10 Essential Steps to Set Up Perfect Payroll

Setting up a payroll system is one of the most important things you’ll do as a business owner. Getting paid is the reason your employees show up to work each day, so here’s how to get it right:

1. Get an employer identification number

The Employer Identification Number (or EIN) is a unique numerical code associated with your business. This number will be used for tax purposes with the IRS, and you’ll need it before you can file documentation.

Pro tip: Don’t fall for online services that charge a fee. You can Apply for an Employer Identification Number (EIN) Online for free.

2. Assess what kind of workers you have

Are they employees or independent contractors? The legal distinction can be fuzzy, but this classification does impact the payroll taxes you will owe, and the IRS takes it very seriously

3. Complete employee paperwork

Employees use Form W-4, which impacts the amount of taxes withheld from their checks.  The Department of Homeland Security requires a Form I-9 on file. Your state may require its own forms to withholding as well. Here’s a great resource to check.

4. Establish the pay period

Most employees are paid weekly, bi-weekly, semi-monthly, or monthly. Note that some areas mandate certain pay periods, favoring employees being paid more often than once a month.

5. Document the terms of compensation

This needs to be a clear and concise plan for outlining employee compensation. This means tracking and measuring:

  • Time/hours worked
  • Paid time off (vacation, sick leave, jury duty, etc.)
  • Overtime (in hours and dollars)
  • Sending other forms of compensation (health care premiums, retirement contributions, etc.) to the appropriate third party vendors

Your employees should be provided an explanation of these categories before they begin work. This is especially impactful for first-time employees, who may be surprised when they take home considerably less money than they expected, after taxes and deductions are factored in.

6. Select a payroll system

There are many payroll systems that you can choose from. Some are designed for in-house use, while others transmit data to a professional to process. Which one you choose depends on your individual situation, but don’t forget: You, as the employer, are responsible for reporting and paying payroll taxes. Regardless of the system you choose, you need to have a way to verify the tax information and payments are being sent in timely.

When in doubt, talk to the trusted financial professionals in your life and ask for recommendations. This will give you a list of options to get you started.

7. Run a payroll cycle

You’re not quite done just yet. Pay close attention for the first few runs of payroll. You may have missed something during the setup phase – such as allocating money to a promised retirement plan…so review every part of the compensation terms and compare to what’s happening within the payroll system.

8. Set up a record management program

The law requires you to retain certain types of information – copies of W-4s and I-9s, filed tax forms, receipts showing the taxes paid at any time, for example. You do not want to lose these records – in fact, it may be worth making copies of each document and housing them in a separate, secure location. If you are audited or lose some documents, you can rebuild your database and get back on track quickly.

9. Report your taxes

Depositing your payroll taxes and filing the requisite forms – and all on time – is arguably the most important function of payroll. Remember, different taxes are reported at different times – some only once a year, while others may be quarterly, monthly, or even more often. Your payroll system should remind you when taxes are due – and, well in advance, so you can prepare.

10. Get your new system audited

Payroll law is complex, especially when you count all the federal, state, and local regulations. Even if you think you’ve done everything right, ask a professional such as an attorney or CPA who specializes in these matters – to audit your system and make sure you’re fully compliant with the law. If you missed something, they can help you fix it before the penalties and interest start adding up.