Overview

Setting up payroll means registering the right tax accounts, collecting employee paperwork, configuring your payroll system, and running pay correctly and on time. Do it right and you’ll avoid penalties, keep employees paid, and gain clean books for lenders and taxes.

This guide shows you how to set up payroll end-to-end—federal and state registrations, multi-state rules, overtime, gross-ups, corrections, accounting, and year-end—so you can confidently run your first payroll in 2–4 weeks.

If you’re a first-time employer or modernizing from spreadsheets, you’ll find a practical path whether you prefer DIY, payroll software, an accountant, or a PEO/EOR. The steps below focus on compliance and clean setup so you can run payroll accurately from day one.

Payroll prerequisites and registrations

Payroll compliance starts before your first hire. You need a federal Employer Identification Number (EIN), enrollment to pay payroll taxes electronically, and onboarding workflows that satisfy federal identity and work authorization rules.

Laying this groundwork shortens your critical path to first payroll and reduces risk.

Set aside a few hours to complete these steps. If you already have an EIN, verify that your contact info and responsible party are current.

If you plan to pay employees soon, enroll in electronic tax payment systems early so deposit deadlines aren’t missed.

Get an EIN and enroll in EFTPS

An EIN identifies your business with the IRS for payroll and other taxes. Without it, you can’t file or deposit payroll taxes.

Apply online via the IRS for near-instant issuance: Apply for an EIN (Form SS-4). Once you have an EIN, enroll in the Electronic Federal Tax Payment System (EFTPS) so you can deposit federal payroll taxes on time and track payments. Use your legal business name and bank account details when you enroll at EFTPS enrollment.

Confirm your responsible party info is correct and store your EIN and EFTPS credentials securely. Late federal deposits can trigger penalties, so get EFTPS ready before your first run.

Complete Form I-9 and understand E-Verify

Every new employee must complete Form I-9 to verify identity and work authorization. You must examine their documents within three business days of hire, per Form I-9 instructions.

E-Verify is an online system that compares I-9 info with government records. It’s voluntary federally but mandatory in some states and for certain federal contractors. Check if your state requires it and enroll at E-Verify if applicable.

Keep I-9s separate from general personnel files and follow retention rules. Your payroll setup should include a consistent I-9 workflow to prevent missed deadlines and audit issues.

Set up a dedicated payroll bank account

A dedicated payroll bank account improves cash control, fraud prevention, and reconciliation. Fund it before each payroll to cover net pay and taxes. Use it as the funding source for your payroll provider or ACH file.

This keeps payroll flows separate from operating expenses and simplifies month-end tie-outs. It also reduces confusion when issues arise.

Ask your bank about fraud controls such as ACH blocks or filters. Enable dual approval for payroll wires. A clean payroll account also makes workers’ comp audits and lender requests easier to support.

Payroll data and document checklist

Collecting the right data early prevents reruns and corrections. Build a lightweight checklist that you use for every hire and company setup.

Create a secure, standardized intake process—ideally integrated with onboarding—so W-4, I-9, and direct deposit forms are complete before the first day.

Decide your payroll approach: DIY vs software vs accountant vs PEO/EOR

Your approach should match complexity, headcount, risk tolerance, and budget. DIY offers control but requires expertise. Software automates calculations and filings. An accountant can run payroll and filings for you. A PEO/EOR outsources employment or co-employment to minimize administrative burden and risk.

A simple threshold framework helps. If you have 1–5 employees in one state and straightforward pay, software or an accountant is often best value.

With 6–20 employees, benefits, or multi-state remote workers, payroll software plus strong support typically scales well. If you face high turnover, multiple states, tipped staff, or frequent corrections, consider a payroll specialist or PEO/EOR to reduce compliance and audit risk.

Provider due diligence: security, SOC 2, and fraud controls

Payroll systems hold sensitive PII and move large sums, so vet vendors carefully. Ask about SOC 2 Type II certification, role-based access controls, multifactor authentication, and segregation of duties for payroll approval.

Confirm who holds tax power of attorney. Clarify who actually remits taxes, and how you’ll be notified of failed debits or returns.

Probe incident response and business continuity plans. Require dual approvals for payroll and bank changes. Confirm audit logs exist for every change to tax IDs, bank accounts, and pay rates.

Switching mid-quarter or mid-year without breaking filings

Switching providers mid-period requires precise year-to-date (YTD) migration to avoid double-reporting or missed taxes. Gather YTD gross wages, taxable wages by tax type, employee-level taxes, benefits and deductions, and employer taxes for each quarter to date.

Reconcile those figures to prior Form 941 totals and state returns before your new provider runs the next payroll. Import employee-level YTDs and verify a trial payroll register matches prior-year and current-quarter totals.

After the first run, reconcile quarter-to-date numbers. This ensures your next federal Form 941 and state filings roll up correctly.

State employer accounts and new-hire reporting

Most states require separate registrations for state income tax withholding and state unemployment insurance (SUTA). If you hire in multiple states, you’ll often need accounts in each state where employees work or live, depending on withholding rules.

New-hire reporting is also mandatory in every state. The deadline is typically within 20 days of hire.

Handle state registrations early because processing can take a few days to several weeks. Keep your registration confirmations and rate notices—especially SUTA—in your payroll records. Update your payroll system as notices arrive.

Withholding and SUTA account setup

You’ll usually register for two accounts: a state withholding account for employee income tax and a SUTA account for unemployment tax. New employers receive a SUTA “new employer rate” until they earn an experience rating.

Watch for your annual rate notice and update your payroll system promptly. Missing rate changes can cause wrong tax amounts.

Sequence registrations logically. Complete withholding first if the state requires a withholding ID to proceed with unemployment, or vice versa. Keep effective dates and deposit frequency handy. State deposit schedules vary and your payroll system needs them to calculate due dates.

New-hire reporting timelines

States require you to report newly hired and rehired employees to a state directory so child support agencies can locate parents. Most states use a 20-day deadline. A few require shorter windows for electronic reporting.

Include new-hire reporting in your onboarding checklist to avoid penalties and missed deadlines. Confirm the state’s portal and format before your first hire.

If you operate in multiple states, designate who submits each new hire report. Verify it’s filed in the correct state based on the employee’s work location.

Multi-state and remote payroll basics

Multi-state payroll starts with nexus. Having employees working in a state typically creates employer obligations there. You may need to register for withholding and SUTA in the work state, and sometimes withhold local taxes.

With remote teams, confirm the physical work location and whether the resident state also requires withholding. Document locations and any moves.

You’ll withhold resident state tax unless reciprocity applies. Where an employee works in a nonresident state without reciprocity, you generally withhold for the work state and the employee claims a credit on their resident return.

Keep local taxes in mind in states like PA and OH, and city taxes where applicable.

Reciprocity agreements and when to withhold out-of-state tax

Some neighboring states have reciprocity agreements that let you withhold only the employee’s resident state tax if the employee submits the required certificate. Without a valid reciprocity certificate on file, you generally must withhold in the work state.

The employee then sorts out credits at tax time. Collect and store reciprocity certificates during onboarding when applicable, and audit addresses regularly.

If an employee moves or starts working from a different state, reassess registrations, withholding setup, and local tax obligations.

Pay schedules, overtime rules, and timekeeping

Your pay schedule shapes cash flow and compliance. Biweekly or semimonthly are common. Weekly is typical in industries with hourly staff or tips.

Confirm your state allows your chosen frequency. Ensure payday falls within any state “prompt pay” rules.

Overtime under the FLSA generally requires 1.5 times the regular rate for hours over 40 in a workweek, unless an employee is exempt, per DOL FLSA overtime guidance. Use a reliable timekeeping system and define your workweek consistently.

Train managers not to edit time in ways that create wage-and-hour risk. If you pay multiple rates or bonuses, you’ll need blended overtime or must include nondiscretionary bonuses in the regular rate.

Blended-rate overtime and nondiscretionary bonuses

When an employee works at multiple pay rates in a week, calculate overtime using the weighted average (regular rate).

Example: An employee works 30 hours at $20 and 15 hours at $30 in a 45-hour week. Total straight-time pay is $600 + $450 = $1,050. Regular rate is $1,050 / 45 = $23.33. Overtime premium is 0.5 x $23.33 x 5 OT hours = $58.33. Total pay is $1,050 + $58.33 = $1,108.33.

For nondiscretionary bonuses earned in a week, add the bonus to straight-time earnings to compute the regular rate.

If a $100 weekly production bonus applies to a 45-hour week with $1,050 straight-time, the regular rate is ($1,050 + $100) / 45 = $25.56. The overtime premium becomes 0.5 x $25.56 x 5 = $63.90. Document your method and apply it consistently to minimize disputes.

Configure taxes, benefits, and deductions

Tax configuration is the backbone of accurate payroll. You’ll withhold federal income tax (per W-4), Social Security and Medicare (FICA), and applicable state and local taxes.

Employers also pay their share of FICA and federal unemployment (FUTA), and SUTA by state. Follow IRS guidance for federal rates and deposit rules, and rely on state tax sites for SUTA rates and deposit schedules.

Set up benefits and deductions with pretax and post-tax designations. Confirm plan documents support those tax treatments. Treat imputed income correctly for taxable fringe benefits.

Verify limits for retirement plans, HSAs/FSAs, and commuter benefits. A short configuration audit before first payroll prevents messy corrections later.

Taxable fringe benefits and imputed income

Fringe benefits like employer-paid group-term life insurance over $50,000, S-corp >2% shareholder health premiums, personal use of a company vehicle, and certain moving or education benefits can be taxable as imputed income. Imputed amounts increase taxable wages even though no cash changes hands.

They must be included for income tax and sometimes FICA. Identify fringe items you offer and map them to the correct taxability flags in your payroll system.

Run a test calculation to confirm the benefit flows to taxable wages. Ensure it appears on the employee’s pay stub and year-end Forms W-2 as required.

Run your first payroll step by step

Your first payroll is a controlled sequence. Gather time and pay data, calculate pay and taxes, fund payroll and tax deposits, and file returns on time.

Build a simple pre-pay checklist. Practice with a preview report before you release funds.

On your first run, reconcile the cash needed for net pay plus employer taxes. As a rule of thumb, employer FICA and FUTA/SUTA can add roughly 8–12% to payroll cost, depending on your state and wage base exposure.

Use your preview register to plan cash precisely.

Supplemental wages, bonuses, and gross-ups

Supplemental wages include bonuses, commissions, and severance. They can be taxed using the percentage method or aggregate method.

For federal tax, the flat percentage method is 22% up to $1 million of supplemental wages. Above that, use 37% for the excess, per IRS Publication 15 (Circular E). States may have their own supplemental rates or require aggregate withholding.

For gross-up payroll, you increase the payout so the employee receives a specific net amount after taxes.

Example: You want the employee to net $1,000 and your combined withholding rate (federal income tax at 22% + employee FICA at 7.65% + state 5%) is 34.65%. Gross-up formula is Net / (1 – rate). Gross = $1,000 / (1 – 0.3465) = $1,530.88. Withholding of $530.88 yields a $1,000 net.

Tipped employees: tip credit, pooling, service charges, and Form 8027

Restaurants can take a federal tip credit against minimum wage. This allows a $2.13 cash wage and uses tips to reach the $7.25 federal minimum, subject to state rules.

You must track reported tips and verify that direct wages plus tips meet minimum wage each workweek. Make up any shortfall. Tip pooling must follow federal and state limits. Mandatory service charges are not tips—they’re employer revenue and may be paid as wages.

Large food or beverage establishments must file Form 8027 annually to report tip income. Implement a daily tip reporting process, including cash and charged tips. Train managers on the difference between tips and service charges to avoid wage-and-hour exposure.

Off-cycle payrolls, corrections, and amended returns

Mistakes happen; fix them quickly using the least disruptive method. If an employee was underpaid, run an off-cycle payroll and document the reason.

If you paid the wrong amount or taxed incorrectly, adjust the next payroll with a prior-period adjustment so taxes and W-2 wages reconcile.

When a previously filed quarter needs changes to federal employment taxes, use Form 941-X instructions to determine if you must amend. Typical triggers include missed taxable fringe, misclassified tips, or reversed paychecks that were not corrected before quarter-end.

If year-end wages are wrong, file a Form W-2c for affected employees and reconcile state equivalents.

Contractors and separations: 1099-NEC, final paychecks, PTO payout

Contractors are not employees, so you don’t withhold payroll taxes. Instead, collect Form W-9 before payment and issue Form 1099-NEC by January 31 for $600+ in services.

If a contractor refuses or provides an invalid TIN, backup withholding may apply at the IRS rate. Track those amounts cleanly and reconcile to year-end forms. Maintain a vendor compliance file just as you do for employees.

For terminations and resignations, final paychecks must follow state deadlines. Some states require PTO payout if your policy or state law mandates it.

Build a separation checklist that covers final wages, accrued PTO, benefits continuation rules, recovery of company property, and access removal.

W-9 collection, backup withholding, and 1099-NEC deadlines

Collect a signed W-9 before the first contractor payment to avoid TIN mismatches and backup withholding. Track cumulative payments so you know who receives a 1099-NEC by January 31.

Capture legal names/DBAs and addresses exactly as they’ll appear on the form. If you receive a “B Notice” or don’t have a TIN, apply backup withholding to future payments and set aside those amounts for remittance.

Keep correspondence and W-9 updates on file to support your decisions.

Final paycheck timing and PTO payout by state

Final paycheck rules vary widely. Many states require payment on the last day or within a few business days for involuntary terminations. Resignation deadlines are often the next payday or within a fixed window.

PTO payout depends on state law and your policy. Some states treat accrued PTO as wages and require payout. Others allow “use-it-or-lose-it” with clear policy language.

Before separations, check the state labor department’s rules for final pay and PTO payout. Schedule your offboarding workflow to meet the required deadline. Document final wages and deductions clearly on the last pay stub.

Garnishments, workers’ compensation, and audits

Garnishments are court-ordered or agency-ordered withholdings. Under federal CCPA limits, most creditor garnishments are capped at the lesser of 25% of disposable earnings or the amount by which disposable earnings exceed 30 times the federal minimum wage.

Orders have priorities—child support and federal tax levies typically take precedence over creditor garnishments. Follow the instructions on each order and maintain records. Provide prompt answers to agencies and adjust when new or modified orders arrive.

Workers’ compensation premiums are audited annually; they’re based on payroll by class code, with adjustments if your actual wages differ from estimates. Consider pay-as-you-go workers’ comp that reports payroll each pay cycle to smooth cash flow and minimize audit surprises.

Keep your class codes, overtime treatment, and subcontractor certificates organized to reduce audit assessments.

Payroll accounting, cash flow, and year-end close

Treat payroll like a high-velocity accounting cycle. Map each tax and benefit to a general ledger (GL) account. Use a payroll clearing account to reconcile cash every run.

Post journal entries that debit wage expense and employer taxes, and credit liabilities and cash. At month end, liabilities should tie to unpaid amounts scheduled for deposit. Investigate any aged balances.

Use an ACH funding calendar to avoid timing surprises. Payroll ACH usually needs 2–4 business days of lead time. Federal Reserve holidays shift effective dates.

Plan cash for net pay, employer taxes, and benefit drafts. Confirm your payroll provider’s cutoff times before approving payroll.

At year-end, reconcile quarterly Forms 941 totals to the sum of all Forms W-2 before you file. Register for and test e-file access long before deadlines. If you e-file W-2s, set up SSA Business Services Online (BSO) and confirm state e-file thresholds and formats.

Close the year by locking your payroll system, archiving registers, and rolling forward SUTA rates and benefit limits.

Finally, document your standard operating procedures: registrations, onboarding checklists, multi-state rules, gross-up methods, overtime calculations, correction workflows, and year-end timelines. A living playbook keeps payroll accurate as your team grows and responsibilities shift.