How to process payroll: Step-by-step guide & tips for payroll processing

Processing payroll might not be the most glamorous part of running a start-up or small business, but it's undeniably one of the most important. It’s about more than just issuing paychecks—processing payroll helps you build trust with your employees, stay compliant with tax laws, and even set the stage for sustainable business growth. 

If you mishandle payroll, mistakes can lead to unhappy staff, legal troubles, and financial losses that no budding business can afford. But here's the good news: you don't need a background in finance to get it right. This step-by-step guide is designed to break down payroll processing into manageable tasks—plus, offer expert tips to help make payroll less intimidating.

Whether you're new to payroll or looking to refine your approach, we'll equip you with the knowledge and tools to handle payroll like a pro, turning a potential headache into a streamlined process that runs smoothly and simply, so you can focus on areas of the business that truly need your time and attention.

What is payroll processing? 

Payroll processing is the administrative task of managing compensation for employees for their work over a specific period of time. It encompasses a series of actions that ensure employees are paid accurately and on time, while also complying with applicable laws and regulations around employee wages and hours.

Payroll processing includes (but may not be limited to):

• Calculating employee wages: Determining each employee's gross pay based on their salary, hourly wage, overtime hours, commissions, bonuses, and any additional compensation
• Withholding taxes and deductions: Subtracting the appropriate amounts for payroll taxes—including federal, state, and local taxes—from employees' gross pay to calculate their paychecks. This also includes deducting Social Security, Medicare, health insurance premiums, retirement contributions, and any wage garnishments from their gross pay.
• Distributing net pay: Issuing the remaining net pay to employees after all deductions, either through direct deposit, physical checks, or payment cards
• Maintaining payroll records: Keeping detailed records of all payroll transactions—including hours worked, wages paid, payroll taxes withheld, and deductions made—for compliance and auditing purposes
• Reporting and compliance: Filing required payroll tax forms and reports with government agencies—such as the IRS and state tax departments—and ensuring adherence to labor laws and employment regulations

Payroll processing can be handled manually or automated using specialized payroll software. 

• Manual payroll processing involves calculating wages and deductions by hand or using spreadsheets. While feasible for very small businesses with a handful of employees, this method is time-consuming and may increase the risk of errors and delays.
• Automated payroll processing via a software provider can handle calculations, tax withholdings, and record-keeping automatically. Automation streamlines the process, reduces mistakes, and helps businesses stay up-to-date with changing tax laws and compliance requirements.

Outsourcing payroll is also an option—meaning businesses can hire a professional payroll provider to handle it for them if they lack the expertise in-house.

Startups and small businesses need a good grasp of what payroll processing entails so they can make sure they compensate their employees correctly, maintain compliance with tax obligations, and foster trust and transparency with their workforce.

How to process payroll in 10 steps 

Wondering how to do payroll for a small business—on your own? It can seem overwhelming for startups and small businesses at first, but breaking it down into steps makes the process more approachable. To run payroll for your business, follow the 10 payroll processing steps below.

Step 1: Establish your employer identification number (EIN) and local tax ID

Before you can even hire employees—let alone pay them—you need an Employer Identification Number (EIN), a nine-digit number from the Internal Revenue Service (IRS). Your EIN, also known as a Federal Employer Identification Number or Federal Tax Identification Number, is used for tax reporting purposes and is a must-have for processing payroll.

How to obtain an EIN:

• Online: Visit the IRS website to apply online and receive your EIN immediately.
• By mail or fax: Complete Form SS-4 and send it to the IRS via mail or fax. This method takes longer—up to four weeks.

In addition to the federal EIN, you'll need to register for state and local tax accounts to handle state income taxes, unemployment insurance, and other local payroll taxes. For example, if your business operates in California, you must register with the California Employment Development Department (EDD) for state payroll taxes.

Step 2: Create a payroll policy

Establishing a clear payroll policy sets expectations for both the employer and employees. It can also help you monitor compliance with varying federal, state, and local employment laws and payroll tax requirements. 

Components to include in your payroll policy:

• Pay schedule: Decide the length of the pay period, or how often employees get a paycheck. This can be weekly, bi-weekly, semi-monthly, or monthly.
• Payment method: Determine whether you'll pay employees via direct deposit, checks, or payment cards
• Overtime rules: Define how overtime will be calculated and compensated. Make sure your policy is in compliance with the Fair Labor Standards Act (FLSA).
• Deductions: Outline mandatory deductions (like FICA tax payments) and voluntary deductions (health insurance premiums, retirement contributions)

Example policy: Your policy might state that all employees are paid bi-weekly via direct deposit, with overtime paid at 1.5 times the regular hourly rate for any hours worked over 40 in a week.

Step 3: Collect employee tax information

Gather necessary tax forms from your employees to ensure accurate withholding. Required forms include:

• W-4s: Employees complete the W-4 form to indicate their federal income tax withholding preferences.
• State tax withholding forms: Some states have their own withholding forms (e.g., California's DE 4 form).
• I-9: Verify each new hire’s eligibility to work in the U.S. by completing the I-9 form and retaining it for your records.

Step 4: Choose a payroll system 

Decide how you’ll process payroll—manually, using software, or through a payroll service provider. Manual payroll processing can be suitable for very small businesses—but it’s time-consuming and often prone to errors. On the other hand, payroll software automates calculations and tax withholdings and can generate reports, and outsourcing payroll to a professional payroll provider gives you an expert partner who can handle all aspects of your payroll processing, from compliance to tax filings.

Some important considerations include:

• Your budget. Evaluate costs associated with software subscriptions or payroll service fees.
• Scalability. Choose a payroll processing system that can grow with your business.
• Integration. Whatever you choose, make sure it’s compatible with other technology your business depends on.

Step 5: Track time and attendance

Accurately recording employee work hours is key for calculating their pay. Common methods for time tracking include:

• Physical or digital clocks where employees punch in and out
• Manual or electronic timesheets submitted by employees
• Automated time tracking software that integrates with payroll software for real-time tracking

Step 6: Calculate gross pay

Once you have a payroll system and you’ve tracked your employees’ hours for a pay period, it’s time to calculate their gross pay—or their total earnings before subtracting any taxes and deductions.

For hourly employees:

1. Multiply their hourly wage by the number of regular hours worked
2. Multiply overtime hours by overtime rate (usually 1.5× hourly rate)
3. Add regular and overtime pay

Example: An employee who earns $15 per hour worked 38 regular hours and 5 overtime hours.

$15/hour × 38 hours = $570
$15/hour × 1.5 × 5 hours = $112.50
$570 + $112.50 = $682.50

For salaried employees:

1. Divide their annual salary by the number of pay periods in the year

Example: An employee earns $52,000.

$52,000 annual salary ÷ 26 pay periods = $2,000 per pay period

Note: If you use payroll software, this step will be done for you when you run payroll.

Step 7: Calculate payroll taxes

Calculate the required federal, state, and local taxes to withhold from each employee's paycheck.

Federal taxes:

• Federal income tax: Use IRS tax tables based on the employee's W-4 information
• Social security tax: Withhold 6.2% of gross pay up to the taxable wage base
• Medicare tax: Withhold 1.45% of gross pay (additional 0.9% for earnings over $200,000)

State and local taxes: 

• State and local income, unemployment and other taxes: Varies by state; use state tax tables

Note: If you use payroll software, this step will be done for you when you run payroll.

Step 8: Determine employee deductions

Subtract additional deductions to arrive at the employee’s net pay. This includes mandatory deductions like wage garnishments (court-ordered deductions for child support, alimony, or debt repayment), and voluntary deductions like health insurance premiums, retirement contributions, life or disability insurance, etc.

Note: If you use payroll software, this step will be done for you when you run payroll.

Step 9: Distribute paychecks or initiate direct deposits

After calculating net pay, pay your employees on their scheduled payday. Your payroll policy should dictate the payment method you use—direct deposit to electronically transfer funds to employees' bank accounts, physical checks, or preloaded debit cards (an alternative for employees without bank accounts).

Note: If you use payroll software to make direct deposits, this step will be done for you when you run payroll.

Step 10: Maintain payroll records and report taxes

The last step in processing payroll is to keep accurate records and comply with tax reporting requirements. The IRS requires employers to keep payroll records for at least four years, including employee details, hours worked, wages paid, taxes withheld, and deductions.

Additionally, employers are required to make quarterly and annual tax filings to report federal income and FICA taxes withheld. You’ll need to provide W-2 forms to employees and file them with the Social Security Administration each year. You also need to comply with specific reporting requirements in your state or local jurisdiction.

Note: If you use payroll software, this step will be done for you when you run payroll and prior to relevant tax deadlines.

Payroll processing compliance considerations

Understanding and adhering to federal, state, and local regulations is crucial when processing payroll, because noncompliance can lead to fines, legal issues, reputational damage, and other penalties. Here are key factors that businesses should consider around compliance:

State-specific payroll regulations

Each state has its own set of payroll laws that may differ from federal regulations. These can include minimum wage rates, overtime calculations, payday requirements, and final pay rules.

• Minimum wage: States may have higher minimum wage rates than the federal requirement, and employers are required to pay employees according to the highest applicable rate.
• Overtime: Overtime laws can also vary—some states require daily overtime pay for hours worked over a certain threshold.
• Pay frequency and methods: States dictate how often employees must be paid (e.g., weekly, bi-weekly) and acceptable payment methods (direct deposit, checks, etc.).
• Final paychecks: Regulations on when and how to issue a final paycheck to terminated employees differ by state. Some require immediate payment upon termination, while others allow for payment on the next regular payday.

Compliance with paid leave policies

More and more states and local governments are considering and passing leave laws that mandate paid time off for specific reasons that can include illness, family care, or safe leave.

• Sick leave: Some states and cities require employers to offer paid sick leave, often accrued based on hours worked. Policies must comply with local accrual rates and carryover provisions.
• Family and medical leave: While the federal Family and Medical Leave Act (FMLA) provides unpaid leave, some states offer paid family and medical leave programs with their own eligibility criteria and benefits.
• Tracking and reporting requirements: It’s up to employers to accurately track leave accrual and usage based on the laws in the jurisdictions where they’re based and where their employees work, to make sure all employees receive the benefits they're entitled to under the law.

Tax withholding requirements 

Federal and state laws require employers to calculate, withhold, and remit payroll taxes, both for themselves and on behalf of their employees.

• Federal taxes: Employers must withhold federal income tax based on employee W-4 forms and pay both employer and employee portions of Social Security and Medicare taxes (FICA taxes).
• State and local taxes: States may have their own income tax withholding requirements, and some localities impose additional taxes, such as city income taxes or school district taxes.
• Unemployment taxes: Employers are responsible for paying Federal Unemployment Tax Act (FUTA) taxes and state unemployment taxes (SUTA), which vary by state. 
• Tax deposits and filings: Employers must make tax payments on a set schedule (semi monthly, monthly, biweekly, or weekly) and file regular payroll tax returns, such as Form 941 for federal taxes and equivalent state forms.

3 payroll processing tips

Here are three best practices to consider when processing payroll:

1. Calculate how long payroll takes to process

Understanding the time required to process payroll helps your organization plan ahead and make sure employees are paid on schedule.

Start by assessing your payroll system’s complexity. Consider factors like the number of employees, different types of compensation (hourly, salaried, commissions), and the variety of deductions and benefits you need to calculate.

Break down each step in the payroll process—from time and attendance tracking to distributing paychecks—and estimate the time needed for each.

Then, allocate your resources to make sure you have the right people on your HR or finance team to handle the payroll tasks you need within the timeframe required to pay your employees on time. Establish cut-off dates for time submissions and approvals to keep the process on track. And keep in mind that payroll automation can streamline the process and remove manual tasks, speeding up payroll processing and helping your HR team get more done in less time, so you can focus your time and resources on strategic, value-adding work.

2. Keep organized records 

Maintaining well-organized payroll records will help your business stay compliant and efficient—and can be a lifesaver in an audit or a payroll dispute.

A centralized system for employee data, like a Human Resource Information System (HRIS), can help you store all payroll-related documents, employee information, tax forms, benefit selections, wage rates, and other important details securely in one place.

Regularly update your records to account for any new hires or changes in employee status, such as promotions, salary adjustments, or changes in deductions. And be sure to protect employee data with encryption and access controls to comply with privacy laws.

3. Remain up-to-date with payroll laws

Payroll regulations can change frequently at the federal, state, and local levels. It’s up to employers to stay current on laws and regulations that apply to their business and employees. Periodically assess your payroll policies and procedures to incorporate any new legal requirements. It may also be a good idea to work with an accountant, payroll expert, or legal advisor who specialize in employment law to make sure your payroll processes remain compliant. Some payroll providers also have compliance features built in, like automatic tax payments and calculations.

Rippling: Easy payroll processing for your business 

If you want payroll so powerful it runs itself, you want Rippling.

Rippling is built on top of a single source of truth for employee data, which means your employee data isn’t tied to one specific app—it’s the same across payroll, time and attendance, onboarding, performance management, and any other apps you use within our unified platform.

What does that mean for you and your team? For starters, you have a single source of truth for up-to-the-minute employee information. It also means that your team doesn’t have to reenter information across systems when an employee gets promoted or moves to a different city to work remotely. From changing security permissions to updating PTO policies, Rippling triggers automatic updates to employee information in a single flow. This is especially beneficial for small businesses. It allows you to do more with less—less money, less headcount, and less time. And all with a 100% error-free guarantee.

With Rippling, you can: 

• Pay employees and contractors in the same platform
• Manage time and attendance natively 
• Run unlimited off-cycle pay runs at no extra cost 
• Set up multiple pay schedules, pay rates, and pay types in just a few clicks 
• Add recurring reimbursements (like cell phone payments, gym memberships, etc.) that are automatically paid out every pay period, monthly, or at whatever interval you choose
• Automatically calculate prorated pay runs for new or promoted employees 
• Manage all currency conversions, including payroll adjustments 
• Automatically calculate overtime for every country 
• Make changes after submitting payroll

Payroll processing FAQs

Can you process payroll by yourself as a business owner?

Yes, as a business owner, you can process payroll yourself, especially if you have a small number of employees. Handling payroll internally gives you direct control over the process and can save money compared to outsourcing payroll. However, it requires a thorough understanding of payroll laws, tax regulations, and meticulous attention to detail to ensure accuracy and compliance.

Tip: If you choose to process payroll yourself, consider using payroll software to streamline the process and reduce the likelihood of errors.

How long does payroll processing take?

The time it takes to process payroll can vary depending on factors like how many employees you have, the complexity of calculating their wages and deductions, and whether you use manual methods or payroll software.

For a small business with a few employees, manual payroll processing might take several hours each pay period. Using payroll software can significantly reduce processing time—often, to under an hour by automating calculations, tax withholdings, and even direct deposits. Initial setup of your payroll system and entering employee data will require additional time upfront but will save time in the long run.

What do you need to process payroll manually?

If you’re wondering how to do payroll manually, here’s what you’ll need:

• Your Employer Identification Number (EIN)
• Employee information, including completed W-4s, state withholding forms (where applicable), and I-9s
• A schedule of pay periods and pay dates
• Accurate tracking of hours worked, including regular and overtime hours
• Each employee's pay rate, including salaries, hourly wages, overtime rates, and any bonuses or commissions
• Current IRS and state tax tables to determine withholding amounts
• A calculator or spreadsheet to compute gross pay, deductions, and net pay. Alternatively, payroll software can calculate these for you.
• A record-keeping system to keep records of all payroll transactions, including earnings, tax withholdings, and deductions
• Tax forms, including Form 941 for quarterly federal tax return, Form W-2 for annual wage and tax statements for each employee, and state and local tax forms as required by your jurisdiction

What are unpaid payroll tax penalties?

Unpaid payroll taxes can lead to penalties imposed by the IRS and state tax agencies. As an employer, you are responsible for withholding taxes from your employees' wages and remitting them to the appropriate authorities on time.

Potential penalties can include:

• Failure-to-deposit penalty: Assessed for late payment of payroll taxes
• Failure-to-file penalty: Imposed when you do not file required payroll tax returns by the due date
• Interest charges: Interest accrues on any unpaid tax from the due date until the tax is paid in full

Consequences can also include legal action or even criminal charges like fines or imprisonment.

This blog is based on information available to Rippling as of September 25, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.