How to Set Up Payroll for a Small Business: 10-Step Guide

Every employer needs an EIN — it is like a Social Security number for your business. The IRS uses it to track your tax deposits and returns. Apply online at IRS.gov and receive your EIN instantly. You can also apply by mail (Form SS-4), but it takes 4-6 weeks. You need the EIN before you open a business bank account, file any tax returns, or run your first payroll. The online application is available Monday through Friday, 7am-10pm Eastern. Keep your EIN confirmation letter (CP 575) in a safe place — you will need it for bank accounts, state registrations, and IRS correspondence.

Most states require you to register as an employer with the state revenue department (for income tax withholding) and the state labor/workforce agency (for unemployment insurance, or SUTA). You will receive a state employer ID and your initial SUTA tax rate (commonly 2.7%-3.4% for new employers). Some cities and counties impose additional local payroll taxes — check your jurisdiction. Notable local payroll taxes include New York City, Philadelphia, San Francisco, and Portland. If you have employees in multiple states, you must register in each one. Many states now allow online registration through their Secretary of State or Department of Revenue websites. States with paid family leave programs (CA, CO, CT, MA, NJ, NY, OR, WA, and others) require separate registration for those programs as well.

Before an employee's first paycheck, they must complete IRS Form W-4 (Employee's Withholding Certificate), which tells you how much federal income tax to withhold. They also must complete USCIS Form I-9 (Employment Eligibility Verification) within 3 business days of their start date — Section 1 must be completed by the employee on or before the first day of work, and Section 2 must be completed by you (verifying identity and work authorization documents) within 3 business days. Many states have their own withholding forms as well (for example, California has Form DE 4). Keep these forms on file — the IRS and ICE can request them at any time. I-9 forms must be retained for 3 years after the hire date or 1 year after termination, whichever is later. You must also report each new hire to your state's new hire reporting agency within 20 days (some states require faster reporting).

Common pay schedules are weekly (52 pay periods), biweekly (26), semi-monthly (24), and monthly (12). Biweekly is the most popular for small businesses (used by about 43% of U.S. employers) — it is simple and frequent enough that employees prefer it. Some states mandate minimum pay frequencies: California, Michigan, and others require semi-monthly or more frequent pay for most employees; Connecticut requires weekly pay; and about half of states allow monthly pay. Check your state's requirements before choosing. Once set, be consistent — changing pay schedules mid-year creates confusion and potential compliance issues. Note: biweekly results in 2 months per year with 3 pay periods, which can affect cash flow planning.

For hourly employees, multiply hours worked by the hourly rate. Include overtime at 1.5x the regular rate for hours over 40 in a workweek (or per your state's overtime rules). For salaried employees, divide the annual salary by the number of pay periods. Add any bonuses, commissions, tips, or other compensation. This total is the employee's gross pay before any deductions.

From each employee's gross pay, withhold: federal income tax (based on the W-4 and IRS tax tables), Social Security tax (6.2% on earnings up to $176,100 in 2026), Medicare tax (1.45% on all earnings, plus 0.9% Additional Medicare Tax on earnings over $200,000), state income tax (if applicable), and any local income or payroll taxes. Also deduct employee contributions for benefits like health insurance premiums or retirement plans. The employer pays a matching 6.2% Social Security and 1.45% Medicare on top of the employee's wages.

Issue paychecks or direct deposits for the net pay amount (gross pay minus all withholdings and deductions). Direct deposit is the most common method — it is faster, cheaper per transaction, and preferred by employees. Provide a pay stub showing gross pay, each deduction, and net pay. Most states require you to provide a pay stub, though rules on format (paper vs electronic) vary by state.

Federal payroll taxes (withheld income tax, Social Security, and Medicare — both employee and employer shares) must be deposited according to your IRS deposit schedule. New employers are typically monthly depositors (due by the 15th of the following month). Larger employers are semi-weekly depositors. If you accumulate $100,000+ in tax liability on any day, you must deposit by the next business day. Deposits are made through EFTPS (Electronic Federal Tax Payment System). State deposit schedules vary — check your state's requirements.

File IRS Form 941 (Employer's Quarterly Federal Tax Return) every quarter by the last day of the month following the quarter (April 30, July 31, October 31, January 31). File Form 940 (Annual Federal Unemployment Tax Return) by January 31. If you deposited all FUTA taxes on time, you have until February 10. Most states also require quarterly unemployment tax returns and annual wage reports. Set calendar reminders for every deadline.

By January 31, provide each employee with Form W-2 showing total wages and taxes withheld for the year. File copies with the Social Security Administration (SSA) by January 31 as well (using Form W-3 as a transmittal). If you paid any independent contractors $600 or more, issue Form 1099-NEC by January 31. These deadlines are firm and non-extendable for employee copies.