Managing Small Business Payroll: Complete Guide

Whether you have one employee or 100, ensuring everyone is paid correctly and on time, while complying with state and federal regulations and tax laws, can be a lot for small business owners to manage.

Whether you do it all manually, automate using payroll software, or use external payroll services, you should understand exactly what needs to be done.

My goal with this article is to give you everything you need to know to effectively manage payroll in your small business.

What’s Needed To Process Payroll

OK, let’s get into the nuts and bolts. To run an accurate, compliant payroll process, you’re going to need:

• An employer identification number (EIN) and state/local tax IDs.
• Employee information: Accurate and up-to-date records of all employees, including their full names, addresses, social security numbers or equivalent identification, employment start dates, and other relevant personal details.
• Employment contracts: Detailed records of employment terms, including salary or hourly rates, overtime rates, bonus or commission structures, and any other compensation agreements.
• Timekeeping system: For hourly employees, a reliable system to track hours worked, including regular hours, overtime, and any leave taken, such as vacation or sick leave.
• Payroll schedule: A clear payroll schedule (weekly, bi-weekly, semi-monthly, or monthly) that complies with local labor laws.
• Benefits information: Details of any benefits provided to employees, such as health insurance, retirement plans, and other perks, and how these impact payroll calculations.
• Bank account information: For organizations offering direct deposit, current bank account information for each employee is necessary.

You’re also going to have to put in some work to understand the applicable local, state, and federal tax laws to accurately withhold and remit payroll taxes. 

This includes federal income tax, Social Security, Medicare, and any state or local taxes. 

Some useful resources here:

• IRS (Internal Revenue Service): Covers tax withholding, reporting (e.g., W-2, 941), employer obligations. Website.
• U.S. Department of Labor (DOL): Covers minimum wage, overtime, recordkeeping, child labor (FLSA). Website.

• State Departments of Labor: Varies by state (e.g., minimum wage, sick leave, final pay). Example sites:
  • California
  • New York
  • Texas  
• State Tax Agencies
  • Covers: State income tax, unemployment insurance, registration. Example sites:
    • California
    • New York
• HR Consultant: If ever in any doubt, talk to a local HR consultant. 

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How To Process Payroll: 12-Step Process

Imagining that you’re starting from scratch, here’s how to set up and run an efficient, compliant payroll process.

Step 1: Gain your EIN and state/local tax IDs

• Follow this guide from the IRS to do so.
• You also need to register with the Electronic Federal Tax Payment System (EFTPS) for submitting payroll taxes.

Step 2: Establish your payroll policy

• Define payroll schedule: Decide on a regular payroll cycle (weekly, bi-weekly, semi-monthly, or monthly).
• Set up payroll policies: Establish clear policies for overtime, leave, benefits, deductions, and other payroll-related aspects and make these easily accessible for all.

Step 3: Collect and verify employee information

• Check employee data: Check you have accurate employee information including:
  • Tax forms e.g. W-4, W-9, I-9
  • Identification numbers (like Social Security numbers)
  • Deductions: benefits such as health insurance and retirement plans
  • Bank account details
  • Employment contracts with correct salary or hourly rates.

Step 4: Open a payroll bank account

Many employers choose to open a separate bank account specifically for payroll, apart from their main business account.

Doing so can simplify financial tracking by clearly separating payroll transactions from day-to-day business expenses, which helps prevent accounting errors and streamlines reconciliation.

A dedicated payroll account also adds an extra layer of security. If the payroll account is ever compromised, the main business funds remain protected. 

Likewise, if your business account experiences issues, your ability to pay employees won’t be affected.

It’s a simple step that improves both organization and risk management.

Step 5: Track time and attendance

• Tally work hours: For hourly employees, track the number of hours worked, including regular hours and overtime.
• Manage leave and absences: Take note of any vacation, sick leave, or other absences as it pertains to worker pay.

Step 6: Calculate gross pay

• Determine gross pay for hourly employees: Multiply the number of regular hours worked by the hourly rate, and add any overtime pay.
• Calculate gross pay for salaried employees: Divide annual salary by the number of pay periods to get the gross pay for each cycle.
• Add any supplemental wages: Add any supplemental wages e.g. commissions, bonuses, tips or reimbursements.

Pro Tip

Watch out for system rounding errors. I’ve seen cases where payroll software rounded differently than time-tracking software, creating tiny discrepancies that added up to thousands of dollars over time.—Andrew Lokenauth, Fractional CFO and financial adviser

Step 7: Calculate deductions

• Withhold taxes: Calculate and withhold federal, state, and local taxes based on employee tax information.
• Deduct benefits and other contributions: Deduct contributions for benefits like health insurance, retirement plans, etc.
• Account for other deductions: Include any other wage garnishments or deductions legally required or agreed upon.

Step 8: Determine net pay

• Subtract deductions from gross pay: The result after all deductions is the net pay for each employee.

Pro Tip

Utilize your payroll register. When run and reviewed before hitting submit, it’s your final checkpoint to ensure that everyone is getting paid correctly, you aren’t missing any critical deductions, and that changes you made from the documents in the payroll folder are reflected appropriately.—Eric Mochnacz, Operations Director, Red Clover HR

Step 9: Process payments

• Issue payments: Pay employees via the chosen method e.g. direct deposit (most common), check, cash, etc.
• Provide pay stubs: Distribute pay stubs to employees, detailing gross pay, deductions, and net pay.

Author's Tip

Be sure to fund your payroll account early to avoid any delays that might arise from bank holidays or insufficient balances. Some payroll providers require that funds be deposited several days in advance, so it’s important to plan accordingly.

Step 10: Record and report payroll

• Maintain records: Keep detailed records of each payroll cycle for internal and legal purposes.
• Report to government agencies: File required reports with tax authorities and other government agencies.

Pro Tip

Maintain separate folders for each pay date. When you receive any information about change in pay rates, deduction changes, supplemental pay or any other things that need to be reflected in payroll, save it to that folder. That way, during payroll processing, you can check if each item has been updated appropriately before you run payroll and it’s easier to audit later.—Eric Mochnacz, Operations Director, Red Clover HR

Step 11: Prepare for year-end processing

• Year-end reports: Prepare and distribute year-end tax documents to employees (like W-2s in the U.S.).
• Reconcile yearly data: Ensure all payroll data for the year is accurate and complete.

Pro Tip

Never rush year-end processing. I block out 3x more time than I think I need. December’s always crazy with W-2 prep, bonus calculations, and benefit changes. Plus, there’s always some last-minute drama with employees wanting to adjust their withholdings.—Andrew Lokenauth, Fractional CFO and financial adviser

Step 12: Review and update payroll information

• Regular audits: Periodically audit the payroll process for accuracy and compliance.
• Update policies and records: Make adjustments as needed for changes in tax laws, employee information, or company policies.

Payroll Options For Growing Businesses

If you're running a growing business, figuring out the right payroll setup can feel overwhelming, but there are a few clear paths you can take, depending on your size, budget, and how hands-on you want to be.

1. Do-it-yourself payroll

This is the old-school way: managing payroll manually using spreadsheets or simple tools.

It can work if you’ve got just one or two employees and you're comfortable calculating taxes yourself. 

Pros: It's cheap (sometimes free), but it’s also pretty time-consuming and prone to mistakes.
Cons: If you mess up a tax filing or underpay someone, it can get messy fast.

2. Payroll software

This is what most growing teams turn to. Tools like Gusto, QuickBooks, or Rippling automate the heavy lifting — calculating taxes, sending out paychecks via direct deposit, filing forms, etc.

It's great if you're looking for something affordable, easy to use, and scalable.

Pros: These platforms often come with employee self-serve dashboards and integrate with your accounting or time tracking tools.
Cons: There’s a learning curve at first, but they really save time as your team grows.

3. Let your accountant or payroll service handle it

If you’re already working with an accountant or bookkeeper, you can offload payroll to them. Alternatively you could outsource to a dedicated payroll service company.

They’ll take care of paying your team, handling taxes, and filing year-end forms like W-2s and 1099s.

Pros: This is a good option if you don’t want to deal with it yourself and your accountant already knows your business.
Cons: Just keep in mind that it might be a bit less automated or flexible than software.

Tip: Sometimes payroll software and services are used interchangeably, but therr are differences. Learn the nuances in our article payroll software vs payroll services.

4. Use a PEO (professional employer organization)

Think of a PEO like a full-service HR partner. They’ll manage payroll, benefits, tax compliance, and even help with things like employee handbooks and workers’ comp. 

You technically become a co-employer with the PEO—they handle the backend, you focus on running the business.

Pros: It’s a great option if you’re scaling fast or want someone else to handle HR entirely. 
Cons: It can be more expensive, and you’ll have to use their systems and processes.

For more, check out our pick of the best PEO companies.

5. Hiring internationally? You’ll need a global payroll or EOR

If you’re hiring people in other countries but don’t want to set up a legal entity there, you’ll want an Employer of Record (EOR) or global payroll provider.

EOR will hire and pay your international employees on your behalf, keeping you compliant with local laws. 

Pros: It’s a huge help for distributed teams
Cons: You’ll pay a premium for the convenience.

10 Common Payroll Mistakes

Payroll’s one of those areas where small missteps can lead to big headaches, but most of them are totally preventable once you know what to look for. 

Whether you’re doing payroll yourself or using software, here are some of the most common slip-ups small business owners and managers run into (and hopefully how to avoid them).

1. Misclassifying employees

One of the biggest (and most expensive) mistakes is labeling someone a contractor when they’re really an employee—or mixing up exempt vs. non-exempt. 

This can lead to unpaid overtime, tax issues, and even fines. If you're not sure, double-check before payday.

2. Missing deadlines

Between tax filing dates, payroll deposits, and year-end reporting, there’s a lot to keep track of. 

Missing a deadline doesn’t just delay paychecks—it can also mean penalties or interest charges from the IRS or state tax boards.

3. Miscalculating pay or overtime

Whether it’s forgetting to add overtime, applying the wrong pay rate, or skipping commissions or bonuses, these mistakes can seriously frustrate your team. Even small errors add up fast if you’re running payroll every week.

4. Incorrect tax withholding

If employees don’t fill out their W-4s correctly — or if you forget to update them after a change — it can mess with their withholdings. That means tax trouble later for both of you. Always check those forms are current and input correctly.

5. Not keeping payroll records

You’re legally required to hang on to payroll records for a few years. If you don’t—or if they’re disorganized or incomplete—you could be in trouble during an audit.

Plus, if an employee questions their pay, having records handy saves time and stress.

Pro Tip

Documentation is everything. My team maintains detailed process docs for each client’s unique payroll requirements—think garnishment orders, special deductions, and union agreements.—Andrew Lokenauth, Fractional CFO and financial adviser

6. Failing to stay up-to-date on tax laws

Federal, state, and even local tax rules change more often than you might think. If your payroll setup isn’t keeping up—or you’re not checking for updates—you might end up underpaying or overpaying taxes.

7. Forgetting final pay rules

If someone quits or is let go, most states have strict rules about when you need to send that final paycheck. 

In some places (like California), it’s due on their last day. Missing this can lead to extra penalties.

8. No backup plan for payroll

What happens if your payroll person is sick or your system crashes? If you don’t have a backup process or someone trained to step in, payday can get derailed quickly — and that’s never a good look.

9. Mixing business and payroll funds

Using your main business account for payroll might seem fine — until it gets messy. It’s easy to lose track of what’s been paid, what’s owed, and what’s tax-related. A separate payroll account keeps things clean and makes reconciliation easier.

10. Not reviewing payroll before it runs

Clicking “submit” without reviewing your payroll preview is like sending an email without proofreading it. Always double-check hours, salaries, deductions, and direct deposit info before you run a pay cycle.

12 Managing Small Business Payroll Best Practices

Payroll can be a lot to keep track of. Between tax deadlines, employee changes, deductions, and staying compliant, it’s easy for things to slip through the cracks. 

But with a few solid best practices in place, you can make payroll a whole lot less stressful and way more reliable. Here’s how to keep things organized, accurate, and running smoothly.

1. Document your payroll process

First things first: write it all down. Create a simple internal guide that explains how payroll runs — from gathering time sheets and calculating pay, to submitting payments and filing taxes. 

Include your software steps (if applicable), approval flows, key contacts, and timelines. If someone else ever needs to take over, they’ll have a clear playbook to follow.

2. Establish clear payroll policies

Set expectations early by documenting how and when employees are paid, how time off is tracked, what happens with overtime, and how payroll corrections are handled. 

Share this with new hires and update it regularly. A clear policy prevents confusion and gives your team confidence in how things are run

3. Watch out for remote workers

As BJ Anderson, Director of Payroll & Leave Management, Humareso, points out “An employee’s work-from-home status may require different local tax withholdings. Validate addresses using geolocation software or prompt your employees to confirm addresses annually.”

4. Automate what you can

Beyond a certain number of employees, doing payroll manually becomes a recipe for errors. 

Payroll software can automate calculations, withholdings, filings, and payments—and they usually keep you compliant, too.

5. Keep your records clean and current

Make sure employee records—pay rates, addresses, tax forms, benefit elections—stay up to date. 

Little changes add up quickly, and old info can mess with everything from tax filings to benefit deductions.

6. Keep up with changing tax rules

Tax rates, filing deadlines, and regulations change all the time — not just federally, but at the state and local level too. 

Subscribing to IRS or state labor department alerts can help you stay ahead of changes and avoid last-minute surprises.

7. Stick to a consistent payroll schedule

Choose a pay schedule (weekly, biweekly, monthly) and stick to it. Employees count on it, and it helps you stay organized with fewer last-minute scrambles.

8. Protect payroll data like it’s gold

Payroll data includes highly sensitive info such as bank accounts, Social Security numbers, and salaries. 

Use encrypted systems, limit access, and regularly update passwords. Security breaches don’t just cost money, they break trust.

9. Do a regular payroll checkup

Every so often, review past pay runs to spot errors or missed deductions. A quick internal payroll audit—even quarterly—can help you catch and fix issues before they snowball or get flagged during tax season.

10. Let employees access their info

Give employees easy access to pay stubs, W-2s, hours worked, and deductions through a secure portal.

When they can see what’s happening with their pay, they’re less likely to question it—and more likely to catch honest mistakes early.

11. Train whoever’s running payroll

Don’t leave your whole system in the hands of one person who’s the only one who knows how it works. 

Whether it’s you or a finance admin, make sure they understand the whole process, know what the laws require, and have backup support if needed. Perhaps a payroll certification would help.

12. Have a backup plan

If your payroll person is out or your system goes down, what’s the plan? Build a simple contingency so someone else can run payroll and employees still get paid on time — no scrambling necessary.

Managing Small Business Payroll FAQs

What are the typical payroll cycles?

Common payroll cycles refer to the frequency an organization calculates and distributes wages to its employees.

The choice of payroll cycle can impact your cash flow and the employees’ budgeting.

Here are the most common types:

1. 1. Weekly payroll: Employees are paid once a week, often on a specific day like Friday. This results in 52 pay periods per year.

1. 1. Bi-weekly payroll: In this cycle, employees are paid every two weeks, typically resulting in 26 pay periods per year.

1. 1. Semi-monthly payroll: Employees are paid twice a month, usually on the 1st and 15th or the 15th and last day of the month. This results in 24 pay periods per year.

1. 1. Monthly payroll: This cycle involves paying employees once a month, resulting in 12 pay periods per year.

The choice of payroll cycle can depend on various factors, including the nature of the workforce (salaried vs. hourly employees), administrative capacity, cash flow considerations, and employee preferences.

Additionally, some regions or countries may have legal requirements or customary practices that influence the choice of payroll cycle.

What are the required payroll documents?

Here’s a list of the documents you need for processing payroll:

• • Form 940: An annual federal tax form that employers must file if they’ve paid wages of $1,500 or more in a calendar quarter. It’s used to report the employer’s annual Federal Unemployment Tax Act (FUTA) tax liability.

• • Form 941L: A form that employers must file quarterly to indicate how much they withheld in payroll taxes across all their employees per quarter. It’s necessary for most small businesses that withhold federal income taxes and FICA taxes from their employees’ paychecks.

• • Form 944: A form that businesses must file if their annual liability for Social Security tax, Medicare Tax, and federal income tax is $1,000 or less.

• • Form W-4: Also known as the Employee’s Withholding Certificate, this form is filled out by employees upon being hired to let their employers know how much tax the employers should withhold from their paychecks.

• • Form 1095-C: An employer-provided health insurance offer and coverage form that applicable large employers must file. It includes information about the health coverage for the employee, including the cost and covered months.

• • Form 1096: A form used by the payers to summarize 1099-INT Forms being filed with the IRS. It’s only required when 1099-INT Forms are filed by paper.

• • Form 1099: A tax document that details any earnings received outside of the salary paid by an employer. It’s required for self-employed people or those who run a side hustle.

Why is managing payroll important?

https://peoplemanagingpeople.com/strategy-operations/payroll-finance/payroll-software-vs-payroll-services/

Effective payroll management isn’t just another administrative task. It’s a critical component in aligning with broader business goals for five key reasons:

1. 1. Financial stability and budget management: Accurate and efficient payroll management ensures that a significant portion of the company’s expenses (employee salaries and benefits) are correctly budgeted and managed. This financial stability is crucial for long-term planning and investment, directly impacting the company’s ability to achieve its strategic objectives.

1. 1. Employee satisfaction and retention: Timely and accurate payroll processing contributes significantly to employee satisfaction. Satisfied employees are more engaged, productive, and loyal, which is essential for achieving business goals related to workforce stability, quality of work, and company reputation.

1. 1. Regulatory compliance: Proper payroll management ensures compliance with tax laws and labor regulations. This compliance is vital for avoiding legal penalties and maintaining a positive company image, which in turn supports broader business objectives like market credibility and operational continuity.

1. 1. Resource allocation: By streamlining payroll processes, resources (both time and money) can be more effectively allocated to other strategic areas of the business, such as growth initiatives, innovation, and market expansion.

1. 1. Data-driven decisions: Efficient payroll systems often provide valuable data on labor costs and trends, which can inform strategic decision-making in areas like staffing, budgeting, and compensation strategies, aligning closely with the company’s overall business objectives.

Get (Pay)rolling Smoothly

As a small business owner, the technicalities of payroll can feel like a lot to think about. But once you know your local tax regulations and get your forms and processes in order, things start to get a little easier.

Here are a few key takeaways:

• It's important to follow payroll best practices so your business meets the needs of its employees and the requirements of the government.
• When selecting payroll software, be sure to read reviews and note the pros and cons so you can make the best selection for your business.
• Whether you keep payroll in-house or outsource it, there are perks to both sides. This is a personal choice, made to suit the unique needs of your business.

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You can also check out our guide on outsourcing HR to discover what other HR functions could benefit from being outsourced.