7 Steps to Payroll Setup and Success
Pen? Check. Checkbook? Check. If only payroll was that simple.
Even if you’re a small business with a handful of employees, there are some essentials you just can’t skip. But, with a few simple steps, you can pay your employees accurately and on time while preventing costly payroll mistakes.
“Payroll doesn’t have to be a pain. When you take the time to do it right, you’re set for success — giving you more time to focus on running your business.”
Before we get started, it’s important to note the key differences between classifying a worker as an employee or contractor. The table below explains the key differences, such as how they’re paid and which tax and labor laws apply, for example:
- Employers must oversee payroll taxes for employees, while contractors handle their own taxes.
- Employees are eligible overtime, while contractors will simply get paid for the extra time.
- Employees receive benefits, while contractors do not unless they are self-provided.
Classifying your employees correctly is something you want to ensure because, whether you’re in the United States or Canada, the penalties for getting it wrong can be expensive and time-consuming. Picture calculating back taxes, wages, and benefits for an employee who’s been incorrectly classified as a contractor for as long as they’ve been employed. Plus, the Canada Revenue Agency (CRA) or Internal Revenue Service (IRS) may also assign penalties for unpaid or overdue taxes.
Note: every business is unique. If you are unsure about any of the steps below we encourage you to talk to a bookkeeper or accounting professional to ensure you are setup for success.
With those items out of the way, let’s dive into seven steps to set yourself up for payroll success.
Step 1 — Register for your Business Identification Numbers
As a business and employer, you have certain tax and withholding responsibilities (also known as employer or payroll taxes) that include taking out the correct amount of employee income tax and paying into government programs like unemployment insurance. In order to process these transactions, you’ll have to have identification numbers (IDs) for your business (See Step 5 for more information on payroll taxes.)
In the United States:
- First, register for a Federal Employer Identification Number (FEIN or EIN).
- To apply, you’ll need to have a valid Taxpayer Identification Number (TIN), like a Social Security Number (SSN).
- If you register online, allow for up to two (2) weeks before being able to file an electronic return.
- If you file by fax or paper form using Form SS-4, make sure that you have all the information entered correctly.
- Once you have an FEIN, you’ll need to register for identification number(s) in any state(s) where you do business.
- This is usually done through state agencies — here’s a list.
Finally, you’ll want to confirm if you are subject to any payroll taxes at a local/regional/city level. If so, you’ll need to register with these tax agencies as well.
- Start by registering for a business number (BN) and program accounts.
- Your BN is the number that identifies your company, while the program account is the number you receive for specific programs, like payroll.
- Get your BN first, then use it to apply for a payroll program account number.
- You will also need to register for provincial programs in the provinces where you do business. If you are unsure of your obligations in a specific province, contact the provincial labour department.
- In order to register for a BN and program accounts, you will need: the legal name of your business, location and mailing address, business structure, gross sales (national and international) and fiscal year-end.
- In Canada, all payroll taxes are handled by the CRA and the provinces, so there are no local authorities that you will need to register with.
Step 2 — Get the right employee information
Whether you’re using a spreadsheet or payroll software, in order to pay your employees, you’ll need a few pieces of information in addition to the rate of pay:
- A Social Security Number (SSN) (United States) | Social Insurance Number (SIN) (Canada).
- A federal and state W-4 (United States) | federal and provincial TD1 forms (Canada).
- A voided blank check (cheque in Canada) for direct deposit.
- Accurate name and address information — each employee’s name and address should match on all pieces of identification, including the banking information.
Additional best practices
- Verify each employee’s right to work/immigration status during the onboarding process.
- In the United States, Form I-9 is used to verify an employee’s eligibility to work. Employers must complete this form for each employee.
- In Canada, all workers must provide a SIN. A SIN that starts with 9 indicates that an individual is not a citizen or permanent resident of Canada. In this case, you would then ask the employee to provide valid immigration documents, such as a work visa.
- Check with employees once a year to see if their withholding amounts are correct. Life events, like getting married or having children, can affect employee withholding amounts. At the same time, you’ll also want to verify your employees’ addresses and names, in case they’ve moved or made a name change.
- Keep detailed records of employment start and end dates.
Step 3 — Pick a payroll schedule
Choosing a payroll schedule isn’t just a roll of the dice — it’s a decision that has to make sense for your business. It’s also a choice that’s impacted by factors like your industry, if your employees are mainly hourly or salary, and even your accounting practices.
The four most common payroll schedules are:
- Weekly — once a week
- A popular choice for trades and service industries with hourly workers whose hours can vary from week to week.
- Bi-Weekly — twice a month
- Enables easy overtime calculation through regular two-week intervals.
- Semi-Monthly — every two weeks
- While it’s the most compatible with monthly accounting schedules, it can be harder to calculate overtime.
- Monthly — once a month
- Depending on how your business is structured, it’s fairly simple to administer.
Note: Make sure you’re familiar with the labor laws where you operate when choosing a payroll schedule. In the United States and Canada, certain state and provincial laws specify how often employees should be paid.
Step 4 — Set up business banking accounts
If you haven’t already set up designated business accounts for your company, it’s highly recommended that you do. Not only is it an accounting best practice, it can also help protect you in terms of legal liability and fraud prevention.
Step 5 — Understand your payroll taxes
As stated in Step 1, there’s more to payroll than salaries and wages. The following are the additional obligations that employers should be aware of and are legally required to comply with when paying employees (contractors are responsible for their own taxes):
In the United States:
- Federal Income Tax — A pay-as-you-go tax, income tax is withheld from an employee’s check by the employer, based on the withholding amounts set by the IRS and the exemptions claimed on the employee’s W-4.
- State and Local Taxes — 43 out of 50 states have a state income tax and even those that don’t have a tax, still have a tax authority. For states with an income tax, these amounts will also have to be withheld.
- Federal Unemployment Income Tax (FUTA) — a tax paid by the employer once monthly salaries and wages equal $1,500 or more each month.
- The current rate is 6.0%, but employers receive up to 5.4% credit based on state unemployment taxes.
- State Unemployment Income Tax (SUTA or SUI) — Also an employer paid tax with rates set by each state.
- Social Security and Medicare (FICA taxes) — Both the employer and employee are required to make contributions and it is the employer’s responsibility to remit both to the IRS. As of 2017, the combined rate for both was 7.65% for the employer and employee, representing a total of 15.30%. (If rates change, they are adjusted the start of the year.)
- Payment and reporting deadlines are determined by how your business is classified.
Incomes like bonuses, commissions, certain types of expense reimbursements, etc. are also taxable, which is when your bookkeeper, accountant, and payroll software will start becoming your best friend.
- Federal Income Tax — A pay-as-you-go tax just like in the United States, with withholding amounts set by the CRA and the exemptions listed in an employee’s TD1.
- Employment Insurance (EI) — Employees pay up to a yearly maximum set by income and employers must pay 1.4X the amount of the employee’s contribution.
- Canadian Pension Plan (CPP) — Employees pay 4.95% up to a yearly maximum and employers match the employee’s contributions.
- Remittance and reporting schedules are set by average monthly withholding amounts.
- In Canada, incomes like bonuses, commissions and certain types of expense reimbursements are also taxable. If you are going the DIY route, the CRA’s payroll tax deduction calculator is a valuable tool.
Step 6 — Consider automation over DIY
With growth of cloud-based mobile technology that lets you run your business from your phone, it’s worth looking into online payroll tools that can automate time-consuming functions — like calculating tax and withholding rates, supplying routine reports, issuing direct deposits, providing access to electronic paystubs and generating employee tax forms (W-2s/T4s). There are even services that can pay employees in the United States and Canada.
Step 7 — Give yourself a pat on the back
This outstanding guest post was written by our friends at Wagepoint. This article is for informational purposes only and does not replace the need for professional legal, payroll or accounting advice. Rates and percentages are accurate at the time of publication but subject to change at any time.