A Step-by-Step Guide to Setting Up a Payroll System

From AllBusiness.com

Any small business owner can tell you that paying employees involves a lot more than writing a check every two weeks.

There are dozens of laws governing employee compensation. If you don't want to run afoul of various government agencies, you have to be well organized and stay up to date on federal and state guidelines.

The key to staying on top of things is setting up a good system that complies with all the applicable state and federal laws. To get started, try this step-by-step approach to setting up a simple payroll system:

Step one: Get an Employer Identification Number (EIN). You can apply for a number by filling out IRS Form SS-4.

Step two: Get state and local identification numbers if they are required in the area or areas where your business operates.

Step three: Separate your independent contractors and full-time employees. You don't have to withhold taxes from an independent contractor's pay. Don't think that you can save time by classifying all of your employees as independent contractors, however: The IRS may penalize your business heavily if you designate regular workers as independent contractors. For details, see the IRS Publication 15 Circular E, The Employer's Tax Guide.

Step four: Have each employee fill out and sign IRS Form W-4. The form provides two critical pieces of information: the employee's Social Security Number and the allowances the employee is claiming for income tax withholding purposes.

New workers should fill out a W-4 as soon as possible. Employees who marry or divorce, have children, gain or lose a dependent or want to change withholding amounts for any other reasons should also complete and sign a new W-4.

If you do not have an employee's W-4 on file, you are required by law to treat the employee as a single person with no exemptions for withholding purposes.

Step five: Establish a pay period. Most states require that employers pay workers on regular paydays. A few states allow some employees to be paid once a month, but most require that you pay your employees at least twice a month. Check with your state department of labor for your state's specific guidelines.