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The Payroll Process

Setting up a payroll system maximizes your ability to stay on top of your federal, state and local  withholding and tax requirements as an employer. One of the easiest and most efficient ways to stay on top of the payroll process is to outsource it to a reputable third party company (refer to Outsourcing Payroll, at left, for more information regarding this option).

  • Obtain an Employer Identification Number (EIN)

Before hiring employees, you need to get an employment identification number (EIN) from the IRS. The EIN is often referred to as an Employer Tax ID or as Form SS-4. The EIN is necessary for reporting taxes and other documents to the IRS. In addition, the EIN is necessary when reporting information about your employees to state agencies. You can apply for an EIN online or contact the IRS directly.

  • Check Whether You Need State/Local IDs

Some states/local governments require businesses to obtain ID numbers in order to process taxes. Check whether this applies in your state with this State Tax Guide.

  • Determine the Difference between Independent Contractor or Employee

It very important to understand the rules that distinguish an independent contractor from an employee. Determining the status of an independent contractor versus an employee will directly affect withholding income taxes, withholding and paying Social Security and Medicare taxes, and paying unemployment taxes. To understand the difference between an independent contractor and a full-time employee, please click here. 

  • Form W-4

Employees must fill out Federal Income Tax Withholding Form W-4. Your employee must complete the form and return it to you so that you can withhold the correct federal income tax from their pay. The Withholding Calculator provided by the IRS can help employees determine whether or not they need to give you a new Form W-4, Employee's Withholding Allowance Certificate to avoid having too much or too little Federal income tax withheld from their pay. Employees can also use results from the withholding calculator to help them fill out the form.

  • Decide on a Pay Period

Setting up a pay-period (whether monthly or bi-monthly) is sometimes determined by state law with most favoring bi-monthly payments. The IRS also requires that you withhold income tax for that time period even if your employee does not work the full period.

  • Organize and Document Your Employee Compensation Terms

It is important to track employee hours, overtime, exempt versus non-exempt status, paid time off and other business variables. Employers must comply with recordkeeping requirements under the federal Fair Labor Standards Act and similar state laws.

Don’t forget that other employee compensation and business deductibles such as health plan premiums and retirement contributions will also need to be deducted from employee paychecks and paid to the appropriate entities.

  • Running Payroll

When all forms and information needed is in, you can start running payroll either internally or through a third party payroll service.

  • Get Recordkeeping Savvy

Federal and some state laws require that employers keep certain records for specified periods of time. For example, W-4 forms (on which employees indicate their tax withholding status) must be kept on file for all active employees and for four years after an employee is terminated. 

  • Report Payroll Taxes

To understand your employer obligations regarding tax filings, please review the Employer's Tax Guide, which provides very clear guidance on all federal tax filing requirements. It is also important to check with your local state tax agency regarding state-related taxes. Visit your state tax agency for specific tax filing requirements for employers.

  • Notify Employees About the Federal Earned Income Tax Credit

The Earned Income Tax Credit or the EITC is a refundable federal income tax credit for low to moderate income working individuals and families. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. The IRS requires employers to notify each employee who worked for the employer at any time during the year and from whom the employer did not withhold income tax of the EITC. There are several methods the employer may use to satisfy this notice requirement, including providing Form W-2 to employees, which has the required information about the EITC on the back of Copy B. Click here for more guidance.

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