How to Do Payroll for Your Small Business

Set up before the first paycheck

You need an Employer Identification Number, state registrations, a payroll schedule and a way to track hours and pay rates. Do this before any employee starts.

Complete these steps first:

1. Get a federal Employer Identification Number (EIN) from the IRS.
2. Register with your state for income tax withholding, if applicable, and for state unemployment insurance. Your state's revenue and labor departments explain how.
3. Open a business bank account so payroll is separate from personal money.
4. Decide your pay frequency: weekly, biweekly, semimonthly or monthly. Some states set minimum frequencies.
5. Confirm whether your workers are employees or contractors. Misclassification can be costly.

Also buy workers' compensation insurance if your state requires it for your headcount.

Collect the required forms from each employee

Each new employee completes Form W-4 for federal withholding and Form I-9 to verify work eligibility. You may also need state withholding forms.

The W-4 tells you how much federal income tax to withhold. Many states have a similar form. Keep them on file and update when an employee submits a change.

Form I-9 verifies identity and authorization to work in the U.S. The employee completes their section by the first day of work, and you complete yours within three business days of the start date. See our guide on how to fill out Form I-9.

Also collect bank details for direct deposit, with written consent. Store everything securely, since it contains personal data.

Calculate gross pay and withholdings

Start with gross pay, then subtract federal and state income tax, the employee share of Social Security and Medicare, and any voluntary deductions to find net pay.

For hourly workers, multiply hours by rate and add overtime where required. Federal law requires overtime pay at one and a half times the regular rate for non-exempt employees working over 40 hours in a workweek, and some states are stricter. Salaried exempt employees receive their agreed amount, but the exemption has specific tests.

Then subtract withholdings:

• Federal income tax from the W-4 and IRS tables
• State and local income tax, where they apply
• The employee share of Social Security and Medicare (FICA)
• Voluntary items such as health premiums or retirement deferrals

You also owe the employer share of FICA and unemployment taxes. Use current IRS and state tables, or payroll software that updates them automatically.

Pay your employees and keep records

Pay by direct deposit or check on the scheduled date and give each employee a pay stub. Keep payroll records for as long as federal and state law requires.

Some states require a written or electronic statement showing hours, gross pay, deductions and net pay. Even where it is not required, it prevents disputes.

Keep time records, pay rates, deductions, tax forms and payment dates organized by employee. The retention period varies by record type and by state, so ask your accountant or check the Department of Labor and IRS guidance.

Reconcile each payroll to your bank statement. Our guide to bank reconciliation shows how to catch mistakes early.

Deposit and file payroll taxes on time

Withheld taxes belong to the government, not to your operating cash. Deposit them on the IRS and state schedules and file the periodic returns.

Your deposit schedule, monthly or semiweekly for most employers, depends on the amount of tax you report. Federal employment tax returns are generally filed quarterly, with annual reports such as unemployment filings and year-end wage statements.

• Employees receive a Form W-2 at year end, and you send copies to the Social Security Administration. See what a W-3 is.
• Independent contractors paid above the threshold receive a 1099 form. Check IRS.gov for the current filing rules.

Late deposits trigger penalties, and unpaid payroll taxes can create personal liability for owners. Move the tax portion into a separate account each payday. Read our guide to managing business taxes for the wider calendar.

Choose between software, a provider or doing it by hand

Software and payroll providers calculate taxes, file returns and issue forms for a monthly fee. Manual payroll is feasible for one or two employees but easy to get wrong.

Compare options on what they handle:

• Manual with spreadsheets. Cheapest, but you own every calculation and filing.
• Payroll software. Calculates withholding, direct deposit and often files taxes. Good for small teams.
• Full-service provider. Handles everything and sometimes HR, for a higher fee.
• Accountant or bookkeeper. A good fit if you already work with one. See hiring bookkeeping help.

Price one pay cycle across the options, including per-employee fees. Ask about error guarantees and support.

Make sure payroll is always funded

Payroll is the one bill you cannot skip. Forecast cash for each pay date and arrange a backup before a shortfall happens.

Many healthy businesses run into payroll gaps when customers pay late. Project cash for the next 13 weeks using our cash flow forecasting guide, and mark each payday and tax deposit.

If a gap appears, options include a business line of credit you draw on and repay, or working capital. Read our note on payroll loans for how to think about cost. ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ monthly revenue, with money in the account the same business day on approved, complete files.