Setting up payroll isn’t just about cutting checks. It’s a compliance-critical process that protects your business from penalties and gives employees a consistent, trustworthy experience.

This guide walks U.S. small businesses through payroll end to end. You’ll register for tax accounts, onboard new hires, choose a pay frequency and system, run payroll correctly, deposit and file taxes on time, and handle special cases and multi-state teams.

Overview

Your goal is a repeatable, compliant payroll process. It pays employees accurately and gets taxes to the right agencies on schedule.

The core workflow is straightforward: register → onboard → run payroll → deposit taxes → file returns → reconcile and improve. Done well, it stabilizes cash flow, reduces risk, and frees up time for growth.

At a high level, “how to set up payroll for a small business” means securing your federal EIN and state tax IDs. You’ll select a payroll approach (DIY, software, accountant, or PEO), decide your pay frequency and payment methods, and set up banking/ACH so funds clear by payday.

Then you’ll calculate gross-to-net, remit withholdings and employer taxes, and meet quarterly and annual filing deadlines. Build in controls—timekeeping accuracy, classification reviews, and reconciliations—to prevent costly mistakes.

Before you begin: registrations, accounts, and documents

Before you run a first payroll, line up your registrations, bank setup, and new-hire documentation. This prevents delays in tax deposits and reduces the risk of penalties. Federal and state rules change annually, so confirm current rates and thresholds in IRS Publication 15 (Employer’s Tax Guide) before processing wages.

Gather the essentials early:

Confirm whether your state requires separate accounts for withholding, unemployment, and local taxes. Start registrations early; they can take days to weeks. Build payroll lead times into your project plan.

EIN vs state withholding ID vs SUTA account

You’ll need three distinct registrations. Your EIN is a federal tax ID issued by the IRS. You use it on federal payroll returns and deposits.

A state withholding ID is used to remit employees’ state income tax withholdings. A SUTA (state unemployment insurance) account allows you to pay employer unemployment tax at your assigned experience rate.

An EIN is issued quickly online. State withholding and SUTA accounts vary by state. Some issue IDs within days; others can take one to three weeks.

Certain states assign multiple IDs, such as a separate SUI account number and a contribution rate letter. Apply early and save your account numbers, PINs, and rate notices in a secure payroll records folder.

I-9, E-Verify, and state new-hire reporting

Every new employee must complete Form I‑9. You must verify identity and work authorization no later than the third business day after the employee begins work. See the official USCIS Form I‑9 page for the current form and instructions.

E‑Verify is an electronic verification program. It is voluntary federally and mandatory in some states. Evaluate it if your industry or state requires it.

States also require new-hire reporting, typically within 20 days of the hire date. Timelines vary. Add this to your onboarding checklist along with W‑4 collection, direct deposit authorization, and any benefit elections.

Missing I‑9s or late new-hire reports are common errors. Use a simple file checklist to avoid them.

Worker classification and onboarding essentials

Classifying workers correctly and collecting the right forms is foundational to compliance and tax accuracy. Employees complete a W‑4 for federal withholding and must be included in payroll tax deposits and returns. Independent contractors generally receive a Form 1099‑NEC and are not subject to payroll tax withholding.

For employees, maintain required time, pay, and deduction records per the Fair Labor Standards Act (FLSA). The Department of Labor’s FLSA recordkeeping basics outline what to retain, such as hours worked, additions and deductions, and pay rates. Use a consistent onboarding packet. Ensure I‑9s are completed on time. Set up a timekeeping system that accurately captures hours, overtime, and meal breaks for nonexempt staff.

Employee vs contractor: tests and penalties

Classification hinges on control and independence, not job titles. Factors include who directs the work and who provides tools. Consider the opportunity for profit or loss, permanency of the relationship, and whether the service is integral to your business.

Misclassification can trigger back taxes, overtime liability, interest, penalties, and reclassification by federal or state agencies. If you control key aspects of the work and the worker is economically dependent on your business, treat them as an employee.

When in doubt, consult current federal and state guidance and consider a conservative approach. Revisit contractor relationships annually. Growth often shifts how much direction and integration exists.

Choose a payroll approach: DIY, software, accountant, or PEO

Pick a model that matches your complexity, budget, and risk tolerance. DIY means you or your team run calculations, submit deposits via EFTPS, and file all returns. Payroll software automates calculations and often tax deposits and filings, while you retain control.

An accountant or bookkeeper can run payroll for you and help reconcile books. A Professional Employer Organization (PEO) co-employs your team, runs payroll, and provides benefits under the PEO’s tax IDs. This shifts more compliance to the PEO.

Costs and timelines vary. DIY can be low cash cost but high time risk. Software often runs a base fee plus per-employee pricing and can be live in days once accounts are ready.

Accountants may bill monthly or hourly and can reduce errors if you lack internal expertise. PEOs typically take longer to onboard and cost more but bundle HR, benefits, and compliance. If a provider files on your behalf, they’ll often use Form 8655 (Reporting Agent Authorization) or co-employer arrangements. Understand how liability is shared and what “tax filing guarantees” cover.

Decision criteria and hidden costs

Match the approach to your situation using a simple checklist:

Decide your pay frequency and payment methods

Choose a pay frequency that meets state rules and fits your cash flow. Weekly and biweekly provide steady take-home amounts for hourly teams. Semimonthly reduces the number of runs and can align with salaried staff.

Monthly is common for owners but can be restricted for hourly workers in some states. Verify your state’s pay frequency and payday timing requirements. Set a repeatable calendar that accommodates holidays and bank cutoffs.

Pick payment methods that are fast, low-cost, and compliant. Direct deposit is standard. Paper checks are a valid fall-back. Paycards can work if employees have free access to wages and you obtain consent where required.

Consider how you’ll handle off-cycle payments such as bonuses, corrections, and terminations. Ensure employees have clear, timely access to pay stubs with year-to-date totals.

Direct deposit, checks, and paycards

Direct deposit is efficient and reduces check fraud. It depends on ACH timing and sufficient funds.

Paper checks work when bank details aren’t available or for last-day terminations. They carry print and postage costs and risk of loss.

Paycards can serve unbanked employees. Many states require employee consent, free withdrawals, and clear fee disclosures.

Use direct deposit for most runs. Maintain secure check stock for exceptions. Deploy paycards only with compliant policies. Always collect a signed direct deposit authorization and verify routing and account numbers to prevent returns and delayed paydays.

Banking, funding, and direct deposit setup

Secure your payroll funding pipeline before your first run. If you originate ACH directly, your bank will complete Know Your Customer (KYC) checks and set transaction limits. They may require separate payroll subaccounts.

If your provider handles funding, expect bank verification through micro-deposits or instant verification. Plan for per-run pre-funding and cutoff times.

Build controls with role-based access for payroll initiation and approval. Use dual controls for ACH files and Positive Pay for check protection. Understand NACHA timing, including how many banking days funds need to settle. Know what happens if a payroll is rejected or an employee’s deposit returns.

Keep a reserve for corrections, reversals, and manual checks when needed.

ACH timelines and payroll lead times

Plan payroll backward from payday. A common cadence is to approve payroll two to four banking days before payday to allow ACH processing.

Many banks and providers enforce daily cutoff times, often mid- to late-afternoon Eastern, for same-day file submission. Holidays can push timelines. Returned ACHs add one or more days for resolution.

Build a calendar that pads lead times and accounts for federal banking holidays. List your provider’s cutoffs. Keep a contingency for off-cycle payments and have a protocol for reissuing funds if an employee’s ACH fails.

Run your first payroll: calculations, withholdings, and remittances

Your first run is about accuracy and documentation. Calculate gross pay (hours × rate or salary). Apply pre-tax deductions such as Section 125 health and retirement deferrals.

Compute federal income tax withholding. Withhold FICA (Social Security and Medicare) and applicable state and local taxes. Then calculate employer taxes. Match FICA. Pay federal unemployment (FUTA). Pay state unemployment (SUTA) at your assigned rate.

Produce pay stubs with year-to-date totals. Retain payroll registers for reconciliation.

Know the mechanics. Federal income tax withholding is based on each employee’s W‑4 and IRS methods. FICA includes Social Security up to an annual wage base and Medicare with an additional employee tax above a threshold.

FUTA applies to the first portion of wages with a potential credit for state unemployment contributions. Verify current rates and wage bases in IRS guidance before you finalize.

Gross-to-net example and employer tax burden

Suppose an hourly employee earns $1,000 in gross pay for the period and defers $50 pre-tax to a retirement plan. Federal income tax is withheld per the W‑4 and IRS tables. FICA is calculated on taxable wages. State and local taxes apply as required.

Employer taxes include a FICA match, SUTA at your state experience rate, and FUTA on the applicable wage base. Employer cost typically exceeds gross pay by several percentage points once FICA, FUTA, SUTA, and any employer-paid benefits are included.

Always confirm the current-year Social Security wage base, FUTA credit, and your SUTA rate in IRS and state guidance. This helps avoid under- or over-withholding.

Payroll tax deposits and filings: Form 941/944, Form 940, and state returns

After running payroll, you must deposit withheld taxes and file returns on schedule. Most employers file Form 941 quarterly to report federal income tax withholding and FICA. The standard due dates are April 30, July 31, October 31, and January 31 for the preceding quarter, per About Form 941.

Some very small employers are eligible to file Form 944 annually. Federal unemployment tax is reported on Form 940 annually; see About Form 940.

State withholding and unemployment returns are typically quarterly. Some states require monthly withholding deposits. Year-end, you must furnish W‑2s to employees and file with the SSA and state agencies. Issue 1099‑NEC to contractors when applicable.

If a provider files on your behalf, confirm whether they need Form 8655. Review their deposit schedule and guarantee terms.

Deposit schedule and lookback rules

The IRS assigns you as a monthly or semiweekly depositor based on your lookback period. The lookback period is total employment taxes in a prior four-quarter window.

Monthly depositors generally deposit by the 15th of the following month. Semiweekly depositors deposit on Wednesday or Friday depending on payday. The $100,000 next-day rule applies to everyone. Reach $100,000 in accumulated tax liability on any day, and you must deposit the next business day.

Example: If your total federal employment tax during the lookback period is $50,000 or less, you’re usually a monthly depositor. If it exceeds $50,000, you’re semiweekly. Review current definitions in IRS employer guidance and adjust your payroll calendar accordingly.

Handling special cases: bonuses, gross-ups, garnishments, and terminations

Supplemental wages like bonuses and commissions can be taxed using the aggregate method or the flat-rate method per IRS rules. If you “gross up” a bonus so the employee nets a specific amount, divide by (1 − total tax rate). Include applicable federal, state, and local taxes.

Off-cycle runs are common for bonuses, corrections, or late timecards. Plan funding and ACH timing in advance.

Terminations require careful handling. Many states set strict deadlines for final pay, sometimes the same day or next business day for involuntary separations. Pay out accrued but unused vacation where required. Deliver pay stubs. Ensure benefits and COBRA notices are handled separately. Keep clear documentation in case of disputes.

Garnishments and child support orders

When you receive a wage garnishment or child support order, you must withhold and remit as instructed. Federal limits under the Consumer Credit Protection Act cap most garnishments to a percentage of disposable earnings. Special rules apply to child support.

Child support typically has priority over most other creditor garnishments. Tax levies and support orders can have different priority depending on timing and state law.

Set up the garnishment in your payroll system with the exact case number, remittance address, and frequency. Watch for multiple orders. Apply priority rules carefully and notify agencies if limits prevent full withholding. Keep copies of orders and payment confirmations with payroll records.

Multi-state and remote teams: nexus, reciprocity, and local taxes

Hiring across state lines creates tax nexus and registration obligations. Generally, you must register for withholding and unemployment in any state where employees physically work, even if your business is located elsewhere.

Some states have reciprocity agreements that allow you to withhold only for the employee’s resident state. In those cases, obtain the required exemption form from the employee.

Multi-state payroll also introduces different wage-and-hour rules, paid sick leave laws, and local taxes. Track the employee’s work location in your system. Set up the correct state and local tax profiles. Maintain separate SUTA rates and wage bases.

For remote teams, define your “primary work location” for each employee. Review your registration footprint at least annually as your headcount shifts.

Local taxes and where they apply

Local payroll taxes arise in cities, counties, school districts, or transit authorities. Some localities tax where work is performed. Others tax based on residency. Some require both.

Examples include city income taxes, occupational privilege taxes, and local services taxes. Applicability can hinge on even a few days worked in a city.

To determine obligations, check the employee’s resident locality and the workplace locality. Then follow sourcing rules in that jurisdiction. Many locales require separate registrations and returns. Build this into onboarding for employees who move or who split time between locations.

Switching providers mid-year and correcting mistakes

Mid-year provider changes are doable with a structured migration. The objective is to carry forward accurate year-to-date (YTD) wages, taxes, and deduction balances. This keeps W‑2s and quarterly returns correct.

Start by locking a go-live date that avoids pay gaps. Leave time for bank verification and test files.

Collect what the new provider needs, including employee demographics, tax forms, direct deposit details, benefit deductions, accrual balances, SUTA rate letters, and copies of prior filings. Decide who will file upcoming 941s and state returns to avoid duplicate or missing filings.

If the new provider acts as a reporting agent, complete any required authorizations. Confirm deposit schedules before the first run.

YTD migration and 941-to-register tie-out

Reconcile your cumulative payroll registers to the amounts reported, or to be reported, on your prior Form 941s quarter by quarter. Sum taxable Social Security and Medicare wages, employee and employer FICA, and federal income tax withheld. Ensure those totals match your payroll system’s YTD for each quarter.

If you find discrepancies from earlier quarters, correct them before year-end. Some errors require an adjusted return (Form 941‑X) for the affected quarter.

After your first payroll with the new provider, re-run the tie-out to confirm continuity. Keep a migration workbook as an audit trail.

Compliance calendar, penalties, and abatement strategies

A visible calendar keeps you on schedule and protects cash flow. Key federal dates include quarterly Form 941 due by April 30, July 31, October 31, and January 31 for the prior quarter. Annual Form 940 is due by January 31. W‑2s and 1099‑NEC must be furnished by January 31. State quarterly returns follow each state’s timetable.

Monthly depositors typically deposit by the 15th of the following month. Semiweekly depositors deposit on Wednesday or Friday based on payday. The $100,000 next-day rule can override both.

Late federal tax deposits trigger penalties ranging from 2% to 15%, per the IRS’s Failure to Deposit penalty. If you have a clean compliance history, you may qualify for first-time penalty abatement.

Reasonable cause abatements may also be available if you can document circumstances like natural disasters, serious illness, or bank errors. Act quickly. Make the deposit, file missing returns, then request abatement with supporting documentation.

Costs, ROI, and how to choose the right solution

Payroll costs include software or provider fees, bank and ACH fees, employer taxes, and administrative time. Software often charges a monthly base plus per-employee fees. Accountants may bill a monthly package. PEOs typically charge a percentage of payroll but bundle benefits and HR.

Add year-end W‑2/1099 fees, potential per-run charges, and costs for garnishment administration or check stock and postage. Your ROI comes from error prevention, time saved, and penalty avoidance.

Simpler operations—single state and salaried staff—can thrive with software. Complex teams with multi-state taxes or tipped or seasonal staff may benefit from expert support or a PEO. Evaluate your next 12–24 months of growth. Switching mid-year is possible but adds migration work.

A practical selection checklist:

Next steps and resources

You’re ready to build a simple, reliable payroll engine. Finish your registrations, set your pay calendar and funding timelines, choose a payroll approach, and run a test payroll with a careful review of checks, stubs, and tax liabilities.

For day one, use a one-page payroll setup checklist you can reuse for every new hire and new state.

Select resources to keep handy:

With clear steps, the right system, and a living compliance calendar, you can run payroll confidently, keep your team paid on time, and stay penalty-free as you grow.