If you’re a new business owner, learning how to pay your employees may seem tricky. You need to document every dollar that passes through your hands to theirs in a legal way.
In this guide, you’ll learn:
- Different types of compensation classifications
- How to determine how much to pay an employee
- How to pay an employee in a small business
- How to pay a worker with a 1099
Different Types of Compensation
Hourlywages are based on an hourly rate. The employee’s pay is determined by how much time they work during a pay period.
An hourly wage is ideal for a part-time employee or someone who doesn’t work a consistent schedule, like a restaurant server. Typically, hourly workers are “non-exempt,” which means they qualify for overtime pay.
Salaried employees are paid a fixed annual rate. Each payday they are paid a consistent figure, which is determined by dividing their annual salary by the number of pay periods.
Salaries are best for corporate roles in which the employee’s time input is predictable. Salaried employees are typically exempt from receiving overtime pay.
You can also pay employees on commission. They would potentially earn a low base rate — which can be hourly or salaried — plus additional pay based on predetermined sales goals.
Commission-based compensation is ideal for sales roles, as it incentivizes employees to meet specific goals.
How Much to Pay an Employee
Conduct market research to see what other companies in your field and location pay for the role you’re hiring for, or for the type of work you need to be done.
How to Pay an Employee as a Small Business
To start paying employees, you’ll need to set up a payroll system.
Let’s uncover what processing payroll involves.
1. Collect Paperwork from Your Employees
Have new employees and current employees fill out and submit these tax forms:
- IRS W-4 form for federal tax withholding
- State form (like California’s DE 4)
- Any other state forms required, as well as forms for local withholding
- USCIS 1-9 form for verifying work eligibility
2. Calculate Pre-Tax Pay
Determine your employees’ gross pay for the pay period:
- Hourly employees:Multiply their hourly rate by the number of hours they worked during the pay period.
- Salaried employees: Divide their yearly salary by the number of pay periods in your annual payroll schedule.
- Commission employees: Determine their hourly or salaried base pay. Then, add their commission earnings for that pay period, based on your company’s commission structure.
3. Determine Tax Withholding
Refer to the paperwork you collected from employees to calculate how much of their earnings you need to withhold for (pre-tax and post-tax):
- Federal income taxes
- State income taxes
- Local taxes
- FICA (Federal Insurance Contributions Act), which comprises Social Security taxes and Medicare taxes, a.k.a. payroll taxes.
- Deductions for benefits such as healthcare, retirement savings plans, flexible spending accounts, and commuter benefits
4. How to Pay an Employee: Calculate Net Pay
You’ve determined your employees’ gross pay and how much to withhold from their paycheck in taxes. Calculate their net pay by subtracting the withheld amount from their gross pay.
5. Distribute Paychecks to Your Employees
Now it’s time to pay your employees the net pay they are owed. Checks and direct deposits are the most popular ways to pay an employee.
6. File Taxes
You are responsible for paying taxes on behalf of your W-2 employees. Take the portion of the employee’s paycheck that has been withheld (determined in step three) and distribute those funds to the proper places. Specifically, file taxes with the IRS, your state’s tax collection agency, and (if applicable) your municipality’s tax collection agency. Note that some taxes are paid only by the employer.
7. Pay Into Benefits
Not all withheld pay will go to the government. Depending on your company, a portion may go toward employee benefits.
This might include contributions toward:
- Health insurance
- Commuter benefits
- Health savings accounts
- Flexible spending accounts
8. Update Payroll Records
You’ll need to keep your payroll records for several years in case of an audit. Keep your payroll register up to date, organized, and accessible. Include information about who got paid, how much they worked, how much they were paid, and what taxes were withheld.
How to Pay a Worker with a 1099
To pay a 1099 worker, simply pay them their gross wages. In other words, follow your normal payroll process but don’t withhold their taxes.
1099 workers technically aren’t employees. They’re considered independent contractors.
Independent contractors are responsible for paying their own payroll taxes. An independent contractor can be classified as such if the person paying for the work (the client) controls the final product or result, but not how the work is done.
So, can you pay a 1099 worker hourly? Yes. You can pay your 1099 contractors an hourly rate or a fixed fee for deliverables.
If a 1099 contractor works 60 hours at $20 per hour, their gross pay or remuneration would be $1200. You would pay the contractor the full $1200. Quarterly tax payments with the IRS and state and local treasuries would be handled by the contractor — not your company.
While you can pay independent contractors a fixed fee, you can not pay them on a salary — otherwise, they’d be considered non-exempt employees and would need to get a W-2 from you.
If you’re unsure about whether someone is an employee or independent contractor, it’s best to consult legal counsel who can clarify how federal laws from the Department of Labor apply to your company. To avoid any potential lawsuits or legal issues, you need to be sure you are complying with the FLSA when paying your employees.