Payroll & Employees

The guide

Employee or contractor

The federal test asks who controls the work: what is done, how, when, with whose tools, and whether the worker can profit or lose on the job. Several states apply a stricter test (California's ABC test is the best known) that treats most workers as employees unless they run an independent business of the same kind.

A signed contract calling someone a contractor does not settle it. Misclassifying costs back taxes, penalties and sometimes benefits, so when it is close, ask before the first payment.

Hiring paperwork

Before the first paycheck: a W-4 for withholding, an I-9 with identity documents within three days of starting, the state new-hire report, and workers' compensation coverage in force. Keep the file for every person you pay, contractor W-9s included.

What a paycheck carries

Gross wage, minus federal income tax withholding, minus the employee's 7.65% for Social Security and Medicare, minus state withholding where the state has one, equals net pay. On top of the gross wage the employer pays its own 7.65%, federal unemployment (0.6% of the first $7,000 per employee after the state credit) and state unemployment.

Budget roughly 8 to 12 percent above wages for employer taxes, before benefits.

Deposits and filings

The IRS assigns a deposit schedule from your prior payroll tax liability: monthly (due the 15th of the following month) or semiweekly (due within a few business days of each payday). Form 941 reports quarterly; Form 940 and W-2s close the year by January 31.

A payroll provider calculates and files; the bookkeeper confirms every deposit cleared and every filing was accepted, because the penalties land on the business either way.

Paying yourself

Sole proprietors and single-member LLC owners take draws, not paychecks, and pay self-employment tax on the profit. An S corporation owner who works in the business must take a reasonable salary through payroll before distributions; the IRS looks at what the same work would pay someone else.

Either way, a fixed amount on a fixed schedule makes both the household budget and the business numbers honest.

Bilingual crews

If part of your team works in Spanish, payroll runs better when the person handling it can explain a pay stub, a W-4 or a workers' comp question in Spanish too. Nothing gets lost between the crew, the office and the books.