How to set up payroll for your small business: A complete guide

Running payroll is one of the most important tasks you’ll handle as a small business owner, but it can also feel like one of the most overwhelming. From determining pay schedules to managing tax withholdings and staying compliant with federal and state laws, there’s a lot to keep track of when you begin to think through how to set up payroll for your business. 

The good news is, with the right guidance and tools—including powerful AI agents—you can streamline the process and get back to focusing on what matters most: growing your business.

In this guide, we’ll walk you through everything you need to know to set up payroll for your small business, step by step. With employment and revenue surging, you might be considering hiring one employee or a whole team. Regardless, we’ve got you covered.

Jump to:

• Step 1: Prepare to pay employees
• Step 2: Understand and manage payroll taxes
• Step 3: Ongoing payroll management
• Next steps for streamlining your payroll process

Step 1: Prepare to pay employees

This step is crucial because it lays the foundation for accurate and compliant payroll. Skipping even one of these sub-steps could lead to costly mistakes or legal headaches down the road, so let’s walk through what you need to do before running your first payroll.

Set a payroll schedule

Choosing the right payroll schedule is one of the first decisions you’ll make as a small business owner. Common payroll frequencies include:

• Weekly: Employees are paid every week (52 pay periods per year).
• Bi-weekly: Employees are paid every two weeks (26 pay periods per year).
• Twice a month: Employees are paid on specific dates, like the 15th and 30th (24 pay periods per year).
• Monthly: Employees are paid once a month (12 pay periods per year).

Keep in mind that there’s usually a short delay between the end of a pay period and payday, which gives you time to calculate hours worked, taxes, and other deductions. You should also check with your state labor agency, as some states have laws that dictate how often employees must be paid.

Your chosen schedule also impacts how you report federal taxes using Form 941, which covers quarterly tax filings. For example, if you run payroll monthly, you’ll still need to reconcile your withholdings and deposits on a quarterly basis.

Gather employee information and forms

Collecting accurate employee information is nonnegotiable for managing small business payroll efficiently and effectively. You’ll need details like Social Security numbers, addresses, and tax filing statuses to calculate withholdings and deductions.

Having all this information upfront prevents errors that could lead to underpayment, overpayment, or missed tax deadlines. Plus, staying organized from the start makes it easier to manage records and respond to audits if needed.

By taking care of these foundational steps, you can set yourself up for smooth and stress-free payroll management. Next, let’s talk through how to handle tax withholdings and deposits.

Form W-4

Form W-4 is essential because it determines how much federal income tax to withhold from an employee’s paycheck. New hires typically complete this form on their first day of work, but employees can also update it after major life events, such as marriage or childbirth.

Some states have their own versions of the W-4, so make sure you’re aware of any additional requirements in your area. Filling out this form correctly ensures that your employees’ tax withholdings align with their financial situations and helps you avoid penalties for under- or over-withholding.

Form I-9 (employment eligibility verification)

Form I-9 verifies an employee’s identity and eligibility to work in the US. Every new hire must complete this form, and you’ll need to inspect original documents—like a passport or driver’s license—to confirm their authenticity.

This step isn’t just a formality; it’s a legal requirement. If an employee doesn’t provide valid documentation within three days of starting work, you may need to suspend or terminate their employment. Keep these forms organized and accessible—they’re subject to inspection by government agencies.

New hire forms

In addition to federal forms like W-4 and I-9, many states require employers to report new hires to a designated agency. This reporting usually needs to happen within 20 days of the employee’s start date.

Other important forms to gather include:

• Direct deposit authorization (FMS-2231): Allows employees to receive their pay via direct deposit
• Emergency information (DL1-65): Collects emergency contact details for workplace safety
• Self-identification of disability (SF-256): Gives employees the option to voluntarily disclose a disability

These forms help streamline processes and ensure compliance with state and federal regulations.

Step 2: Understand and manage payroll taxes

Payroll taxes might sound intimidating, but they’re just part of doing business—and understanding them is key to staying compliant. Let’s break down the basics of what you owe as an employer and how to manage these obligations without losing sleep over the details.

Social Security and Medicare taxes (FICA)

FICA taxes are contributions to two programs: Social Security and Medicare. These taxes are shared between employers and employees, so it’s important to know how they work.

• Social Security tax: Both you and your employee contribute 6.2% of wages, up to an annual wage limit ($176,000 in 2025). Once an employee earns more than this limit, no additional Social Security tax is withheld.
• Medicare tax: The standard rate is 1.45% for both employers and employees. However, there’s an additional Medicare tax of 0.9% for high earners (those making over $200,000 annually). This additional tax is only paid by the employee, not the employer.

By understanding FICA taxes, you can ensure accurate withholdings and avoid costly mistakes. These contributions help fund essential benefits for employees, so it’s worth getting them right.

Federal unemployment tax (FUTA)

The Federal Unemployment Tax Act (FUTA) provides unemployment compensation to workers who lose their jobs. As an employer, you’re responsible for paying this tax, which is calculated at 6% on the first $7,000 of each employee’s wages.

Here’s the good news: Most businesses qualify for a 5.4% credit, reducing the effective rate to just 0.6%. However, if you’re in a credit reduction state (a state that owes the federal government money for unemployment benefits), your credit might be lower. Be sure to check with your state unemployment agency for details about additional state taxes and credit eligibility.

Depositing and reporting payroll taxes

When it comes to depositing payroll taxes, the IRS requires businesses to use the Electronic Federal Tax Payment System (EFTPS). Here’s how it works:

• Deposit schedules: Depending on your business type and tax liability, you’ll follow either a monthly or semiweekly schedule. Monthly depositors report and pay taxes by the 15th of the following month, while semiweekly depositors have deadlines based on their payroll dates.
• FUTA deposits: If your FUTA tax liability is $500 or more in a quarter, you’ll need to deposit it quarterly via EFTPS. To calculate your FUTA tax, multiply taxable wages by the applicable rate (usually 0.6%). 

Staying on top of these deadlines ensures you avoid penalties and keep your business running smoothly.

Penalties for noncompliance

Let’s be clear: Missing deadlines or making errors with payroll taxes can lead to stiff penalties. For example, late deposits can result in fines ranging from 2% to 15% of the unpaid tax, depending on how late the payment is.

For more details on potential penalties, refer to IRS Publication 15, which outlines everything you need to know about federal payroll taxes. Trust us—staying compliant is far easier (and cheaper) than dealing with the consequences of mistakes.

Step 3: Manage ongoing payroll

There are few one-and-done tasks when you think about how to manage payroll for a small business, because it’s an ongoing responsibility. But with the right systems in place, managing payroll can feel less like a chore and more like a seamless part of running your business.

Calculating paychecks

Every pay period, you’ll need to calculate your employees’ paychecks accurately. Here’s how it works:

For hourly employees, gather their hours worked and multiply by their hourly rate to determine gross pay.

Apply all relevant deductions, including:

• Federal and state income taxes
• FICA taxes (Social Security and Medicare)
• Pre-tax deductions like 401(k) contributions
• After-tax deductions like garnishments or union dues

While manual calculations are possible, using small business payroll software can save time, reduce errors, and minimize the cost of payroll. With just a few clicks, you can generate accurate paychecks and stay compliant with tax laws.

Paying employees

When it comes to paying employees, you have options:

• Direct deposit: This is the most popular method because it’s fast, secure, and convenient for both you and your team.
• Paper checks: While less common these days, some businesses still prefer printing checks for payroll.

Whichever method you choose, make sure payments are timely and accurate to keep your employees happy. 

Filing payroll tax forms is another ongoing responsibility. You’ll need to submit periodic reports to federal and state agencies, including:

• Form 941: A quarterly federal tax return that reports wages, tips, and taxes withheld
• Form 940: An annual federal unemployment tax return

Staying organized and keeping detailed records makes this process much smoother.

Benefits of payroll software

If managing payroll feels overwhelming, you’re not alone. That’s where payroll software comes in. These tools handle everything from paycheck calculations to tax payments and form filings, saving you time and reducing the risk of costly errors.

With payroll software, you can focus on growing your business instead of stressing over compliance. It’s a small investment that pays off big in peace of mind and efficiency.

Next steps for streamlining your payroll process

Setting up and managing payroll doesn’t have to be overwhelming. By following these steps—preparing to pay employees (including remote employees), understanding tax obligations, and staying on top of ongoing tasks—you can build a solid foundation for accurate and compliant payroll. The right tools can simplify the process even further.

If you’re ready to take the stress out of getting money into employees’ hands, consider exploring payroll software that automates taxes, payments, and more. Not only will it save you time, but it also ensures your team gets paid accurately and on time—every time. Let us help you focus less on paperwork and more on growing your business!

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