How to run payroll for your small business

Gather what you need before the first run

You need your EIN, state tax accounts, a business bank account, and a signed W-4 and I-9 for each worker. Without these, the first payroll will stall.

Open a dedicated business account so payroll money is not mixed with personal funds. Our guide to opening a business bank account covers what banks ask for. Get your EIN, then register with your state for income tax withholding and unemployment insurance where applicable. See also the business tax ID number explainer.

For each employee, keep a Form W-4 for federal withholding, a Form I-9 for work eligibility, their pay rate, pay schedule and a way to pay them such as direct deposit.

Decide your pay schedule before the first run and put it in writing. Pick a regular pay day, say what happens when it falls on a holiday, and explain how overtime is calculated. Employees stay happier when pay is predictable.

Choose how you will process payroll

Pick software if you want control at low cost, a payroll service if you want filings handled for you, or an accountant if your pay structure is complex. Match the choice to your headcount and your time.

• Do it yourself. Cheapest, but you carry every deadline and calculation.
• Payroll software. Calculates withholding and can file for you, usually for a monthly fee plus a per-employee charge.
• Accountant or bookkeeper. Useful when you have tipped staff, multiple states, or union or prevailing-wage work.

Our general guide to how to do payroll compares these methods in more detail.

Whichever route you pick, run a test payroll first if the system allows it. Check one employee's net pay against your hand calculation. Catching a setup error in a test saves you a corrected filing later.

Calculate gross pay, withholding and net pay

Start with gross pay, subtract employee withholding for taxes and any deductions, and the remainder is net pay. Then add the employer-side taxes you owe on top.

Here is an example with round numbers. An employee earns $1,000 gross in a pay period. Suppose withholding for federal income tax, Social Security and Medicare, and state tax totals $180. Net pay is $820. As the employer you also owe your share of Social Security and Medicare, plus unemployment taxes, so the real cost to you is above $1,000.

All of those amounts are examples. Federal rates, wage bases and state rates change, so use current IRS publications or your payroll software. Our post on payroll versus income taxes explains how the two differ.

Deposit and file taxes on schedule

Payroll taxes are held in trust for the government, so deposit them by the due date and file the required reports. Late deposits can bring penalties.

Employers deposit federal payroll taxes on a schedule set by the IRS, which depends on how much tax you reported in a past lookback period. Most small employers file a quarterly federal return and send year-end forms to employees and the government. States have their own schedules for withholding and unemployment taxes.

Look up current deadlines on IRS.gov and your state's tax agency, or let a payroll service file for you. If you ever fall behind, talk to an accountant quickly instead of skipping deposits, since penalties grow over time.

A good routine is a calendar reminder for each deposit and filing date, set a few days before the deadline. If you use a service, still look at the confirmation each time, because you remain responsible for the taxes even when someone else files them.

Keep records and handle corrections

Keep payroll records for the period the IRS and your state require, and fix mistakes in the next run or on a corrected form. Do not ignore errors.

Keep time cards, pay stubs, tax filings and employee forms in an organized place. Retention periods differ by agency, so ask your accountant for the current rule. If you overpay or underpay someone, document the correction and follow your state's rules about recovering overpayments. Good records also support your applications for funding, because funders review bank statements and may ask about payroll.

Also separate employees from contractors in your records. Contractors receive a Form 1099 at year end rather than a W-2, and mixing them into payroll creates tax problems.

Cover payroll when cash runs short

If sales arrive slower than payroll is due, bridge the gap with a line of credit or working capital rather than delaying paychecks or tax deposits. Missed payroll hurts trust and can create legal trouble.

Seasonal and invoice-based businesses often meet payroll before customers pay. A business line of credit lets you draw only what you need and repay it as cash comes in. Working capital can also fit. Read our post on payroll loans for how funding for payroll works.

Borrow for a clear timing gap, and check the true cost first. ROI Funder shows payback math and monthly-equivalent payments before you sign. Applying is a soft pull with no obligation.