10 Payroll Tips for Small Businesses

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Owning a business is filled with challenges. You have to find the right talent, compete in today's hyper-competitive marketplace, and convince people to choose your product or service over your competitors. It's not easy. There's a reason that 20% of SMBs fail in the first year and 80% cease to exist by the 10th year; running a small business is a constant battle for survival.

But here's a secret: marketing, sales, conversions, leads, and growth aren't the components of running a business that gives owners the night sweats. It's the little stuff like payroll posting. In fact, 40% of business owners say that bookkeeping and taxes are the single most challenging part of running a business. Fortunately, payroll doesn't have to be a thorn in your side. Once you set up your payroll processes correctly, it's straightforward to manage. But you should probably consider outsourcing payroll if you want to stay compliant and financially healthy in the long-term.

So how do you avoid payroll mistakes? Here's what you need to know about payroll posting and how it affects your business.

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1. What counts as payroll?

The term "payroll" refers to the entire process of paying employees. Believe it or not, this process has multiple complex layers, so let's break each of them down:

  • New-hire documentation: The payroll process begins the moment you hire an employee. The initial tax documents they complete (e.g., W4, etc.) help inform you of tax deductions. Employee classification (e.g., exempt vs. non-exempt) determines how you will calculate gross pay, overtime, etc.
  • Payroll processing: The term payroll processing refers to the process of calculating pay, taxes, and withholdings, cutting the paycheck and distributing payment to employees. Payroll processing is typically done on a bi-monthly basis, as California law dictates most employers must pay employees at least twice a month. Let's briefly cover the difference between pay and withholdings:
    • Pay: The pay for employees is either salary, hourly, or on a per-contract basis. Gross pay (i.e., the total pay before taxes) can include overtime, commission, and tips.
    • Withholdings: To calculate net pay (i.e., total pay minus taxes), you need to calculate withholdings, which are generally payroll taxes and benefits deductions. These come in a variety of shapes-and-sizes, including:
      • Local, state, and federal taxes
      • Health insurance premiums
      • Life insurance premiums
      • Retirement plans
      • Garnishments
  • Pay stubs: While calculating payment is the most mathematically-dense and error-prone component of payroll, pay stubs are notoriously tricky. In California, there are hyper-specific pay stub requirements that, if not met, can result in significant fines and even litigation.
  • Recordkeeping: You must keep records of payments for all employees. In California, employers should keep records of payments, taxes, withholdings, and pay stubs for at least four years after an employee leaves the employer.

2. How are employees classified?

Typically, employee classification falls into three categories:

  • Full-time
  • Part-time
  • Temporary

However, California is a little different. In addition to these three core buckets, employees are also classified based on their exemption status for overtime. Nonexempt employees must follow overtime laws, and exempt employees (as the name suggests) are exempt from these overtime laws. For the most part, California's overtime exemptions mimic the Fair Labor Standards Act (FLSA). But there are some key differences that you should thoroughly discuss with your outsourced HR partner, accountant, or Head of Payroll.

3. Does it matter where employees live?

With 98 percent of employers embracing remote work during the height of the COVID-19 pandemic and 89 percent expecting to have a significant number of their workforce remain remote for the foreseeable future, where employees live is an important part of the payroll conversation. In general, employees are covered by the payroll laws in their state — not the state of the employer.

As an example, California overtime laws only apply to California residents. So, if you have employees that work outside of California, you must meet the overtime laws in their state. Of course, federal laws apply to every state. We typically recommend following the laws of the state that's most protective of employees' rights. Most often, this means following California laws, regardless of where the employee lives.

4. What taxes have to be withheld from employee paychecks?

    • FICA: The Federal Insurance Contributions Act (FICA) stipulates that you must withhold Social Security and Medicare taxes from employee paychecks.
    • FUTA: Employers must pay unemployment insurance taxes.
    • State income tax: Each state has its own unique income tax rate, and this rate is tiered based on income. For example, California has nine tiers of income tax. Currently, income made under $8,809 is taxed at 1%, income made under $20,883 is taxed at 2%, and so forth — with any income earned above $1 million being taxed at over 13%.
    • Federal income tax: Like state income tax, employees must pay federal income tax — which is identical across states.
    • State unemployment insurance (SUI): Some states require that you withhold additional money from employee wages for state unemployment taxes. SUI rates vary from state to state. 
  • Employment training tax (ETT): Employment Training Tax (ETT) is paid by employers from deductions taken from employees.
  • Benefits: Employers deduct benefits costs from employees to pay benefits providers. This may include healthcare premiums, retirement/401k costs, and other fringe benefits agreed upon by the employee.
  • Charitable donations: Any charitable donations employees make can also be withheld from their paychecks, though this is a relatively rare deduction.

5. What taxes have to be paid?

As an employer, you have to make regular payroll tax deposits with the IRS. These taxes include both the FICA and income taxes withheld from your employees as well as your contribution to their taxes, which is around half. As an example, the current FICA rates require employees to pay 6.2% of their income in social security. Employers are required to contribute a further 6.2% for a total of 12.4%.

Note: Employee FICA taxes are withheld from employees and impact their net pay. Employer FICA tax contributions are not withheld from employees, and they do not affect their net pay.

6. What are payroll tax rates?

For employers, payroll taxes constitute FICA and FUTA taxes. Each of these taxes could change annually, but it's relatively rare. For example, FICA rates have been stable 15.3% (12.4% for social security and 2.9% for Medicare) for the past decade.

Here are the current rates for both FUTA and FICA taxes:

  • FICA: The FICA tax rate is 15.3%. This is a flat tax rate that does not operate on a tiered, income-based system.
  • FUTA: The FUTA tax rate is 6%. But it's not a flat 6%. For starters, FUTA taxes only apply to the first $7,000 made by each employee. Also, states are given FUTA tax credits so that you can claim a 5.4% FUTA tax credit on your Form 940. In a nutshell, the FUTA tax rate you will likely pay is 0.6% on the first $7,000 each employee makes (or ~$42 per employee).
  • State taxes: State taxes, such as SUI, vary from state to state and rates tend to fluctuate. Check with your outsourced HR partner for solutions to state tax payments. 

Note: You will also receive employee deductions for benefits, but these costs will be paid directly into premiums.

7. When do payroll taxes have to be paid?

There are two distinct FICA payroll deposit schedules offered by the IRS — monthly and semi-weekly. To figure out which schedule your business belongs under, you will need to check IRS Publication 51 (on Forms 941, 943, 944, and 945). Choosing the appropriate schedule is critical. Fines for missed payments (called failure-to-deposit penalties) can cost you up to 15 percent of your total payroll tax bill.

FUTA works differently. You must pay FUTA taxes on the quarter in which the tax exceeds $500. So, let's say that your FUTA taxes were under $500 in the first quarter of the year. You would carry them over to the next quarter. If the first quarter plus the second quarter still doesn't equal $500, you carry both totals over to the third quarter. Once you hit the $500 mark, you make your FUTA payment.

8. How are payroll taxes paid?

Both FICA and FUTA are deposited via the IRS electronic funds transfer network, and they are incredibly observant of missed payment dates.

Each quarter, you will also file a Form 941. This form shows how much you owe in payroll taxes and how much you've paid.

9. Are employees ever exempt from payroll taxes?

Yes and no. Certain employees (depending on their unique life situations) can claim exemption from income taxes on their W-4 Forms. However, all employees — regardless of their exempt status — are subject to FICA taxes.

10. How does the business owner get paid?

Small business owners have multiple options when it comes to taking capital out of their business. There are plenty of nuances when it comes to paying yourself. Your compliance requirements, business type, and business classification can all influence your decision, so it's best to reach out to your outsourced HR partner for clarification.

Payroll Can Get Complicated

There's a reason that accounting and administrative tasks are two of the most popularly outsourced small business functions. They're tricky. Working with a payroll expert like a Professional Employer Organization can help you navigate the payroll process and provide expertise you need when it comes to payroll processing and human resources.

Should Your Business Be Partnering with a PEO?