EIN stands for Employer Identification Number. The IRS assigns you an EIN so you can identify your business on different tax documents. Like a Social Security number, an EIN is a taxpayer identification number. When you become an employer, you need to apply for an EIN. You can obtain an EIN by applying online or faxing/mailing Form SS-4 to the IRS.
There are many terms associated with running payroll. Here are a few payroll terms you should familiarize yourself with:
- Compensation: Everything you give employees in exchange for their work, like wages, bonuses, and small business employee benefits.
- Deduction: The money you withhold from an employee’s wages for taxes, benefits, etc.
- Gross wages: An employee’s wages before deductions.
- Net wages: An employee’s wages after deductions are taken out.
There are a few ways you can run payroll, depending on what you feel most comfortable with. Business owners can outsource their payroll to a specialist, run payroll by hand, or use payroll software. Generally, outsourcing payroll to a payroll accountant or PEO (professional employer organization) is the most expensive and least time-consuming method while learning how to do payroll by hand is the least expensive and most time-consuming. Using payroll software can be a good middle ground to save yourself time and money.
Direct deposit is one type of payment you can offer employees. It is used by 82% of workers, making it the most popular payment method. Many business owners like direct deposit because it is convenient. You can pay employees without having to hand them a physical check, which also makes it a safe payment option. You don’t need to worry about employees losing paychecks with sensitive business information. Some states let employers implement mandatory direct deposit.
Yes, it is legal to pay employees in cash. But, you might come under more scrutiny if you do. Paying employees in cash is often associated with avoiding taxes. If you decide to pay employees in cash, remember to take out taxes and deductions before giving employees their final take-home pay. And, keep accurate records in case you do come under the IRS’s watch.
A pay stub lists details about an employee’s paycheck, including their gross wages, taxes and other deduction amounts, and the employee’s take home, or net, pay. The pay stub also includes information like the pay period and date. Some states require that you provide either a physical or electronic pay stub for each payroll you run.
Supplemental wages are dollars you give employees in addition to regular wages. A few examples of supplemental wages are bonus payments, commissions, and severance pay. Because supplemental pay is not part of an employee’s regular wages, you withhold taxes differently from them. You can choose between the percentage and aggregate methods. With the percentage method, you must withhold a flat rate of 25% on the employee’s supplemental wages. With the aggregate method, you must add the employee’s supplemental wages to their regular wages and withhold tax from the updated tax bracket.
Understanding the Fair Labor Standards Act’s (FLSA’s) laws on overtime is essential. Overtime is any time worked beyond 40 hours in a workweek. If a nonexempt employee puts in overtime hours, you must pay overtime wages. Overtime wages are one and one-half times the employee’s hourly wages for hours worked over 40 each workweek. For example, if an employee earns $16 per hour and works three hours of overtime, they would earn a total of $72 in overtime wages ($16 X 1.5 X 3).
Unless an employee is exempt, you must pay them overtime wages. Exempt employees must meet three requirements to be considered exempt:
- The employee must make at least $35,568 per year/$684 per week
- The employee must be paid on a salary basis
- The employee must have job duties that are considered exempt (e.g., executive, administrative, or professional)
If the employee does not meet the above requirements, they are nonexempt. In that case, you must pay them at least the federal minimum wage as well as overtime wages
You must withhold federal income, Social Security, and Medicare taxes. You might also need to withhold state and local income taxes depending on your locality. Federal income tax is determined by an employee’s Form W-4 and the tax brackets found in Publication 15. Social Security and Medicare taxes make up FICA tax. FICA tax is 7.65% of an employee’s pay. You also need to make a matching employer contribution of 7.65% for each of your employees. Withhold Social Security tax until you reach the Social Security wage base. There is no wage base for Medicare; there is an additional Medicare tax, however.
As an employer, you are not off the hook when it comes to taxes. But, how you pay taxes depends on your business structure. If you are incorporated and receive a salary, payroll and income taxes are deducted from your gross wages. If you are self-employed, you do not receive a salary, but you still need to pay taxes on your income. Instead of FICA tax, you must pay self-employment tax. With self-employment tax, you pay the entire 15.3% for Social Security and Medicare taxes. And, you need to pay income tax. Self-employed individuals pay estimated taxes, which includes both self-employment and income taxes.
There are federal and state unemployment taxes. When you have employees, you are responsible for paying FUTA (Federal Unemployment Tax Act) tax and SUTA tax (state unemployment). Generally, you do not withhold unemployment tax from an employee’s wages. The FUTA tax rate is 6%, but most employers only pay 0.6% due to a tax credit. You only pay FUTA tax on the first $7,000 each employee earns. Your state determines your SUTA tax rate. When you hire your first employee, you must register with your state unemployment agency. They will let you know your SUTA tax rate.
FSAs (flexible spending accounts) and HSAs (health savings accounts) are great benefits you can offer employees. While both are healthcare plans that reduce an employee’s income tax liability, you need to understand the difference between FSA vs. HSA. Employees can contribute up to $2,650 per year to their FSAs and $3,450 for self-only coverage / $6,900 for family coverage to their HSAs in 2018. There are other differences, including ownership, eligibility to contribute, access to money, rollover rules, and more.
Benefits are an important part of an employee’s full compensation package. Fringe benefits include health insurance, educational assistance, and stock options. Fringe benefits can be taxable or nontaxable. Nontaxable fringe benefits are not subject to federal income tax withholding, FICA tax, or FUTA tax. The IRS determines the taxes that apply to different types of fringe benefits.
Pre-tax deductions are amounts you take out of an employee’s gross wages before withholding taxes. This lowers the employee’s taxable income, which can save them more money. Some pre-tax deductions include retirement plans, health insurance, FSAs, and HSAs.
All employees are required to fill out Form W-4, Employee’s Withholding Allowance Certificate, and Form I-9, Employment Eligibility Verification, before they can start working at a business. Use Form W-4 to determine how much to withhold from an employee’s wages for federal income tax. Use Form I-9 to verify that an employee is legally allowed to work in the United States. Employees might also need to fill out state tax withholding forms, benefits forms, and more.
Filing forms needs to become second nature when you run a business. The most common forms you should keep track of include:
- Form W-2, Wage and Tax Statement: Create a form for each employee you paid wages to. Send a copy of this form to the Social Security Administration; state, city, or local tax departments (if required); and to the employee by January 31. You also need to keep a copy for your records.
- Form W-3, Transmittal of Wage and Tax Statements: This is a form that summarizes your Forms W-2. Send Form W-3 to the Social Security Administration along with Forms W-2 by January 31.
- Form 940, Employer’s Annual Federal Unemployment: File this form annually to report your FUTA tax payments.
- Form 941, Employer’s Quarterly Federal Tax Return: Report federal income and payroll taxes on this form quarterly OR
- Form 944, Employer’s Annual Federal Tax Return: An alternate to Form 941, file this once a year to report federal income and payroll taxes. You can only use this form if the IRS notifies you.
Hanging onto records is also part of being a small business employer. You need to keep all payroll records for at least three years, according to the FLSA. And, you must keep all records of employment taxes for at least four years after filing the fourth quarter of the year, according to the IRS. Basically, your payroll record retention should last for a long, long time.