Manual payroll is brutal. Paying your employees and contractors involves so many working parts that you might wonder how companies ever did it before payroll software became available. No other element of accounting requires such painstaking setup: You need to supply details about your company, your payroll bank account, your employees, state and federal taxes, and any benefits you offer. Most importantly, your records must be complete and accurate to avoid IRS fines and penalties or confrontations with unhappy workers. Payroll apps simplify this daunting set of tasks by providing (mostly) clear instructions during setup. But nothing is entirely foolproof, so I’m here to walk you through it.
Why You Should Use Payroll Software
Before I take you through the complete process, you should know that payroll software isn’t perfect and that the setup process demands precise attention to detail. Payroll software requires a more comprehensive setup than other financial applications.
In accounting software, it’s possible to send an invoice without completing every field in a customer record and to enter a bill without a comprehensive vendor record. But you can’t do a payroll run, set up payroll schedules, or complete state registrations if you omit W-4 details or forget to enter any previous payroll records, for example. But mistakes can also be outright errors that won’t stop you from running payroll but will inevitably get you in hot water with the IRS, such as incorrectly assigning employee and contractor statuses. Such mistakes will result in fines and other legal complications, as well as inaccuracies in your payroll and reports.
The Best Payroll Software We’ve Tested
You shouldn’t let these dangers dissuade you from using payroll software, however. Dedicated apps are still a lot safer than manual methods. They have plenty of error-checking tools, and the companies that develop them employ large teams of payroll experts that can help if you get stuck—especially during setup.
Payroll software companies encourage support calls because it’s easier to help you at the start rather than try to untangle a problem that crops up during a later payroll run. This sort of on-demand help is almost always available at no extra cost.
Get Organized First: Prep Makes Setup Smoother
All payroll apps have unique setup procedures. They might, for example, do things in a distinct order or group tasks in a particular way. But they all provide ways for you to supply the information required for running your first payroll. They use a variety of interface conventions and navigation aids to help you move through the process, employing wizard-like tools, checklists, and Settings menus. You provide answers to their queries by entering data, checking boxes, and selecting options from lists.
It’s highly unlikely that you complete all the setup steps in one sitting, especially if you’re new to payroll. Some payroll companies recommend that you pull together all the information you need before you even create an account and log in for the first time. Doing so will make for a much smoother, less time-consuming process. But if you’re a novice, you probably don’t know what details you need. I cover what you need below, and you don’t have to worry about working across multiple sessions since you can always save your work as you go.
Step 1: Enter Your Company Details Accurately
So, where should you start? You, of course, need to create an account. Payroll websites have robust security measures because they contain sensitive information, such as bank account and Social Security numbers. Take these safety measures very seriously.
Some sites, such as Gusto, ask a series of initial questions to start shaping your experience. But most payroll websites dive right into collecting your company information. You need to supply basic details about your company, such as your legal business name (the name the IRS uses) and a contact phone number, along with information for the responsible party or owner (most likely you).
Your payroll app will also ask you to specify your business entity type (such as LLC, partnership, or sole proprietor). And it will guide you through connecting to the business bank account you use to fund any benefit deductions you offer, pay workers, and submit payroll taxes. At some point, you will need to provide your bank account number, type, and routing number.
Step 2: Complete Employee and Contractor Records Without Errors
As you work through the setup process, you might find that you don’t have all the information you need for the current section until you complete another section. For example, some websites’ employee records contain sections for benefits or pay schedules, while others handle those topics separately. That’s OK. As mentioned, payroll software saves your work so you can come back later to add or edit data.
Employee records must include some fields (such as birth date, legal name, mailing address, salary or hourly rate, Social Security number, and title), but most sites have unique, optional extras (such as demographic information, department, manager, and spouse’s name). Some apps, such as OnPay, even support custom fields.
Employee record in Patriot Software Payroll (Credit: Patriot Software/PCMag)
As the payroll administrator, you can complete these records based on your workers’ input. Alternatively, you can invite individuals to fill in these fields, except for those related to personnel (such as salary). Doing so saves you time and helps prevent transposition errors. You might also be able to import a mapped database of contractors and employees.
As part of the employee onboarding process, you need to have workers complete an IRS W-4 form so you can withhold the correct federal income tax from their pay. You might also have to complete state W-4 forms. Both employees and contractors must submit an I-9, Employment Eligibility Verification.
Employees and contractors have extremely different tax obligations. Be vigilant about classifying them correctly. The IRS takes the distinction very seriously, and you could face penalties if you don’t assign them correctly.
Once you complete your employee records, you can view, edit, and delete them via special landing pages.
Step 3: Set Up Pay Schedules and Rates Like a Pro
This is a crucial step before you can run your first payroll. Payroll software shows you your options, such as weekly, biweekly, semi-monthly, or monthly. You will also enter your first pay date, along with pay period start and end dates. The services will automatically establish subsequent pay periods. Some payroll apps allow you to pay different employees on different schedules (such as hourly workers on a weekly basis and salaried workers on a biweekly basis) and set up automatic payroll.
Payroll software saves you a lot of time and improves accuracy by allowing you to set up pay types. You select the correct ones when you actually run payroll. You can create pay designations for hourly workers, such as regular and overtime (which will vary based on the hourly rate assigned to each worker or job type). Other pay types include bonuses, commissions, and reimbursements.
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Step 4: Define Time-Off Policies Clearly
Most companies offer time off as a benefit, including PTO, sick, or vacation days. You can set up accrual policies in payroll software using the formulas it provides. For example, you might allow employees to accrue hours based on hours worked, on a pay period basis, or as a lump sum. You might also consider factors like longevity. It’s possible to set a cap on the maximum hours allowed annually and let hours roll over, too. Some apps offer numerous additional options here that aren’t necessarily tied to accrual policies, such as bereavement or holidays. OnPay is especially flexible in this regard.
The mechanics of setting up accrual policies in payroll software aren’t difficult. But you still have to do some calculations to determine specific formulas. Once you do, it’s just a matter of filling in the blanks.
Step 5: Add Benefits—Medical, Retirement, and More
One of the more complicated payroll setup tasks involves entering information on employee deductions and employer contributions for benefits, such as health insurance and retirement plans. You can work directly with your current benefits providers and set up the withholding manually, but some payroll software companies function as independent brokers or work with third-party affiliates. Fees vary for this support.
(Credit: ADP/PCMag)
Every payroll service provider offers unique types of coverage. Besides medical, dental, and vision, some also include administration for benefits such as HSAs and FSAs, life insurance, numerous types of retirement plans, and workers’ comp. Some states also offer Paid Family and Medical Leave Programs, which payroll software supports. You might also have to withhold money from paychecks for other reasons, such as garnishing an employee’s wages in compliance with child support payments.
As with other elements of payroll setup, the hardest part falls to you: deciding which benefits to offer and choosing the best plans for your workers. The mechanics of actually setting them up in payroll software aren’t difficult. Every app displays your options and walks you through the sign-up process, sometimes using a wizard-like tool that asks questions, for example, about your target monthly premium range. OnPay and Gusto, which have their own broker entities, do an especially good job of helping you shop for benefits. OnPay doesn’t charge for third-party broker integration, unlike some competitors.
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Step 6: Manage Payroll Taxes Without Stress
The term “payroll tax” refers to the money you withhold from your employees’ wages every pay period and submit to the IRS, state, and local agencies. They cover Social Security and Medicare obligations, which together comprise the Federal Insurance Contributions Act (FICA) tax. Employers and employees each pay half of the taxes. Unlike income taxes, payroll taxes are based on the same flat percentage for everyone. You don’t have to worry about tax calculations (or any others)—payroll software does them for you.
For payroll tax filing and reporting, you need an Employer Identification Number (EIN). You can apply for one here, and the IRS provides them free of charge. You will receive a confirmation notice from the IRS that tells you which federal tax form you file and how often you pay taxes. Keep this notice and any other notices you receive from the IRS in a safe place. You will need to request a new EIN if you ever change business structures.
Note that the IRS says that you should go through state registration (see below) before you apply for an EIN if you are forming a legal entity (corporation, LLC, partnership, or tax-exempt organization).
You might also want to register for the Electronic Federal Tax Payment System (EFTPS). You can use this system to eventually make tax payments online and to see what payments your tax software company has made on your behalf.
Payroll taxes in QuickBooks Payroll (Credit: Intuit/PCMag)
You must gather state and federal unemployment insurance account numbers (SUTA and FUTA), tax IDs, and information on how often the IRS, state, and local agencies tell you to pay your taxes (and how to submit them). This information will come from the IRS, state, and local tax agencies once you start interacting with them.
State registration can be a bear. Every state has different payroll requirements. The IRS maintains a list of links to state websites that can provide specific information, including links to state Departments of Revenue (or similar agencies) for a state ID and for information about any local IDs that apply. Patriot Software has a guide to state registration sites for business owners new to payroll.
All of this might seem overwhelming, but payroll websites tell you what you need and how to get it, providing a great deal of assistance in the process. For example, Gusto and ADP Run can handle state registration if you’d like (for an extra fee). Other free support options are generous. As mentioned, every payroll service provider has expert staff available to answer your questions.
Step 7: Import Past Payroll Data to Stay Accurate
If you’ve already been running payroll during the current year, it’s crucial that you get that data into your new payroll app. This might involve looking up pay stubs and reports from your previous system, though some payroll service providers offer direct imports from competitors’ accounts.
This is another area where you are likely to need assistance from your provider. If you fail to import this existing data or do so incorrectly, expect serious problems with the IRS and state tax agencies. On top of that, your reports won’t be accurate.
Setup Is Just the Beginning
You’ll still have more to learn about payroll once you complete the setup and start paying workers. The IRS requires periodic reports, for example, and you also must learn how to create 1099s and W-2s at the end of the year. Payroll software guides you through these tasks, too. But, importantly, if you build a rock-solid foundation for your payroll data by following all the setup requirements, your actual payroll runs and other administrative tasks should go smoothly.
About Our Expert
Experience
I write about money. I’ve been reviewing tax software and services as a freelancer for PCMag since 1993. Along the way, I took on reviews of other types of business and personal finance technology. Prior to that, I had spent a few years writing about productivity and entertainment applications for 8-bit personal computers (my first one was a Commodore VIC-20) as a member of the editorial staff at Compute!
After working at Lawson Associates, now Lawson Software, I switched my focus to accounting but learned that personal computer applications were more progressive and interesting to cover than mainframe solutions. So I served as editor of a monthly newsletter that provided support for accountants who were just starting to use PCs. I still ghostwrite monthly how-to columns for accounting professionals. From there, I went on to write articles and reviews for numerous business and financial publications, including Barron’s and Kiplinger’s Personal Finance Magazine.
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