How to Set Up and Choose a Small Business Payroll System

LAST REVIEWED Mar 25 2021 10 MIN READ

By Cyndia Zwahlen

As soon as your small business hires its first employee it’s time to set up a proper payroll system. In fact, it’s better to have yours in place beforehand if you know you’ll be adding workers just to make sure the process runs smoothly and legally. And payroll is a process! From the first time you hand your new employee a W-4 form to cutting paychecks, to reporting and filing a myriad of payroll taxes, it can be complicated. And it’s a high-stakes effort. Unlike messing up a vendor payment, a payroll error can bring costly penalties. State and federal labor laws, Internal Revenue Service rules and even local laws cover how you are to pay employees and report and file payroll taxes. And they include big enforcement sticks. So how do you make sure you get it right? Before you can decide how you want to set up your small business payroll system, you need a clear idea of what the system has to do. It has three basic jobs: record-keeping, paying both employees, and tax collectors and filing tax reports. Here’s a quick look at each job and which tasks and responsibilities fall under each category:

Recordkeeping

This includes basic timekeeping and calculating overtime, sick time, or vacation pay. Inputting and tracking the numbers accurately is a key part of record-keeping, and the possibility of human error should be minimized as much as possible. Keeping track of tax records also is required: IRS employment forms including I-9s, W-4s, and W-2s have to be distributed, filled out, collected and entered into your payroll system properly. States also require that business owners track and report wages and payroll taxes the businesses owe and have paid. Employer tax records have to be kept for at least four years, according to the IRS.

Payments and Taxes

Pretty straightforward: your payroll system also has to handle paying your employees and the payroll taxes they and you owe!

Method of payment: To cover payday, your system can issue paper paychecks or you can opt for direct deposit if your workers have bank accounts. If they don’t, you can give them their wages on prepaid cards.

Frequency: You can also choose how often payday will be, to some degree.

  • Hourly workers: State labor laws often require hourly workers — those who get paid by the hour and are eligible for overtime — to be paid at least semimonthly. Daily pay is sometimes required for day laborers, including in New York, and weekly pay for temporary staffing workers, unless they are on a long-term assignment.

  • Part-time workers: They have to be paid at the same frequency as full-time workers.

  • Executives or professional workers (including commissioned salespeople): They can be paid as infrequently as once a month, under most state labor laws, but many companies stick to a semimonthly schedule for all their employees for simplicity.

Of course, the more often you pay your workers, the more it costs you in administrative time. And the money leaves your bank account more frequently. Whatever you decide, the law says you have to make it known ahead of time.

Non-employees: Freelancers or independent contractors don’t get paid through a payroll system at all. They are not employees of your small business and they are responsible for paying their own payroll taxes. An independent contractor usually submits an invoice for work done, which, like any other vendor’s, would be paid through your accounts payable system.

Taxes: Your payroll system also has to be set up so you know when to send payroll tax money to state and federal tax collectors. That includes the federal and state income taxes you are withholding for your employees based on instructions on their W-4s, which of course you are keeping safely on file. Social Security and Medicare taxes also have to be figured and sent. In California, payroll taxes also include two for unemployment insurance and employment training, which are paid by your small business, and state disability insurance tax, which comes out of employees’ wages.

Filing

Payroll is all about paperwork, even if the paper is a digital file. And filing tax reports with state and federal tax collectors is something your payroll system has to handle in an error-free way. Tax collectors post-filing deadlines on their websites, including the IRS. Online payroll systems will alert you when a filing is due. And outside payroll companies can even handle sending the payments for you.

Integrations

The more modern payroll systems are web and cloud-based, which means they can easily connect to other payroll-related services to minimize manual data transfer and checking. If you foresee that you’ll be requiring any of these services that require a connection to payroll data or information, be sure to ask your payroll provider which integrations and add-on services they support. These are the most common:

It’s quite a painful process to switch payroll providers, so you’ll want to make sure that the one you select is one that can grow with you and offer flexibility in the future, as you add on new employee benefits, take on different types of employees, etc.!

Your Options

Once you have a handle on what you need your payroll system to do, you can decide if you want to use a manual system, a software program in-house, or pay an outside entity.

In-house manual system: Plenty of small business owners still handle their payroll chores by hand. It doesn’t cost, except in time, and it gives an owner control over the process. Here’s a free payroll calculator from Intuit QuickBooks that can help. This system is obviously best for a business with fewer employees. It can also be more error-prone.

In-house online system: If you’d rather spend your time on other business tasks, an online system in-house is an option. Choose a cloud-based program—one that stores your data on remote servers so you can access it almost anywhere you are. Human Interest’s recommended online payroll systems, based on what’s popular with our clients: QuickBooks Online, Intuit Online Payroll, Intuit Full Service Payroll, ADP, Namely, Gusto, TriNet, Justworks, Paylocity, Paycor. Human Interest integrates with all of these payrolls and many more.

Payroll company: They take almost all the work off your plate, for a cost. That can range from about $25 to $100 a month plus a charge of $1 or $2 per employee. Direct deposit can cost another $8 per employee. The payroll companies can make mistakes, too, so it pays to find one that lets you have access to your payroll data.

Accountant: Accountants also can set up and operate payroll systems for a cost, but you aren’t required to use a CPA, or certified public accountant, to handle your payroll. This is the most expensive option, generally. Take time to make an educated decision because, no matter which method you choose, as the business owner you have bottom-line responsibility for making sure it runs smoothly and within the law!

Recommended further reading: 401(k) Payroll Regulations Under ERISA

If you’re looking for a great 401(k) for your employees, click here to request more information about Human Interest.

Cyndia Zwahlen, a former small-business columnist for the Los Angeles Times, is a freelance business writer and editor for media, academic and business clients. She founded the Small Biz Mix blog.

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