue Service that require businesses to hold onto these documents in the event that a company is audited.
Compliance: Ensuring adherence to all relevant laws and regulations.

Now that we better understand what it means to manage payroll and generally what it entails, let’s find out who actually takes on this role at a company.

Who manages payroll?

Here are some ways that businesses handle this responsibility.

Can I run payroll myself?

Yes, you can run payroll yourself, especially if you have a small team. However, doing this yourself from start to finish will likely require a clear understanding of payroll rules and regulations. Initially, many small business owners use payroll software and opt to manage payroll themselves to save costs. In a study of small businesses, we found that almost 50% of organizations use online payroll software when running payroll.

Who usually manages a company’s payroll?

In larger companies, payroll is typically managed by the HR department or a dedicated payroll administrator. In smaller businesses, the owner or a trusted employee often takes on this responsibility. It depends on how much bandwidth a company has, or if they have someone on staff that takes this role.

HR sometimes helps here

In many organizations, HR handles payroll. Some of their responsibilities align with other administrative work that comes with bringing on new hires, such as making sure that employees complete Form W-4 and their I-9 forms. However, some businesses may have a separate finance or accounting team that manages payroll.

External assistance

Some companies go a different route by working with an outside company. This could be accounting professionals in your community, a CPA that you trust, or payroll service providers that make this their sole offering. In a small business market survey that OnPay conducted, almost a quarter of the participants we reached out to said they work with an accountant for payroll runs.

PEOs
Another option for those who may not have an interest in managing this in-house is using a professional employer organization (PEO). PEOs can partner with employers to handle the heavy lifting. These companies help with tasks such as:

Calculating wages and withholding employee taxes
Making mandatory and voluntary deductions
Depositing employee and employer taxes
Issuing Form W-2s and 1099s at the end of the year
Maintaining payroll records

This is another service that you pay for and outsource. In addition, some PEOs can also help with benefits administration for employers who want to set up an employee plan.

Now that we better understand who you can turn to when running payroll, let’s cover an overview of the different items that need to be taken care of when it’s time to manage it all.

Step-by-step guide to managing payroll

Even though there are many moving parts, here’s an overview of what to expect.

Get your employer identification number (EIN) in order

Applying for and obtaining an EIN is essential for reporting taxes and other documentation to the IRS. It’s something you are going to want to take care of before hiring employees. This ID number is putting an official stamp on your business venture. You’ll need it for opening bank accounts.

After your EIN

On the same subject, once you have obtained your EIN, you’re ready to pay tax obligations to Uncle Sam. The Department of the Treasury has a no-cost, online system that you can use to pay some of the payroll taxes we covered earlier in the article. By registering with the Electronic Federal Tax Payment System or EFTPS online, you can remit all of your federal taxes in one place.

Related resource: Here’s a definition of EFTPS from our payroll glossary

Put a payroll policy in place

Having a payroll policy can be a good way to document what employees should expect each payday and be included in your employee handbook (for reference if questions come up or there are disputes). A payroll policy is a document that outlines how your company handles timesheets, how you pay your employees, how deductions are managed, what employees need to do if they find that there’s a mistake on a paycheck, and what your payroll schedule looks like (we’ll dive into common pay periods in the next section)

Figure out your pay schedule (and how wages get paid)

When bringing on new hires, it’s common for employees to want to know when payday is. So, when you manage payroll, you’ll need to decide how often employees will be paid (weekly, bi-weekly, monthly, semi-monthly, etc.) and stick to the schedule.

Here are some of the most common periods that companies adopt.

Weekly pay schedule

What does it cover? This schedule covers 52 pay periods during the year, one for each week.

Biweekly pay

What does it cover? A biweekly pay period refers to a payment schedule in which employees receive their wages every two weeks, typically resulting in 26 pay periods in a year.

Semimonthly (or bimonthly) pay

What does it cover? This schedule covers 24 pay periods each year. A semimonthly pay period is a schedule in which employees are paid twice a month, typically on the 15th and the last day of the month. This differs from a biweekly pay period, which occurs every two weeks on a consistent day of the week.

Monthly pay schedule

This is another option which covers 12 payments a year.

If you’re wondering which one makes the most sense for your situation, and are unsure which to pick, it could be helpful to know what other small businesses use. In a survey we conducted, OnPay found that most end up using either:

Weekly
or biweekly schedules

What else? You’ll need to figure out how wages get distributed to your employees. The most common methods to pick from are direct deposit or distributing paper checks. But there are also some companies that use pay cards and others even use cash. However, this last option can be a little risky. It’s hard to keep track of (and you’re going to need to have payroll records to maintain – we talk more about this further in the article), and there’s not much you can do should money get misplaced.

Related resource: Picking a pay period

Stay up to date on state, local, and federal taxes

To stay in good standing with Uncle Sam, and where you do business, it’s important to have a system in place for remitting any payroll taxes that you owe. We mentioned some basics earlier in the article, but the topic is worth revisiting.

FICA (Federal Insurance Contributions Act) is a federal payroll tax — not a state or local tax. It funds programs such as Social Security and Medicare. Employers and employees both pay a percentage of wages toward FICA taxes.
FUTA (Federal Unemployment Tax Act) is a federal payroll tax, not a state or local tax. It is paid solely by employers to fund unemployment benefits for workers who lose their jobs. The FUTA tax rate is 6% on the first $7,000 of each employee’s wages, though employers can claim a credit of up to 5.4% for paid state unemployment taxes.
Also, it’s commonplace for each state to have payroll taxes that employers are responsible for. State income tax withholding is required in most states, with rates varying from state to state. All states are going to have a state unemployment tax (SUTA) that employers must pay to fund state unemployment programs. Some states and localities also have tax obligations for items such as disability insurance and programs like paid family leave.

Even if you are not managing payroll yourself, it can be a good idea to know the basics of the rules under which you do business, and the payroll taxes you are responsible for.

Related resource: Payroll calculator and tax information

Time tracking for schedules

Using time tracking can also come in handy for correctly calculating wages. There are many standalone platforms that employers can use to manage this process, while companies like OnPay have integrations so you can set this up in one place. Time tracking can also help you collect data so that you can find potential scheduling inefficiencies. For example, you may find your weekend shifts are overstaffed after reviewing the data.

Related resource: Time tracking guide

Balance benefits and deductions

Most employers will use employee benefits during the recruiting process. From paid time off to group health insurance, perks can put you a step ahead of competitors when vying for the same talent. Remember, though, that you’ll need to make sure that deductions and withholdings are taken care of (which means you’ll need to know how much to deduct for employee benefits each pay period). For example, you’ll want to be sure that pre-tax deductions, like health insurance or flexible spending accounts, are set up before payroll is run. Most companies will use benefit administration systems to keep all of the data and deductions organized.

Managing payroll can also include employee perks

When it comes to general employee benefits, over half provide workers’ compensation insurance, followed by a third of SMBs offering a retirement savings plan.

Also consider that having a workers’ compensation policy is likely a requirement where you do business (unless you are in Texas or South Dakota, though it is highly recommended that you have it). To manage this, you can sync up payroll, so that you pay premiums based on how many employees you have with pay-as-you-go workers’ compensation. When managing it all, the takeaway is that benefits and some required insurance should be something to think about.

Related resource: Benefits employees want the most

Consider hiring a payroll administrator

If managing payroll becomes too complex, hiring a specialist can save you time and reduce the risk of errors. We mentioned earlier that some owners handle this task on their own or bring on a dedicated specialist. Some of these professionals must earn certifications where they put their skills to the test.

Related resource: What is a certified payroll professional (CPP)

Payroll records are important

Earlier in the article, we touched on the fact that one of the main tenets of managing payroll is also keeping records. To stay compliant (and to have a backup in the event any workers have questions), maintain all of your payroll transactions, including employee hours, wages, tax withholdings, and benefits. This is more than just housekeeping, though. In some cases, you may need to have these documents available should your business be subject to an IRS audit. For more information on the different rules, we have a guide, plus some tips on how to keep it all organized.

Related resource: Payroll records retention employer’s guide

Audit payroll management throughout the year

Think of audits as a way to ensure that your processes are in good health. Payroll audits help ensure accuracy in calculating wages, benefits, deductions, and tax withholdings. They can also help prevent costly penalties, legal disputes, and ensure that you’re staying compliant with payroll laws and regulations. Additionally, audits can help prevent the misuse of funds. What do we mean by this? An audit can identify and prevent fraudulent activities such as ghost employees, unauthorized payments, or timesheet manipulation (sometimes referred to as “buddy punching“).

Related resource: What is a payroll audit?

Payroll runs smoothly when managed properly

Having a payroll management process in place is important to the success of a business because it goes beyond paying employees accurately and on time. From making sure you get taxes withheld properly and remitted to the correct agencies to create a process that can become part of your operations, you should have more time to focus on other aspects of your business. Whether you choose to handle payroll yourself, hire a specialist, or use advanced software, having this portion of your business buttoned up will keep you informed, organized, and compliant.

Employer's guide to managing payroll: A step-by-step approach | OnPay (2024)