How to Set Up a Payroll System (Even if You Only Have One Employee)

If your business has any employees, you’re not only responsible for issuing paychecks on a set schedule, but also for deducting and paying all applicable federal, state, and local income taxes to the government. Some people are intimidated by this responsibility, but the truth is that once you have a payroll system in place, it’s not that difficult to keep it running smoothly, especially with the help of your accountant. Here are the steps you should take to set up a system that will streamline the process.

Apply for an Employer Identification Number

An Employer Identification Number (EIN) identifies you as a business entity that’s responsible for paying payroll taxes to the government. According to the IRS, if you have employees (not just independent contractors), you’ll need to apply for one. To do so, go to the IRS website and print out Form SS-4 [PDF] if you plan to submit it by mail or fax. If you are an international applicant, you can apply by phone. You can also complete and submit the form online.

Learn Your State's Withholding Requirements

In addition, some states require that you withhold state income tax, disability, or unemployment taxes from your employees' paychecks. Your state may require their own, separate, employer number and also an Account Number for unemployment purposes. The IRS offers a list of all state government offices where you can find your state’s requirements. Your accountant will be able to help with any questions or concerns you have with this process.

Get the Required Paperwork from Employees

You’ll need to have each of your employees fill out a Federal Income Tax Withholding form W-4 [PDF]. This will allow you to withhold the right amount of income tax from their paychecks.

Decide How Often You’ll Pay Employees

Next, you’ll need to decide how often to pay your employees. In addition to what’s convenient for you, you’ll need to adhere to your state's laws. (Every state has laws that determine how long you can go in between paychecks.) The typical pay schedule is every week, or every-other week.

Choose Your System

Next, you’ll need to decide which type of payroll system to use. Many business owners choose to calculate and record their payroll themselves manually. This option may seem lucrative, as it is the cheapest method, but it is also the most labor intensive and the most prone to error, leading to headaches during tax season and possible fines from the IRS.

Using an online payroll service saves time and makes it easier to track important details such as employee hours, overtime, vacations, health care premium deductions and retirement contributions. In addition, the online system calculates the amount of the paycheck and tax withholdings, files the required tax forms, and pays your payroll taxes.

If you’re like most small-business owners, time is your most valuable asset -- which is why many choose to completely outsource their payroll system to an accountant. Hiring an accountant to handle your payroll takes all calculations, reporting, and check issuing off of your plate and allows you to focus on other more pressing matters.

Run the Payroll

After you’ve set up your system, you’re ready to run payroll. If you use a desktop software program, you’ll have to enter the required information and print out the checks. If you choose an online payroll service, you simply enter the hours, and then either print the checks yourself or use the free direct-deposit feature. All that’s left is to report the payroll taxes to the appropriate tax agencies, paying them within the required time period. If you have chosen to outsource your payroll to an accountant, the process will run without you having to worry about it. All checks or direct-deposits will go out, plus all payroll taxes will be reported and paid within the required time period.