Setting Up Payroll for an LLC or Corporation

Payroll involves far more than just cutting a paycheck to employees. It entails calculating work hours, wages, salaries, benefits, wage garnishments, and withholding and paying employment-related taxes. So, what do business owners need to know about setting up payroll for an LLC or corporation? In today’s post, we’ll cover all of this and more.

Seven Key Steps for Getting Started

The account registrations needed, steps necessary, and forms required to set up and administer payroll are similar regardless of the business entity type. My recent article, What Is Payroll? offers detailed information to help you understand everything that goes into payroll responsibilities.

Essential steps for starting payroll include:

1. Obtain an Employer Identification Number (EIN) – An EIN is a business entity’s federal tax identification number used for payroll taxes and other purposes (such as opening a bank account).
2. Apply for State Tax ID Numbers – Employers must obtain a state employment tax Identification number, if the state requires it. Some local tax authorities require tax ID registration as well.
3. Set up a payroll bank account – Some businesses find it beneficial to use a separate bank account for payroll purposes rather than use their primary business bank account for payroll expenses.
4. Decide on a payroll schedule – Common schedules include weekly, bi-weekly, semi-monthly, and monthly. Some states may have different requirements.
5. Get a workers’ compensation insurance policy – Premiums paid provide wage-loss and medical benefits to people who are injured or become ill at work.
6. Decide which optional employee benefits you’ll offer – And determine the portion of those costs your employees will be responsible for. Examples of voluntary benefits to which employees contribute include health insurance, health savings accounts, retirement plans, group term life insurance, and educational reimbursements.
7. Gather the required documentation from employees – Paperwork employers need from new hires for payroll purposes includes:
   • IRS Form W-4 (and state equivalents of this form) – Documents the employee’s filing status and determines the percentage of payroll taxes to be withheld from their paychecks. (If the person will be an independent contractor, the business should ask for Form W-9 instead. Independent contractors are not on company payroll and do not have taxes withheld from their compensation.)
   • Form I-9 – Verifies that each new employee (whether U.S. citizen or non-citizen) hired is legally authorized to work in the United States.
     Health insurance forms – Confirms an employee’s participation in the company’s health insurance plan and authorizes any applicable payroll deductions.
   • 401(K) plan documentation – Verifies the employee’s participation in the plan and identifies the percentage of wages or salaries to be withheld and deposited into the employee’s 401(K) account.

Types of Payroll Deductions

Any business that hires employees must register to pay payroll taxes in the state(s) where it has employees. The requirements and processes are essentially the same regardless of a business’s legal structure. However, payroll tax rules vary from state to state, which can become confusing (especially for employers with remote employees in states other than where their company is located). Business owners need to educate themselves, ideally enlisting the help of a payroll specialist or accountant, to gain an understanding of the payroll taxes and other withholdings they will be responsible for.

The following payroll taxes and withholdings may apply to LLCs and Corporations depending on where the business is located, where its employees are based, and other factors:

• Federal income tax – This tax is withheld from an employee’s pay, with the tax amount determined by the information the employee provided on their W-4 form.
• State and local income tax – Generally, employers must withhold funds from their employees’ paychecks to cover these taxes.
• FICA (Social Security and Medicare taxes) – Half of FICA is withheld from employees’ paychecks, and the employer pays the other half.
• Unemployment taxes – Federal unemployment tax (FUTA) is paid by employers and not withheld from employee paychecks. State unemployment tax (SUTA) — also known as state unemployment insurance (SUI) — is typically paid by the employer and not withheld from employee paychecks.
• Workers’ compensation insurance – The employer pays Workers’ compensation insurance premiums; they are not deducted from employee paychecks.
• Employee wage garnishments – These court-ordered withholdings from an employee’s pay are for money owed for things like alimony, child support, loan debt, and unpaid taxes.
• Other voluntary deductions – If an employee has opted into voluntary benefits — such as a health care plan, union dues, retirement plan, group life insurance, disability insurance, or charitable giving — their contributions to those options are withheld from their pay.

Keep Learning: What Are Payroll Deductions?

Steps for State Payroll Tax Registration

As I mentioned, state and local governments have different requirements, and their registration processes for setting up tax accounts and obtaining ID numbers vary.

To begin payroll tax registration, employers must:

1. Determine the tax agencies to which the business must report and make payments.
2. Complete and submit the required tax account application forms.

An LLC’s or C Corporation’s Employer Identification Number (EIN) is used for reporting and paying federal payroll taxes, including federal income tax and unemployment tax (FUTA). The types of state payroll-related accounts and IDs required vary.

Corporation and LLC Payroll FAQs

While setting up payroll and registering for payroll taxes are generally the same for all business entity types, LLC and Corporation owners may wonder how the rules affect them personally. They might also have other questions related to their business structure.

Can the owners of an LLC pay themselves through payroll?

Generally, no. A Single-Member LLC (one owner) is considered a “disregarded entity” and taxed as a Sole Proprietorship, and a Multi-Member LLC (more than one owner) is taxed as a Partnership. Owners are paid in draws or distributions from the business profits and may not be on the payroll. So, an LLC must complete payroll tax registration only if the business hires employees.

However, if the LLC meets eligibility requirements and files for S Corporation election or chooses to be taxed as a C Corporation, then LLC members who work in the business must be put on the payroll and paid like employees. Therefore, the company must register for tax accounts with the state and local government agencies.

LLCs that opt for S Corporation tax treatment must not pay their members wages or salaries below what’s reasonable for the work they perform. This also applies to shareholders of C Corporations that elect to be taxed as S Corporations. The IRS is on the watch for that!

Some LLCs have faced penalties for paying themselves excessively low wages and taking the rest of their compensation as profit distributions to decrease their Social Security and Medicare tax burden. Wages and salaries are subject to those taxes in addition to income tax, while only income tax applies to profit distributions.

Can a C Corporation’s shareholders be on the payroll?

Yes, shareholders may pay themselves via payroll for services rendered in running the business. Even if a corporation has no other employees, it must register for payroll taxes if one or more of its shareholders are on the company’s payroll.

It’s critical that shareholders on payroll pay themselves reasonable compensation for the work performed. Because wages and salaries are tax-deductible expenses for the business, the IRS requires that compensation paid to shareholders through payroll is not beyond a reasonable wage or salary for the work those individuals do for the business. This stipulation is meant to prevent business owners from gaming the system by paying themselves exorbitant salaries and low distributions (a.k.a. dividends, which are not tax-deductible) to lower their corporate taxable income.

Are payroll taxes deductible for Corporations and LLCs?

Not only are wages and salaries tax-deductible business expenses, but any employer-paid portion of payroll taxes may be deducted on LLCs’ and corporations’ tax returns. Tax amounts withheld from employees’ pay are not deductible expenses for the business because the employee, rather than the employer, has paid those dollars.

What determines an employer’s payroll tax deposit schedule?

At the federal level, the schedule is either monthly or semi-weekly. Before the beginning of the calendar year, the business must determine which schedule it should use. The required schedule is based on the total tax liability previously reported on forms during the specified lookback period. State and local tax deposits vary.

Where to Turn for Assistance

Payroll for LLCs, corporations, and business entities of all types can be complex. Misunderstanding the requirements, miscalculating any of the components involved, missing deadlines, and failing to fulfill any other compliance obligations can result in costly fines, penalties, legal actions, or worse. It’s important for business owners to enlist the expertise of qualified professionals — such as human resources, accounting, and payroll specialists — who can guide them through the process of setting up and managing all aspects of their payroll.

CorpNet offers payroll registration services in all 50 states, and we partner with Gusto, a full-service payroll and HR platform, to help its customers. Using a resource like Gusto for payroll management can simplify the entire process from setting up state and local tax accounts to paying employees, withholding taxes, and remitting monies to the appropriate tax authorities and other government agencies to maintaining an accurate payroll register (a.k.a. payroll recordkeeping).