As a small business owner, you have employees that you need to pay. Therefore, you need a solid system for managing payroll. This doesn’t have to be as daunting of a task as it might seem. You have the option of managing your payroll in-house or outsourcing it to a reputable company.


Simply stated, payroll includes the salaries and wages paid to a business’s employees. Payroll is more than just paying wages though; it also includes withholding specific deductions and keeping accurate records. Whether a small business has 2 employees or 20, the payroll process is the same, and it must be processed with the utmost attention to detail.


Keep in mind that if you are just at the beginning stage of setting up your company, you will need to determine what your pay periods are and ensure that this information is clearly conveyed to your employees. Businesses may choose to pay their employees monthly, semi-monthly, bi-weekly, or weekly. The number of pay periods you choose will impact your hours per pay period and the overall cost associated with processing payroll.

Additionally, you will need to determine if the people you hire will be classified as employees or contractors. This will directly impact the deductions that must be withheld and the unemployment taxes you will pay. Carefully research the different classifications and make sure you classify your associates properly.


When small business owners process payroll, they must collect a record of hours worked by all non-salary workers. This record should include the number of hours worked per pay period, any paid or unpaid breaks, and any overtime worked. Many companies choose to use a physical or electronic timecard to assist with calculations.


It is relatively easy to calculate an hourly employee’s gross pay. Simply multiply that employee’s pay rate by the number of hours worked. If the employee worked any overtime, those hours are typically multiplied by 1.5x their hourly rate, and some companies offer 2x the hourly rate for working on holidays. If you offer employees any kind of shift differential (extra pay for working certain shifts), you will want to include that extra pay at this time as well.

Gross pay for salaried employees will remain the same each pay period. It will be their annual salary divided by the number of pay periods in a year. The final figure is the gross salary per pay period. Most salaried employees aren’t eligible for overtime pay, but this will need to be made clear through HR documentation or through other means.


The next step in processing payroll is to subtract any applicable deductions from the gross pay. There are several kinds of deductions that may apply, depending on the state, the benefits offered to employees, and any miscellaneous deductions that may apply to your business. Some of these deductions might include:

  • Medicare and Social Security Tax
  • Health Insurance and other benefits
  • Federal and State Income Tax

To calculate the employee’s net pay (take-home pay), subtract the deductions from the gross pay. This final figure is the amount they will receive on their check, direct deposit, etc.


After ensuring that your payroll account has sufficient funds, you are ready to pay your employees. Small businesses often choose to pay their employees via check or direct deposit. The method you choose will depend on personal preference and if you decide to process payroll in-house or not.


One of the essential parts of processing payroll is making sure that you keep proper documentation. This starts when you hire an employee, and you are required to gather information such as:

  • Employee name, address, zip
  • State/federal W-4 (or W-9) and I-9
  • Pay rate
  • Employee status (contractor, etc.)
  • Direct deposit information (if applicable)

After you run payroll, you will also need to keep additional records, including:

  • Time cards
  • Pay stubs
  • Change in pay rates
  • Bonuses, etc.

Definitely check with your state tax agency for full details on what information you need to collect, what documents you need to maintain, and how long you need to keep physical/electronic records.


Small business owners have a couple of options when it comes to managing their payroll; they can choose to process it in-house or outsource it to a payroll service.


When small businesses choose to process their payroll in-house, they choose to either process payroll by hand or use accounting software. Processing payroll by hand is best for those that have the time and skills needed to perform and document calculations properly.

Many small businesses choose to use accounting software that will do the hard work for them. This takes a bit of time to set-up, but the process runs smoothly once the initial setup is complete.

Some of the benefits of processing your payroll in-house include:

  • You can quickly manage any updates or emergencies. You can update employee records yourself or quickly issue checks for bonuses and fix any errors in pay rates.
  • You can be in charge of keeping records in a safe location and choose who has access to them.
  • Payroll software allows you to easily add and remove employees from the system.
  • Software packages are customizable depending on your needs.
  • Oftentimes, payroll software integrates with bookkeeping and accounting software.

There are some drawbacks to processing payroll in-house, such as:

  • Some commercial payroll software can be pricey, especially if your business grows. It is important that you research different software packages and choose the one that will both suit your needs now and grow with your company.
  • Initial set-up is time-consuming and needs to be done with the utmost accuracy. Incorrectly classifying your workers or mistakes involving payroll taxes can be costly and trigger IRS audits.


Outsourcing your payroll service is when you hire a third-party company like Gusto Payroll to manage it. Your only job would be to provide the company with the information they need: hours, wage changes, time off, etc. The third-party company would then take care of handling deductions, taxes, and all the finer details of processing payroll.

Choosing to outsource your payroll has many potential benefits, including:

  • This method will inevitably save you time. As a business owner, you may not want to hire someone to process your payroll in-house, and you may not have the time or skillset to do it yourself. Outsourcing your payroll can allow you to focus on your business and spend less time worrying about the small details.
  • Payroll companies stay abreast of changing requirements and tax laws. As your business grows, your payroll company can make sure you are regularly meeting all payroll-related legal requirements.
  • Payroll services take charge of storing your information accurately and safely, which can help reduce instances of data breaches.
  • These companies can help you file the necessary paperwork for new employees and make sure you are in compliance with state and federal mandates.

There are a few downsides to utilizing a third party service, including:

  • These services can be costly for small businesses. Depending on your needs, the associated costs may outweigh the benefits.
  • Many of these services are not fully customizable, which can mean that you are paying for more than you need or that you need to do some additional legwork to make up for the areas where the service cannot fully address your specific needs.

Correctly setting up payroll for your small business will be a time-consuming process at first, but it will pay off in the end. Choosing the best approach to processing payroll will depend on how your small business is structured and your relative comfort with the process. Whether you choose to process payroll in-house or outsource it to a trusted partner, choosing the right payroll system for your company will simplify your life and help you focus on running your business.

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Recommended: To help you select a payroll service for your business, we’ve reviewed the best payroll services for small businesses.