Setting up payroll is one of the highest-stakes admin tasks for a new employer. Done right, you’ll pay people accurately and on time, meet federal and state requirements, and avoid costly penalties. This guide walks you through how to set up payroll from registrations to first payday, then goes deeper on multistate teams, garnishments, year-end corrections, accounting entries, and when to upgrade your payroll model.

Overview

Your payroll setup has two tracks: registrations and configuration. First, get your employer tax IDs (federal, state, and sometimes local), enroll to make electronic tax deposits, and collect employee forms. Then configure your pay schedule, earnings and deductions, and tax settings so each run withholds, deposits, and reports correctly.

A few core facts ground the process. FICA payroll taxes include Social Security (6.2% employee + 6.2% employer) and Medicare (1.45% employee + 1.45% employer) on most wages. There is an additional 0.9% Medicare tax withheld on higher wages. See current rules in IRS withholding guidance such as Publication 15-T.

FUTA federal unemployment generally applies only to the first $7,000 of each employee’s wages each year, reported on Form 940. Federal income tax withholding and employer/employee FICA are reported quarterly on Form 941.

By the end of this guide, you’ll have a clear checklist, worked pay-calculation examples, and decision criteria to choose the right payroll operating model.

Payroll prerequisites and registrations (EIN, state and local accounts)

Before your first paycheck, you must register for the right tax accounts so you can withhold, deposit, and file. These registrations establish your identity with the IRS and state agencies and determine where you file.

They also set the stage for electronic payments. If you skip steps or start paying without them, you risk penalties and misapplied payments that are tedious to fix later.

Start at the federal level with your Employer Identification Number (EIN) and Electronic Federal Tax Payment System (EFTPS) enrollment. Then register for state income tax withholding and state unemployment (SUTA), plus local tax accounts if applicable. Aim to complete this well before your first payroll to account for processing times, which can range from same-day (EIN) to several weeks (some state portals).

Once your accounts are active, calendar new-hire reporting deadlines and any state deposit schedules. You’ll use these IDs to set up your payroll system and to make tax deposits and filings going forward.

Get your EIN and enroll in EFTPS

Your EIN is your federal employer ID used on all payroll tax filings and deposits. You can apply online and receive it immediately through the IRS; start here: Apply for an EIN (IRS).

After you have your EIN, enroll in the Treasury’s EFTPS to make federal tax deposits electronically. You’ll receive a PIN by mail, so begin this step early.

At a minimum, you’ll use EFTPS to deposit federal income tax withholding and both employee and employer FICA. Your quarterly filings reconcile these deposits with totals withheld and owed. Keep your EIN confirmation and EFTPS enrollment letters on file; you will need them to onboard any payroll software or service and to verify your identity with the IRS if questions arise.

Register state withholding and unemployment accounts

Most states require separate registrations for employer payroll withholding (state income tax) and unemployment insurance (SUTA). These are different agencies and account numbers, even within the same state.

New-employer SUTA rates are typically assigned by the state and may be higher for the first few years until you build an experience rating. Processing times vary by state—from instant online accounts to several weeks—so plan accordingly.

Once approved, note deposit frequencies and filing cycles for each account; they may not match federal schedules. You’ll provide these IDs to your payroll system so it can calculate state taxes and produce returns. If you plan to hire in additional states, repeat this step before your first hire in each state.

Check for local/city payroll taxes

Certain localities (cities, counties, school districts) require separate payroll tax registrations and filings. Examples include local earned income taxes or municipal withholding.

Check the municipality where employees work (and sometimes where they live), and register before payroll begins in that location. Keep a simple matrix of where each employee works/lives and which local accounts apply to avoid missed filings as your team grows.

Choose your payroll model: DIY, software, CPA, or PEO (cost and ROI)

How you operate payroll affects cost, time spent, and compliance risk. DIY means maximum control but the steepest learning curve. Software automates calculations and filings. CPAs bring expertise and human oversight. PEOs aggregate compliance and benefits under a co-employment model.

Choose the model that fits your complexity and risk tolerance today, with a plan to upgrade as your needs change. DIY and software both leave tax liability in your company’s name. CPAs typically act as paid preparers, while PEOs file under their tax accounts and often provide benefits at scale.

Consider not just sticker price but also your time-on-task, penalty exposure, and the “unknown unknowns” of multistate, garnishments, and year-end corrections.

Cost components, hidden fees, and time-on-task

Payroll cost includes money and time. Budget for core fees (software subscriptions or service retainers) and ancillary costs (year-end processing, amended returns, off-cycle runs, garnishment administration, bank/ACH fees).

Also budget for the hours you’ll spend on setup, each payroll run, responding to notices, and year-end close. Ask vendors about add-ons for multistate filings, local taxes, benefits integration, and historical data imports so you don’t get surprised later.

Typical ranges for small employers:

Weigh savings from time reclaimed, reduced error rates, and penalty avoidance against subscription or service fees. A simple way to evaluate ROI: multiply your hourly rate by monthly time saved and compare to the added monthly price of the upgrade. Include a contingency for the cost of correcting notices.

When to switch or upgrade

Upgrade your payroll model when the compliance surface area outgrows your in-house capacity. Common triggers include:

If two or more triggers apply, consider moving from DIY to software, from software to a CPA, or from a CPA to a PEO, depending on how much risk transfer you need. Revisit the decision annually as headcount, locations, and benefits change.

Set your pay schedule and pay methods

Your pay frequency and methods influence cash flow, compliance, and employee experience. Choose a schedule that balances predictability with admin load. Then pick payment methods that are fast, low-friction, and compliant.

Lock your calendar to ensure time for timesheet approvals, payroll processing, and funding. Common pay frequencies include weekly, biweekly (every two weeks), semimonthly (twice a month), and monthly.

Weekly is most predictable for hourly teams. Biweekly simplifies overtime calculations under the FLSA. Semimonthly aligns with salaried payrolls but can complicate overtime for hourly staff.

Pay frequency laws and compliance guardrails

States set minimum pay frequencies by worker type or industry. Some require weekly or biweekly for hourly staff; others allow semimonthly or monthly for exempt employees.

Check your state’s wage payment laws before finalizing your schedule. Remember that a pay period is distinct from a pay date—ensure pay dates are soon enough after period close to meet state timeliness standards.

Build your internal timeline backward from payday to include timekeeping cutoff, manager approvals, payroll prep, bank funding, and any holidays that affect ACH timing. If you’re expanding across states, confirm that your chosen frequency is legal in all relevant jurisdictions and adjust where required.

Direct deposit, checks, and pay cards

Direct deposit via ACH is standard, fast, and low cost. Paper checks offer flexibility but bring reissue and fraud risks.

Payroll cards (pay cards) can be convenient for unbanked employees. Many states require voluntary consent, fee disclosures, and access to wages without fees. If you offer pay cards, ensure you comply with state rules and provide at least one alternative payment option.

Whatever method you choose, document it in onboarding. Collect authorizations, and test account information with a pre-note or small deposit before the first payroll to reduce payment failures.

Gather and validate worker paperwork and classification (W-4, I-9, W-9)

Accurate onboarding paperwork drives accurate payroll. You’ll collect tax forms, verify work authorization, and confirm whether each worker is an employee or independent contractor. Getting this right prevents miswithholding, costly corrections, and penalties.

For employees, collect Form W-4 for federal withholding and any required state equivalents. Complete Form I-9 to verify work authorization by day three of employment; see the current form and instructions from USCIS I-9.

For contractors, collect Form W-9 for taxpayer information so you can issue a Form 1099-NEC if you pay $600 or more in a year. If a contractor refuses to provide a TIN, IRS backup withholding rules may apply.

Maintain a secure, audit-ready file for each worker. When in doubt about status, pause and review classification guidance before the first payment.

Employees vs contractors and misclassification risk

Employees are subject to payroll taxes, minimum wage, overtime rules, and employer control. Contractors run independent businesses and are paid on invoices without payroll withholding.

The IRS and DOL evaluate multiple factors (behavioral and financial control, relationship of the parties) when determining status. Misclassification can trigger back wages, taxes, penalties, and interest.

If a role looks and operates like an employee—set schedule, tools provided, integral to your business—treat it as employment and run it through payroll. Use written agreements thoughtfully, but know they don’t override law. When stakes are high, consult an employment attorney or CPA familiar with IRS and DOL guidance.

Configure taxes: FICA, FUTA/SUTA, and local withholding

Tax configuration converts gross pay into net pay and employer costs. You’ll set up federal (FICA and withholding), state unemployment (SUTA), any state/local income taxes, and deposit schedules.

Your system should also track wage bases and additional taxes that kick in at thresholds. At the federal level, Social Security and Medicare are shared by employee and employer; see current rates and withholding methods in Publication 15-T.

Federal income tax is withheld based on each employee’s W-4. At the state level, set your SUTA rate and wage base, and turn on local tax withholding where applicable.

FICA: Social Security and Medicare

FICA payroll taxes fund Social Security and Medicare. The employee pays 6.2% for Social Security and 1.45% for Medicare, and the employer matches the same amounts.

High earners may owe an additional 0.9% Medicare tax withheld by the employer once wages pass the federal threshold (employers do not match this additional tax). You report and reconcile these amounts quarterly on Form 941.

Ensure your payroll setup tracks the annual Social Security wage base so the 6.2% stops at the limit while Medicare continues without a cap. If you pay bonuses, confirm that withholding methods follow current IRS supplemental wage guidance.

FUTA/SUTA mechanics and credit interaction

FUTA is a federal unemployment tax paid by employers and generally applies to the first $7,000 of wages per employee each year, reported on Form 940. Employers often receive a credit against FUTA for state unemployment taxes paid (SUTA), but if a state is a “credit reduction” state in a given year, your FUTA liability may increase.

Set your SUTA rate and wage base exactly as provided by the state. Most systems stop calculating SUTA after the employee hits the state wage cap, but verify this during your first few runs, especially if you switched providers midyear.

Set up benefits and deductions (pre-tax vs post-tax)

Benefits and deductions affect taxable wages and employee take-home pay. Configure the tax treatment correctly from day one to avoid under/over-withholding and W-2 errors.

The key distinction is whether a deduction is pre-tax (reduces taxable wages) and under which statutes, or post-tax. Confirm plan documents, eligibility dates, and limits, and coordinate employer contributions (matches) to budget total labor cost.

Common pre-tax categories:

Post-tax deductions include Roth 401(k) contributions, certain voluntary benefits without a Section 125 plan, and charitable deductions. Confirm taxability for each deduction type. When you add or change benefits midyear, update payroll configuration and provide employees with clear summaries of the impact on net pay.

Multistate and remote employees: nexus, reciprocity, and UI rules

Hiring across state lines expands your payroll footprint. You must register to withhold in the state where the employee works (and sometimes where they live), set up SUTA in the correct state under UI localization rules, and apply any local taxes.

Reciprocity agreements between certain states may let you withhold only the employee’s resident state income tax if the employee files the proper exemption form.

A practical setup sequence:

When services span multiple states, apply the UI localization hierarchy. First, use the state where the work is localized. If not localized, use the state of the base of operations. If none, use the state from which direction and control emanate. If still unclear, use the worker’s residence.

Review state rules on wage statements, pay frequency, and paid leave accruals, which vary. Build a simple internal register listing each employee’s work and resident states, tax accounts used, and reciprocity status to keep audits and year-end tidy.

Running payroll: calculations, examples, and gross-ups

When your setup is complete, you’ll calculate gross pay, apply pre-tax deductions, withhold payroll taxes, and compute employer taxes and benefits. Validate your first few runs with hand-checked calculations and spot checks against IRS methods in Publication 15-T and overtime rules in FLSA guidance.

Example 1: Hourly employee with overtime and pre-tax health

Example 2: Salaried employee with a discretionary bonus

Example 3: Net-to-gross bonus (gross-up)

For each example, keep audit notes showing how you derived pay, withholdings, and employer costs. This makes it easier to answer employee questions and reconcile quarter-end filings.

Time tracking, rounding, and break rules

Accurate timekeeping underpins compliant pay, especially for nonexempt employees. Under the FLSA, overtime is generally 1.5x the regular rate for hours worked over 40 in a workweek; see FLSA overtime basics. Some states set daily overtime or double-time rules.

Rounding is permitted in limited, neutral fashion (e.g., to the nearest 5 minutes or one-tenth of an hour) but must not systematically underpay employees. Many states require meal and rest breaks and impose penalties for missed or late breaks. Use reliable time-tracking and adopt conservative rounding and break policies to avoid wage-and-hour disputes.

Deposits, filings, and penalties to avoid

After each payroll, you must deposit withheld taxes on time and file returns on schedule. Deposit schedules depend on your total tax liability during a lookback period; most small employers are monthly or semiweekly depositors for federal taxes.

Make deposits through EFTPS and align state/local deposits to their schedules. File quarterly federal payroll returns on Form 941, annual FUTA on Form 940, and state/local returns per jurisdiction.

Late deposits trigger failure-to-deposit penalties that escalate with time outstanding; interest may also apply. Avoid “pyramiding” liabilities by reconciling every payroll to your next deposit and verifying confirmations are posted.

Wage garnishments and child support: priorities and limits

Garnishments require you to withhold from pay and remit to agencies or creditors. Child support orders, federal tax levies, state tax levies, bankruptcy orders, and creditor garnishments all have specific priorities and limits.

Under the CCPA, most creditor garnishments are limited to the lesser of 25% of disposable earnings or the amount by which disposable earnings exceed 30 times the federal minimum wage. Child support and tax levies follow different rules and priority.

Operationalize a clear process:

If multiple orders exist, apply priority rules carefully and document your calculations. When in doubt, contact the issuing agency before the first withholding to confirm instructions and prevent over- or under-withholding.

Year-end close and corrections (W-2/W-3, 940; W-2c and 941-X)

Year-end reconciles payroll records to tax filings and prepares employee and agency forms. You’ll verify totals across all quarters, issue W-2s/W-3s, file your annual FUTA return, and correct any errors discovered.

A practical year-end checklist:

If you find errors after filing, use corrected forms. File W-2c with SSA to fix wage/tax amounts or identity data. To correct federal payroll taxes and withholding reported on a prior quarterly return, use the Form 941-X instructions and follow the “adjustment” vs “claim” pathways and timelines. Maintain a binder of year-end reconciliations to speed up future audits and lender requests.

Accounting entries and cash flow timing

Recording payroll in your general ledger turns pay runs into clean financials. Each cycle, you’ll debit wage expense and employer taxes/benefits, credit cash for net pay, and credit liabilities for taxes and withholdings to be remitted.

When you make deposits and vendor payments, you’ll clear those liabilities. Two practical tips improve accuracy:

Cash flow often dips on paydays and again on federal deposit dates for semiweekly depositors. Build a rolling 6–8 week forecast that includes pay dates, expected tax deposits, benefits premiums, and retirement plan remittances to avoid liquidity surprises.

Switching payroll providers midyear: migration checklist

Midyear migrations are manageable when you bring accurate year-to-date (YTD) data and validate thoroughly. The goals are to preserve wage bases and taxes-to-date, prevent duplicate filings, and ensure the new system properly picks up limits and accruals.

Use this sequence:

After your first live payroll, reconcile liabilities and deposits. Monitor tax notices closely for the next 1–2 quarters. Watch for issues like local tax codes not transferring, stale bank accounts, and benefit deduction mismatches.

Paying owners and officers by entity type

Owner compensation depends on your business structure, and mistakes here are common. Set it correctly to avoid payroll tax issues and improper deductions.

If ownership or tax classification changes (e.g., you elect S status midyear), coordinate with your tax advisor and adjust payroll prospectively with clear documentation.

By following this roadmap, you can set up payroll confidently, avoid the most common compliance pitfalls, and scale your payroll process as your team grows. Keep your registrations current, validate the first few payrolls by hand, and maintain clear documentation so deposits, filings, and year-end close run smoothly.