Inflation is soaring, and payroll costs are following suit. More than ever, small businesses cannot afford to neglect payroll best practices — practices far more exhaustive than simply having enough cash to pay your workers.

How to classify employees, the necessary forms, proper tax withholding, and reimbursement of expenses are among the most pressing details. And as aforementioned, understanding how inflation impacts these details will set your small business up for long-term success. This article discusses ways to eliminate unforeseen costs and tax-deductible strategies to accompany your payroll practices.


Employees are classified — by federal and state laws — as either exempt, non-exempt, or as contractors.

To be classified as exempt, employees need to meet very specific legal requirements. Before you begin paying them, make sure you are correctly classifying your employees. If you classify an employee incorrectly, they can miss out on certain benefits like overtime, unemployment insurance, and family and medical leave. In addition, make sure you understand the difference between an independent contractor and an employee.

Although overtime pay isn't ideal for small businesses, the cost of improper employee classification won't positively affect the bottom line, either. For example, a small business misclassifies an employee as an independent contractor, causing the employer's share of taxes to be unpaid and the workers' taxes not withheld. As a result, the business is responsible for the missing taxes.

New Hire Procedures and Taxes

As soon as your new employee is hired, you're required to perform new hire reporting with your state agency, which means submitting basic employer and employee information to them. The agency must confirm that the employee is legally allowed to work in the country and provide the necessary tax forms — including a W-4 for federal income tax withholding and the state's tax-withholding form. If there's any confusion, review the Employer's Tax Guide from the IRS[1].

Wages and Benefits

Payroll is more than about issuing a paycheck. Before you set up payroll, be sure you know what type of wages your employee is legally entitled to, and what wages you'll be paying them. Does their pay include commission and bonuses? What about vacation, sick days, and other kinds of personal days? In addition, you need to be aware of federal and state laws concerning minimum wage, classification, and paid breaks or overtime. Finally, understand what your employees are legally entitled to, and decide what you'll additionally provide.

Tax-deductible employee benefits include discounts, fringe benefits, sick or vacation time, and educational reimbursements. Finally, and especially in light of "The Great Resignation," offering these benefits reduces the negative impact of high turnover.


Calculating mandatory payroll deductions are an important step. These deductions include federal, state, and local taxes, as well as state disability insurance and wage garnishment. If you are offering your employees health and life insurance, retirement contributions, or other kinds of benefits, you'll have to make those deductions as well.


Payroll requires significant attention to detail, so consider hiring an accountant or third-party accounting company to manage your books. Not only will a good accountant keep track of these details for you, but they can also make sure you're following all necessary payroll laws and help keep track of the many tax deductions available to small businesses. If you decide to take on accounting yourself, there are plenty of online platforms that small businesses use to manage payroll and report taxes to the government. But whether you decide to outsource accounting or keep it in-house, understand that you are responsible for reporting — and paying — all payroll taxes.