How to pay employees in a small business: Eight rules to follow

When it comes to paying your employees, many small business owners find themselves asking the following questions:

• What forms do I need to collect?
• What information do I need from my employee?
• What do I need to know about taxes?
• What legislation do I need to be aware of?
• What rules and penalties do I need to know about?

With all this in mind, it can be difficult to know where to begin. To help you out, we’ve outlined eight key rules every small business owner needs to follow when it comes to paying their employees – whether it’s your first employee, or your fiftieth.

How to pay employees in a small business

Rule #1: Decide how much you need to pay your employees

Deciding what to pay your employees is one of the most important business decisions you can make as a small business owner. Aside from paying employees fairly and competitively, you’ll also need to consider your business needs and minimum wage obligations.

To start, determine what you can afford to pay your employees, what they’re worth in the market, and what compensation they’re expecting. You’ll also need to consider merit increases, bonuses, commissions, and any other form of payment.

Rule #2: Collect accurate employee information and forms

Once an employee starts work, you’ll need to collect important information such as their Social Insurance Number (SIN) and ensure you’re using the same name and number that’s on the SIN card or letter. Keep in mind that you’re required to request an employee’s SIN within three days of their hire date and if the employee doesn’t provide a valid SIN, you must show that you’ve made reasonable efforts to obtain it.

New employees will also need to complete TD1, Personal Tax Credits Return forms (both federal and provincial) within seven days of their start date so you can determine how much tax needs to be deducted from their earnings. According to CRA, employees who do not fill out new forms may be penalized $25 for each day the form is late. The minimum penalty is $100 and increases by $25 per day to the maximum of $2,500. Using technology to automate this process will help you keep track of all paperwork and ensure employees complete required forms during onboarding.

Rule #3: Correctly classify your employees

An individual’s employment status directly affects what an employer needs to withhold from pay. Employees’ earnings are subject to deductions of Employment Insurance premiums and Canada Pension Plan contributions. If you misclassify your employees as contractors, and don’t make the appropriate deductions or include their remuneration in your provincial payroll tax totals, you may be required to pay significant penalties, interest, and legal fees, in addition to the outstanding payroll deductions.

Note: Employees are also generally protected by employment standard minimums (see Rule #5) whereas contractors are not.

To properly classify employees, you’ll need to determine their working relationship and whether they are in a “contract of service,” which is an employer-employee relationship, or a “contract for services” which is a business relationship. To help you distinguish between different worker arrangements, the CRA has put together guidelines to follow. A few factors to consider include how much control the worker has over the work, how the work is done, and what work will be done. There are also common law tests which can include examining the organization’s degree of control over the actions of the worker but also the chance of profit/risk of loss and the integration of the services being provided.

Related: Processing payroll for your small business: What you need to know

Rule #4: Determine the frequency you’ll be paying employees

You’ll need to determine how often you’ll pay your employees. Many businesses will opt for a biweekly payroll frequency; however, this depends on your specific business needs including cash-flow cycles. Other options include weekly, semi-monthly, or monthly payroll frequency. You may also want to consider a pay frequency that makes sense for your workforce. For example, employees living by pay cheque to pay cheque may struggle to make ends meet with a monthly payroll frequency. It's also important to note that a monthly frequency is not permitted in all provinces.

Rule #5: Stay compliant with employment standards

When you’re determining how to set up and pay employees in your small business, you’ll need to comply with your province’s employment laws. Accomplishing this can become increasingly complex as you hire more people. You’ll need to consider overtime rules, holiday pay entitlements, leave laws, and more. Many businesses will choose a payroll solution that helps them automate their policies and business rules so they can worry less about errors or inaccuracies. Employment standards typically set minimums around:

• Pay statements and pay frequency
• Minimum wage and overtime
• Vacation pay and holiday pay
• Hours of work and breaks

Rule #6: Know the payroll penalties so you can avoid them

Small businesses can be penalized for inaccurate calculation or deduction of tax, late or non-payment of remittances, wrong method of filing information returns, and wrong method of payment.

The penalties start at 3% if a remittance is one day late and can go as high as 10% if the payment is more than seven days late, as stated by the Canada Revenue Agency. That rate can increase to 20% if you’ve been assessed more than once in the same calendar year and the violation is done knowingly or with gross negligence. 

Ontario, Manitoba, Québec, British Columbia and Newfoundland each have employer-paid taxes based on total payroll (ON EHT, MB HE Levy, QHSF, BC EHT, HAPSET). When paying employees in these provinces, employers should be aware of payroll-based provincial taxes.

Rule #7: Keep accurate payroll records

From an HR and payroll perspective, keeping employee records up to date is a legal responsibility. You’ll need to keep a record of employees’ rate of pay and the hours worked. You’ll also need to keep a record of amounts paid each payday including overtime, vacation pay, and holiday pay.

Keeping records to support year-end tax filings and the issuance of Records of Employment is essential. It’s recommended that employers put all employee records in a central HR system for ease of access.

Related: How to simplify and save time on payroll

Rule #8: Choose the right payroll processing option for your business

When you’re finalizing your plan on how to pay employees in your small business, choosing the right payroll processing solution is critical to managing payroll accurately and efficiently. There are a few different approaches to consider when deciding on a payroll solution. The first option is processing payroll in-house, either manually by a trained professional or using payroll software. Another option is choosing to outsource payroll to a trusted partner to facilitate the processing end-to-end. As a SMB owner, it’s critical to get the payroll basics right so you can deliver on paying employees efficiently and free up time to focus on growing your business.

Learn more about the benefits of having experts manage your small biz payroll

^{This post was originally published on August 7, 2020 and was updated on August 2, 2023 for recency and to include new perspectives on the topic.}