Payroll is often cited as one of the most complicated aspects of running a small business. You need to calculate due amounts for each employee, including withholdings and deductions, stay compliant with federal and state regulations, and file all necessary tax forms correctly and on time. Because of these complexities, most employers rely on a payroll checklist to make sure nothing is overlooked.
In today’s step-by-step payroll compliance checklist, we will cover everything you need to know to meet your obligations as an employer, from collecting employee data to processing paychecks and addressing payroll queries. We will also break down how Factorial’s software can help you build a compliant and efficient payroll system so that your business runs smoothly and you pay your employees accurately and on time.
Let’s get to it!
Why Payroll Management Is So Important
First things first, let’s quickly touch on why payroll management is so important for your business.
For one thing, having an effective system that covers all payroll activities helps your business stay legally compliant with all federal and state laws and regulations. This includes calculating and withholding taxes, correctly classifying your employees, maintaining accurate records and filing all tax forms on time. That way, you can keep everything above board and avoid any costly fines and penalties.
Effective payroll management is also essential for building workforce trust and morale as your employees rely on accurate and timely payments so that they can meet their financial obligations. Plus, it helps your business maintain a healthy cash flow and budget more effectively as you get a clear picture of labor costs, and you can manage your payroll expenses more efficiently. This financial stability is essential for overall business growth and operational planning.
Finally, having an effective system in place for managing payroll helps you build a reputation as a professional and reliable organization, which boosts your employer brand and helps you attract and retain top talent. Again, this is crucial for ensuring the sustainability and competitiveness of your business in the long run.
A payroll checklist can help with all this by providing you with a structured framework for managing all payroll activities, from pre-payroll tasks like collecting employee data and classifying workers, right through to issuing paychecks and maintaining accurate records.
Without further ado, let’s jump right into our comprehensive payroll checklist for small businesses.
Pre-Payroll Activities
The first section of our payroll checklist is dedicated to pre-payroll activities. This includes collecting employee data, classifying each member of your workforce, verifying employment eligibility and completing all necessary tax forms.
Let’s explore all these steps in a bit more detail.
Collect Employee Data
Make sure you collect all the payroll information you need from each of your employees.
This includes:
- Full name
- Address
- Contact details
- Social Security
- Employment details, including job title, department, start date, and employment status
- Bank details for direct deposits (if applicable)
- Any benefits enrollments (such as health insurance or retirement plans, for example)
Classify Employees
The next pre-payroll activity in our payroll checklist is classifying the status of each employee. This is important as determines their eligibility for benefits and tax withholdings.
So, what do we mean by this exactly? There are actually a couple of things to consider here.
The first level of employee classification is simple: is an employee full-time or part-time, temporary, or seasonal? This is more of an internal classification (there are no federal definitions) and it will depend on the hours an employee works, how long you expect them to work at your company, and the duties they perform.
Make sure you define clear guidelines for these employment classifications, document them in your handbook (including guidelines for independent contractors), and apply them consistently throughout your company. You should also conduct regular internal audits to make sure all employees are classified as they should be in your employee records.
The second level of employee classification is a little more complicated: are your employees exempt or non-exempt? This is important as it ensures compliance with wage and hour laws and directly impacts whether or not you have to pay them overtime.
This form of classification is regulated by the Fair Labor Standards Act (FLSA), so it is vital that you understand the difference and correctly classify your entire workforce. If you don’t, then you run the risk of being investigated by official authorities which can be stressful, costly, and time-consuming.
To determine if your employees are exempt or non-exempt, consider the following factors:
- How much you pay them
- The type of work you have contracted them to do
- The specific responsibilities and job duties that you assign to them
Verify Employment and Complete Tax Forms
Under the Immigration and Nationality Act (INA), employers can only hire people who are eligible to legally work (i.e. US citizens and residents, and foreign nationals who are authorized to work). It is your responsibility as an employer to verify the identity and eligibility of everyone you hire with an Employment Eligibility Verification Form (I-9).
Once you have verified that an employee is eligible to work, the next step in our payroll checklist is getting each employee to complete all necessary tax forms.
Common tax forms include:
- W-4 form. Used to calculate how much federal income tax you need to withhold for each employee.
- W-2 form. Used to report wages and tax withholdings.
- 1099 form. You will need this form if you hire independent contractors (to report all payments that you make to them.)
- State and local tax forms. Check the requirements in your local area to ensure compliance with relevant state and local tax laws.
Finally, make sure your business has an Employer Identification Number (EIN). You will need this for reporting and filing federal taxes on behalf of your employees.
Payroll Calculations
The next group of tasks in our payroll checklist relate to calculating payroll for each of your employees. There are a few things to keep in mind here, including the hours that an employee works, if you have to pay them overtime, and any amounts that you need to deduct and withhold from an employee’s paycheck.
Here’s everything you need to know.
Track Employee Hours
Although the FLSA does not specify how data should be collected and managed, federal employment law does state that it is mandatory to keep a record of employee working hours for non-exempt hourly workers as well as both exempt and non-exempt salaried employees. This includes hours worked per day, clocking in and out times, breaks, overtime, and paid wages. Failure to comply with these FLSA time-tracking legal requirements can lead to fines and penalties.
So, what’s the best way to record and store all this data?
Providing all time and attendance data is monitored and recorded, employers are free to track this information in any way they choose. Some companies use employee time-tracking software, others use an electronic time clock app to track this information. Above all, make sure that the solution you pick can easily integrate with your payroll system so that you can quickly and easily calculate an employee’s pay at the end of each pay period in line with their hours worked and overtime eligibility.
Calculate Wages
The next step is using this information to calculate an employee’s wages. This will depend on a couple of things. Firstly, whether or not an employee is salaried or hourly. Salaried employees receive a fixed annual amount divided by pay periods, while hourly employees are paid based on the number of hours that they have worked.
If an employee is salaried then this task is simple as they will receive the same amount at the end of each pay period, regardless of the hours that they have worked (plus any applicable holiday pay or bonus pay and extra pay in line with new overtime rules, where applicable). However, things are a little more complicated in the case of hourly workers. This is because their pay will depend on the time they spend on duty as well as any entitlements to overtime (time and a half), bonuses or commissions. As we mentioned in the previous section, accurate timekeeping systems are crucial to ensure that hourly employees are compensated correctly for all the time they work.
Deductions and Withholdings
OK, so far so good! Seems simple enough, right?
Great, let’s move on to the next step: applying payroll deductions, withholdings and garnishments.
Let’s start by taking a look at exactly what we mean by employer payroll taxes. These are federal, state and local taxes that an employer withholds from an employee’s salary. Employers deduct calculated amounts from an employee’s wages in line with tax rates and salary and pay the withheld amounts directly to the Internal Revenue Service (IRS) on the employee’s behalf. Most jurisdictions require employers to report these statutory deductions quarterly and annually.
Employer Payroll Taxes and Deductions
In the United States, there are numerous employer payroll taxes and deductions.
This includes:
- Federal income tax. A tax on workers’ salaries that is paid to the US government. The United States uses a progressive Federal income tax system. That means the higher an employee’s income is, the more tax they will pay.
- Social Security and Medicare Taxes (FICA). These are collectively known as FICA taxes (Federal Insurance Contribution Act), and they are paid by both the employee and employer.
- Federal Unemployment Tax (FUTA). This is an employer-paid tax. In other words, these taxes are not deducted from an employee’s paycheck. Instead, they are paid directly by the employer.
- State income tax. A tax levied by individual states on the income earned by residents and (sometimes) non-residents within the state. Each state has its own regulations, tax rates, and brackets, which can vary widely.
- State Unemployment Tax (SUTA). Referred to in certain states as State Unemployment Insurance (SUI) or reemployment tax. The State Unemployment Tax Act (SUTA) was established to offer unemployment benefits to displaced workers. In most states, this is funded by employers only.
- Local taxes. Finally, you also need to determine if your city or municipality requires you to withhold any local employer payroll taxes. These taxes are paid by both the employee and employer and rates vary depending on location. They are used to pay for local maintenance and improvements.
Benefits and Wage Garnishments
Finally, apply any deductions that relate to benefits and wage garnishments. For example, health insurance premiums, retirement plan contributions, and any other employee-elected benefits. And, if applicable, deduct wage garnishments for child support, tax levies, or creditor judgments.
Payroll Processing
Once you’ve done all the above, you will have a list of payroll totals for all your employees and you will be ready to process their paychecks!
There are a few things to consider in terms of payroll processing. Firstly, you will need to define a clear payroll schedule so that you pay your employees on a fixed, regular basis. You will also need to implement a system for processing your payroll payments.
Let’s explore these two next stages in the payroll checklist.
Payroll Schedule
A payroll schedule, also known as a pay period, is a designated timeframe in which an employer pays their employees for their work. The duration of a pay period can vary depending on the employer and their payroll system, but it typically ranges from weekly to monthly. By establishing a fixed, recurring schedule in this way, employers can ensure that employees receive consistent and predictable paychecks. According to the U.S. Bureau of Labor Statistics, biweekly pay is the most common payroll schedule in the United States.
Above all, whatever schedule you choose, make sure you stick to it consistently so that employees can count on getting paid regularly, helping them better manage their finances. Consistent pay schedules also help keep the business running smoothly and within legal guidelines.
Payroll Software and Systems
Payroll software plays a crucial role in streamlining your payroll processes and ensuring accurate and efficient payroll management. From automated calculations to tax filings and reporting, modern payroll software solutions offer a range of features to simplify each stage of the payroll process. But it’s essential that you pick a solution that meets the specific needs of your business. Most importantly, choose software that is easy to use, fits your budget, and suits your needs as your business grows.
Questions to ask yourself:
- What are my specific payroll management needs?
- Is the payroll software user-friendly?
- Does it integrate with other systems? (Time-tracking systems, for example.)
- What level of customer support is provided?
- What security measures are in place?
- What is the pricing structure of the payroll software?
- Is the payroll software scalable?
- Does it offer compliance with payroll regulations?
- What reporting capabilities are available?
- Are there any additional features or services? (Such as employee self-service portals, mobile apps, employee onboarding, or benefits management.)
Post-Payroll Activities
This takes us to the next group of tasks in our payroll checklist: post-payroll activities. This includes distributing paychecks, reporting payroll taxes, and recordkeeping.
Here’s everything you need to know.
Distribute Paychecks
The first activity in this section of the payroll checklist is distributing paychecks. You can do this by direct deposit, paper checks, or electronic pay cards. Another increasingly popular option these days is on-demand pay, also known as earned wage access (EWA). Essentially, this method provides employees with direct access to some or all of their earnings. In other words, instead of waiting for a payroll cycle to end, employees have the option to receive payment as they earn.
Whatever payment method you choose, make sure payments are correct and on time to keep your employees happy and help them manage their money easily.
Then, finally, provide your employees with a pay stub with an itemized summary, including a breakdown of all withholdings, deductions and wage garnishments. This information must be clear and easily accessible so that employees can understand their earnings and deductions and manage their finances effectively.
Tax Filing and Reporting
The second activity in this section of the payroll checklist is tax filing and reporting.
You will need to use the following tax forms for this:
- Form 941. Also known as the Employer’s Quarterly Federal Tax Return. You use this form to report and pay federal income tax, Social Security tax, and Medicare tax.
- Form 940. Also known as the Employer’s Annual Federal Unemployment (FUTA) Tax Return. You use this form to report and pay federal unemployment taxes.
- Form W-2. Also known as the Wage and Tax Statement. You use this form to report annual wages and paycheck deductions. You must give this form to each employee at the end of each tax year. You must then provide a copy of each completed form to the Social Security Administration.
- Form W-3. Also known as the Transmittal of Wage and Tax Statement. You must submit this form to the Social Security Administration together with your W-2 Forms. Essentially, the W-3 summarizes all federal employee tax withholdings.
- Form 1099-NEC. Also known as the Nonemployee Compensation Form. If you have paid independent contractors or freelancers more than $600 over the fiscal year, you must use this form to report all payments.
You can access all tax forms from the IRS website. Most forms can be filed electronically through the IRS e-file system or mailed to the appropriate IRS address, which can be found in the instructions for each form.
Recordkeeping
All that’s left, now that you’ve filed and paid all employer payroll taxes, is making sure that you maintain accurate and up-to-date employee tax records. This is essential for both state and federal compliance. Your records must detail all paid wages, withheld taxes, and processed tax payments. Keep a record of all this information for at least four years to comply with federal and state law requirements. That way, you’re prepared for any potential tax audits or investigations.
It’s also a good idea to conduct periodic internal audits to ensure that your payroll tax records are accurate and up to date. That way, you can catch any discrepancies early, make necessary corrections, and maintain compliance with all tax regulations. Regular audits also help you identify any areas where your payroll processes can be improved, helping your business run smoothly.
The best way to ensure your employee tax records are complete and up to date is by using employee record management software. Employee record management software is a digital employee file management system that makes it easy to store, locate and manage employee data.
Think of it like an electronic filing application that helps you record and track all your payroll data. Instead of searching for an employee’s paper file in a huge filing cabinet, you just access their information from an intuitive platform, and you have all the tax data you need at your fingertips.
Address and Correct Payroll Issues
Even though it’s not a specific step in the payroll checklist, it’s important to have a system in place for addressing any payroll issues that employees might have. For example, set up a simple way for employees to report mistakes, quickly look into and fix any errors, and keep employees in the loop so that they know you are working to address their concerns. This helps you build a work environment founded on trust and employee satisfaction.
One of the best solutions for this is an employee self-service portal, a feature included in certain Human Resource Information Systems (HRIS). Essentially, instead of having to contact HR each time they have a minor query, this feature gives employees the freedom to access the following directly from their own dashboard:
- Employee personal data, such as banking and contact information
- Time off requests and managing scheduling changes
- Payroll and benefits information, including pay stubs and tax documents.
That way, your HR team can spend less time handling routine inquiries and instead focus on more strategic initiatives.
How Factorial Can Help
Factorial’s HR software offers a comprehensive solution to streamline your payroll processes and ensure compliance.
Here’s how Factorial’s payroll software can help your business:
- Automated payroll calculations. Factorial automates payroll calculations, reducing errors and saving time.
- Time tracking integration. Seamlessly integrate timekeeping data for accurate payroll calculations.
- Automated tax withholding. The software automatically calculates all federal, state, and local tax withholdings based on the latest regulations.
- Integrated tax filing. File your payroll tax returns electronically (e.g., Forms 941, 940), directly from the platform.
- Real-time compliance updates. Keep up-to-date and compliant with real-time updates on tax law changes and rate adjustments.
- Comprehensive reporting. Generate detailed reports for payroll, tax withholdings, and contributions, making it easy to track and review financial data.
- Employee self-service portal. Give your employees access to their tax documents, pay stubs, and personal information, reducing your administrative workload.
- Customizable settings. Customize the platform to fit the specific needs and requirements of your state and locality.
- Payroll security. Protect sensitive employee data with robust security features, ensuring that payroll information is secure and confidential.
- Customer support. Access expert assistance to resolve payroll-related issues and optimize your payroll system.
Ultimately, Factorial’s payroll software helps you manage your payroll checklist more effectively, ensuring accuracy, compliance, and efficiency in your payroll processes.
