20 February 2023
Payroll accounting involves tracking employee hours and wages, calculating taxes and deductions, managing employee payments (including bonuses), and keeping accurate records of all transactions. Doing it on your own can sound like a daunting task, but if you equip yourself with the right knowledge, enough time, and a sturdy calculator, it can be easy and efficient. You don't need to sit for accounting certification programs or obtain professional experience.
This guide will provide you with a comprehensive understanding of payroll accounting so you can learn to process it yourself. It goes over who you should process payroll for, what to do before processing, and how to process payroll.
Who should be on your payroll?
There are two types of workers: employees and independent contractors. Employees are individuals hired by an employer to perform a specific job, and independent contractors operate their businesses that provide services to employers. Employees can be full-time, part-time, seasonal, or temporary.
Who do you need to process payroll for?
You need to run payroll for all your employees, whether part-time, seasonal, temporary, or full-time, regardless of their citizenship status. You must calculate and withhold their federal, state, and local taxes and remit them to the relevant authorities.
You don't need to process payroll for your independent contractors. They are responsible for paying their taxes. If you work with independent contractors, you pay them in full for their services without running payroll or withholding taxes.
Use common law rules by IRS to determine whether a worker is an employee or an independent contractor. If it is still unclear, you can file Form SS-8 with the IRS so they can help you determine the worker's status. Misclassifying employees can result in fines, penalties, or jail time.
What to do before processing payroll
Before you start payroll accounting, there are several one-time things you must do. They include the following:
Apply for a federal employer identification number (EIN)
A federal EIN is a unique number the IRS uses to identify your business. It is the business equivalent of a Social Security number and is needed to pay employees salaries.
To get an employer identification number, file an online application or use other application options, such as fax and mail. You will be asked to provide details about your business, such as the type of company and its address. Once approved, your EIN is permanent and can't be cancelled.
Obtain your local or state business ID
Some states and local governments require every employer to have an identification number for tax purposes. But you should obtain an EIN first because some states can use it to identify your company instead of having you apply for another ID.
The procedure to obtain your local or state business ID varies with location, so check with your local and state agencies.
Learn federal, state, and local labor and pay laws
There are several federal, state, and local labor and pay laws you must know about before running payroll. They include the following:
- The minimum wage
- How to calculate overtime
- Tax withholding requirements
- Payday frequency requirements
- The required paid and unpaid breaks
- Workers' compensation insurance requirements
If your business has operations in different locations, you must learn each location's labor and pay laws to ensure compliance and avoid costly penalties and fines.
Choose your payroll schedule
Check your state and local payday frequency requirements and decide how often you will process payroll. Certain areas dictate pay periods for different types of employers, employees, or circumstances. The most common pay periods are every two weeks, weekly, and monthly. Others pay daily, and others every two months.
The best pay period for your business depends on your cash flow. How often can your company afford to pay its employees based on your cash flow and profits?
Collect employee tax information
After hiring new employees, they need to provide their tax information so you can pay them. Have them fill out Form W-4 and Form 1-9. You need the details provided on these forms to do payroll accounting.
Form I-9 verifies they are US citizens and have the right to work in the country, and Form W-4 supplies the information you need to calculate and file taxes for each employee. If you have independent contractors, collect their tax information using Form W-9.
Report your new hires to the state
Federal and state laws require employers to report information on hired employees to the appropriate agencies within some days of starting employment. You must report them to be able to run their payroll. Use this list of new hire requirements by state.
You may also be required to purchase workers' compensation insurance and provide benefit payments like dental care and health insurance and other benefits, like many employers, to make your business an attractive workplace. Note that benefits can increase payroll expenses.
How to process payroll yourself
After completing the above pre-processing steps and gathering all the information you need, it is time to process payroll. The payroll accounting process can be divided into the five simple steps outlined below.
1. Calculate gross pay
Gross pay is the total amount your employee earns before deducting anything. If your employee is hourly, you can calculate their gross wage by multiplying their paid time (i.e., the total number of hours they worked in the pay period) by their hourly or minimum wage rate. You can track the total number of hours worked using punch clocks, spreadsheets, and paper time sheets. If your employee is salaried, their gross pay is their annual salary divided by the number of pay periods per year.
If the employees are non-exempt, you should calculate the tips and overtime they receive in accordance with Fair Labor Standard Act. Consider the different state overtime requirements.
2. Calculate payroll taxes and deductions
Process payroll deductions using the information you collected before you started running payroll. If you offer employee benefits like group-term life insurance, disability insurance, and 401(k) plans, the first step is to subtract pre-tax deductions from gross wages.
The next step is to calculate taxes to withhold from the employee's paycheck. There are two types of federal payroll taxes: federal income taxes and Federal Insurance Contribution Act (FICA) taxes. FICA taxes include Social Security taxes and Medicare taxes, and you are required to match them as the employer. If you offer fringe benefits it is subject to fringe benefit tax. Keep in mind that generally, paid holidays are treated the same as regular workdays for tax purposes.
If your employee makes more than $100,000 annually, calculate the federal income tax using the percentage method. You can use either the percentage or wage bracket method if they make less. If you prefer not to use the percentage or wage bracket method, IRS offers other alternative methods.
Depending on your state, you may be required to withhold additional state income taxes. Check with the state's labor department.
3. Calculate net pay and pay employees
The next step is to calculate employee salaries by subtracting the total withholdings and other deductions from gross wages. Note that apart from taxes, you may need to make other deductions such as:
- Health insurance premiums for your business's dental, vision, or medical plans
- Voluntary donations to charity
- Retirement savings plans contributions
It is simple, and requires no education and experience requirements. Calculate the net employee compensation by subtracting the total withholdings from the gross wage. After calculating for each employee, pay their salaries and wages using their preferred payment method.
Methods of manual payments include cash and direct deposit into their cash account. Make the correct journal entries and record the payment in the general ledger.
Many states and jurisdictions have varying requirements for employee compensation, so you should be well-versed in local salaries and payroll laws.
4. File tax reports
The second to last step of doing payroll accounting yourself is to file the tax forms required by the state and federal government. They include the following:
Form W-2 reports employee wages, deductions, and tax withholdings. You must submit it by January 31st every year and send a copy to your employees, your state or local tax department, and the Social Security agency. You should also file Form W-3, which summarises all the W-2s.
Form 941, Employer's Quarterly Federal Tax Return, reports the amount of money you have withheld from your employees and the amount of employer taxes you have paid. It is filed every quarter. Employers of businesses with seasonal, household, and farm employees are not required to file Form 941.
You may also need to file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, but the unemployment taxes are employer-only.
5. Document and store payroll records
Document and store employee payroll information and financial records to avoid compliance issues. Some of the payroll data you should record include the following:
- Personal details
- Hours worked each pay period
- Pay rate
- Pay period earnings
- Gross and net employees wages paid
- Benefits paid
- Taxes withheld
- Forms W-4 and W-9
Ensure the ledger and journal entries are correctly recorded to avoid costly penalties. Note that payroll taxes are typically recorded in the liability accounts in your financial statements. They are recorded as liabilities in your general ledger until you pay them. You must keep the company's recording for at least four years. Check with the appropriate agency to know if you're making the correct general and journal entries and keeping them for the correct time.
Should you do payroll accounting yourself?
The above breakdown of how to process payroll yourself reveals it is not that complicated. You can pull it off without accounting experience or most certifications, including a bachelor's degree and master's degree in accounting. But a manual payroll system can be very time-consuming, especially if you have many workers.
According to a survey of over 1000 US employers, accounting takes nearly five hours every pay period, which can add up to 21 days per year. An average of 111 minutes is spent calculating, 96 minutes filing, and 86 minutes allocating funding per pay period. The 63% of respondents who admitted to doing payroll accounting themselves agreed it is frustrating, complicated, and confusing.
So, is doing payroll accounting yourself worth it? To answer this question, let us look at the alternatives of payroll accounting: outsourcing and hiring a payroll accountant. Outsouring payroll means delegating a portion or all your payroll operations to a third party, while hiring payroll accountants is employing an internal department that deals with the payroll process.
Of the employers who do payroll accounting themselves, 45% can't outsource because of the cost, and 34% are unwilling to pay or trust an outsider with their payroll accounting duties.
Hiring a payroll accountant leads to higher payroll expenses than outsourcing. In-house payroll accountants can also be prone to mistakes and make it scaling up and down a slow and long process. A business that frequently scales up or down needs flexibility that payroll accountants can't provide.
So, what do you do if manual payroll processes are too time-consuming and their alternatives are too expensive?
You should stick with doing payroll accounting yourself because it saves the other expenses you would need for the payroll accountant or payroll service provider and other payroll expenses. But use payroll accounting systems and accounting software to reduce the time you spend processing manually. Because most of the time is spent calculating, you need an accounting software like Shifbase. It digitizes time tracking and salaries and wages calculation and payment, simplifying the payroll accounting process for small business owners and human resources. This accounting software can make your accounting more efficient.
Ease the burden of payroll processing with Shiftbase
Instead of tracking the time your employees work using time-consuming methods like a spreadsheet, you can use Shiftbase, an accounting software for employee scheduling and time registration. It can help you track time worked using an online registration form, time clock, or the Shiftbase app, which has a punch clock feature. It also gives you a quick overview of labor costs according to your collective labor agreement or business rules to simplify payment.
You can integrate Shiftbase with your payroll software or POS system if you want to make the payroll accounting process more efficient.
Request a demonstration now without obligation to learn how Shiftbase can improve your payroll accounting process.
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