How to set up payroll for your small business: A step-by-step guide

Setting up payroll for your small business means juggling a lot of new processes at once — and if you’re just getting started, it can feel overwhelming. Between tax registrations, employee classifications, withholding calculations, employer liabilities and reporting obligation deadlines, there’s plenty to keep track of.

The good news? Once you get your arms around the set-up process, small business payroll becomes a manageable, repeatable routine.

In this guide, we’ll walk through how to set up payroll for your small business from start to finish. We’ll also explain how Block Advisors can help lighten your load with payroll services designed for small business owners like you.

Why setting up payroll correctly matters for small businesses

Payroll setup is essential for tax compliance because it determines how accurately you calculate, withhold, and remit the federal, state, and local taxes you’re responsible for as an employer.

If your setup is wrong from the start—say, you misclassify a worker or enter the wrong withholding allowances—those errors ripple through every pay period and every tax filing that follows. Done right, payroll setup keeps you compliant, protects your bottom line, and builds a foundation of trust with the people who work for you.

Avoiding IRS penalties & late fees

Improper payroll setup can lead to tax compliance issues on top of other headaches. When you under-withhold, deposit taxes late, or file the wrong forms, the IRS can hit you with interest charges and failure-to-deposit penalties — and those can add up quickly. Add in state-level penalties for missed unemployment or state income tax deposits and filings, and a simple setup mistake can turn into a significant financial burden.

Building trust with your employees

Paying your employees accurately and on time does more than keep you compliant — it builds trust. When your team knows they can count on a correct paycheck every pay period, it maintains your professional credibility and confidence.

Now that you know the benefits of getting your set up right, let’s get into the steps of how to set up payroll.

Step 1: Obtain your federal employer identification number (EIN)

Your first step in setting up payroll is obtaining a federal Employer Identification Number (EIN)— a unique nine-digit number the IRS uses to identify your business for tax reporting. You’ll need it to open a business bank account, file payroll tax returns, and register with state tax agencies. Requirements can vary depending on your business structure: sole proprietorships without employees do not need one, while LLCs, partnerships, and corporations generally do. If you already have one you do not need to get a new one.

Applying via IRS.gov (free & quick)

The fastest way to get your EIN is through the IRS website, where the online application is free and issues your number in a few minutes.

You’ll need the following for your EIN application:  

• your business name
• mailing address
• the responsible party and
• your reason for applying

For a deeper dive, see our article on how to get an Employer Identification Number and our guide to the IRS EIN application. You can also find EIN information on the IRS website.

Step 2: Register your business with the state

After you have your EIN, you’ll want to file documents with your state’s business registration office (often called the Secretary of State). This step establishes your legal recognition allowing you to do business in the state. Depending on your business structure and state, you may file certification (or articles) of organization or incorporation.

Step 3: Register for state and local payroll tax accounts

After you have your EIN, the next step is registering with your state and local tax agencies. This allows you to remit state income tax withholdings and unemployment contributions. The exact registrations you need depend on where your business operates and where your employees work, so check with your state’s revenue and labor departments, along with any states where your employees perform services.

State income tax (SIT) & state unemployment tax (SUTA)

Setting up state payroll tax accounts generally means registering with two types of agencies: your state’s revenue department for state income tax (SIT) withholding, and your state’s labor or unemployment agency for state unemployment tax (SUTA).

• For SIT, you’ll register as an employer so you can withhold and remit state income tax from employee wages in states that impose one. This may be through the same portal that you use for your business’s tax payments, so check your state’s rules.
• For SUTA, you’ll open an unemployment insurance account and begin making contributions based on your payroll.

Keep in mind, state payroll and income withholding rates vary widely. It’s also worth noting that new employers typically have an introductory SUTA rate which can adjust over time based on your experience rating.

Step 3: Classify your workers (W-2 employees vs. 1099 contractors)

Setting up correct worker classification is critical. Misclassifying an employee as a contractor can cost you back taxes, unpaid FICA, interest, and labor fines — sometimes going back years. The fundamental difference: W-2 employees are on your payroll, subject to tax withholding and payroll taxes, while 1099 independent contractors are self-employed and responsible for their own taxes. For a detailed breakdown, see our guide to contractor vs. employee or review the IRS website.

IRS three-factor test (behavioral, financial, relationship)

The IRS uses a three-factor test to determine whether a worker is an employee or an independent contractor:

• Behavioral control — Do you control how the work is done, not just the final result? If you provide instructions, training, or set specific methods, the worker leans toward employee status.
• Financial control — Does the worker have a significant investment in their own tools, offer services to other clients, and bear the risk of profit or loss? Greater financial independence points toward contractor status.
• Relationship type — Is there a written contract, are benefits provided, and is the work ongoing or project-based? Permanent, benefit-eligible arrangements suggest employment.

No single factor decides it on its own — the IRS weighs all three together to assess the overall working relationship for each individual you bring on.

Step 4: Collect essential employee onboarding forms

Before you issue your first paycheck, you need to collect the right documentation from each worker. These forms determine how much to withhold, verify work authorization, and give you the information you’ll need for year-end reporting.

Form W-4 (federal income tax withholding)

Form W-4 tells you how much federal income tax (FIT) to withhold from each employee’s paycheck. It captures the employee’s filing status and any adjustments — like additional withholding or dependents — that govern how much comes out of gross pay each period. If your state has a state income tax, you’ll also need the equivalent state withholding form on file.

Form I-9 (employment eligibility verification)

Form I-9 verifies your employee’s identity and authorization to work in the United States. It’s mandatory for every new hire—both citizens and noncitizens. You must inspect the employee’s original documentation (such as a passport, or a combination of a driver’s license and Social Security card) in person, and you have three business days from the hire date to complete and sign the form.

Form W-9 (request for taxpayer identification number)

Form W-9 is for 1099 independent contractors, not W-2 employees. Before you pay a contractor, have them complete a W-9 so you have their name, business name (if applicable), and taxpayer identification number on record. You’ll use that information to prepare Form 1099-NEC at year end if you paid them $2,000 or more for the 2026 tax year.

Direct deposit authorization forms

If you’re offering direct deposit, you’ll need a direct deposit authorization form that captures each employee’s bank routing number, account number, and account type, along with their signed consent.

Step 5: Establish your pay schedule and pay rates

Comparing weekly, bi-weekly, and semi-monthly schedules

Your pay schedule and pay rates form the backbone of your payroll routine. Your pay frequency may also be subject to state requirements, which can vary based on where your employees work and, in some cases, the type of work they perform. Before selecting a schedule, make sure your chosen pay frequency meets any requirements that apply to your business and employees.

Common pay schedules include:

• Weekly: Employees are paid once a week, resulting in 52 pay periods per year.
• Biweekly: Employees are paid every two weeks, typically resulting in 26 pay periods per year. Some years may have 27 pay periods depending on the payroll calendar.
• Semimonthly: Employees are paid twice a month, resulting in 24 pay periods per year. Paydays are generally established on two specific dates each month.
• Monthly: Employees are paid once a month, resulting in 12 pay periods per year.

Pay rate categories

You’ll also need to establish how each employee will be paid, such as an hourly rate or salary, and confirm that their compensation meets applicable wage and hour requirements.

• For hourly (non-exempt) employees, track hours worked and apply the Fair Labor Standards Act (FLSA) overtime rule: pay 1.5 times the regular rate for any hours over 40 in a workweek. Note that some states have additional rules for when overtime is required.
• For salaried exempt employees, confirm they meet the FLSA duties test and salary threshold so you classify them correctly and avoid compliance issues down the line.

There may also be sick pay accruals to account for based on state rules.

Step 6: Choose your payroll processing method

Your options for payroll methods range from handling it yourself to outsourcing it entirely. The right  choice depends several factors: your budget, the number of employees, and how much time you want to spend on compliance.

Manual/spreadsheet payroll (risks & pitfalls)

Running payroll in a spreadsheet is the most hands-on option, and it comes with real risks. Common pitfalls include formula errors, manual tax table lookups that go out of date as rates change, and miscalculated withholdings that can lead to costly underpayment penalties and interest.

Payroll software vs. dedicated full-service payroll advisors

Payroll software for small businesses automates the calculation, withholding, and filing steps, which reduces human error and saves time — a big reason why payroll software saves time for small businesses. If you’re comfortable with setting up, staying up to date on tax laws and entering the date, payroll software options like Wave can be a convenient option.

As you’re looking to choose a payroll provider, you may also consider a full-service option. For those looking to leave it to the pros, Block Advisors provides ongoing support year-round with a dedicated accountant. Whether you have one employee or a growing team, we can help you save time and stay compliance at an affordable rate.

Step 7: Calculate withholdings, run payroll, and submit tax deposits

At this point, you’re ready to put payroll in motion. Let’s run through the final concepts you need to know.

Gross pay vs. net pay

Gross pay is what an employee earns before any deductions—their hourly rate times hours worked, or their salary for the period. Net pay is the take-home amount left after you subtract all statutory deductions: federal income tax, state and local income tax, the employee’s share of FICA, and any voluntary deductions like retirement or health contributions.

FICA taxes, FIT withholdings and FUTA

FICA taxes fund Social Security and Medicare, and they’re split between employer and employee.* See the amounts below:

• Social Security — 6.2% on the employer side and 6.2% on the employee side, up to the annual wage base limit.
• Medicare — 1.45% on the employer side and 1.45% on the employee side, with no wage base limit (higher earners may also owe Additional Medicare Tax).

On top of FICA, you withhold federal income tax (FIT) from each employee’s paycheck based on their W-4 along with state income tax withholdings.

And, lastly, you’ll need to account for Federal unemployment tax. This tax is 6% of the first $7,000 of an employee’s wages. You may qualify for a credit of up to 5.4% if you are paying into state unemployment funds, which makes the effective FUTA rate 0.6% for many employers. Learn more about FUTA obligations.

*Find details about the Social Security and Medicare tax rates in IRS Publication 15.

Tax deposits & EFTPS

To submit your federal tax deposits, you’ll use the Electronic Federal Tax Payment System (EFTPS) — a free service from the U.S. Treasury. You’re automatically enrolled when you receive your EIN, and you’ll use EFTPS to deposit withheld federal income tax and both the employer and employee shares of FICA. Deposits follow either a monthly or semi-weekly schedule, depending on the total tax you reported during a lookback period. Learn more about these schedules in our payroll liabilities guide.

FUTA deposits must be made quarterly if you meet the FUTA deposit threshold.

For state payroll tax deposits, refer to your state’s requirements for how and when payments must be made. Many states provide an online business tax portal where employers can submit state income tax withholdings and other required payroll taxes.

Before you can make these deposits, you’ll generally need to have completed your state employer registration (Step X) and have the required state tax account information. Make sure your registration has been processed before your first state payroll tax payment is due.

Quarterly & annual filing obligations

Payroll doesn’t end with deposits — you also have recurring filing obligations:

• Form 941 — Employer’s Quarterly Federal Tax Return, filed every quarter to report wages, tips, withheld taxes, and FICA.
• Form 940 — Employer’s Annual Federal Unemployment (FUTA) Tax Return, filed annually to report federal unemployment tax.
• Forms W-2 and W-3 — Year-end wage and tax statements for employees, with W-3 serving as the transmittal summary to the Social Security Administration.
• Form 1099-NEC — Issued to independent contractors paid $2,000 or more during the year.
• State Forms—Check with the states you have employees in for the required forms to be filed.

Staying on top of these deadlines keeps you compliant and avoids late-filing penalties. For more on the quarterly filing process, see our guide to Form 941.

Setting up payroll as an LLC owner or sole proprietor

Paying yourself as a business owner can get tricky. Often business owners will ask if they can put themselves on payroll as an LLC owner or how they should run payroll as an LLC in general. It depends on how your LLC is taxed.

• If you’re the owner of a single-member LLC that is taxed as a sole proprietorship (also called a disregarded entity), you generally can’t pay yourself through W-2 payroll. Instead, you pay yourself through owner’s draws. An owner’s draw is simply transferring money from your business account to your personal account. The draw itself isn’t taxable, but you owe income tax and self-employment tax on your business’s net profit, regardless of how much money you withdraw.
• If you have a multi-member LLC and opt to be taxed as a partnership, you could opt to take distributions or get guaranteed payments.
• If your LLC elects to be taxed as an S Corporation or S Corporation and you actively work in the business, the IRS generally requires you to be treated as an employee and receive a W-2 salary. That salary must be “reasonable compensation,” meaning it should be similar to what you would pay someone else to perform the same work.

In either scenario, if you have W-2 employees, you’ll need to run payroll for them and stay in compliance with all payroll tax requirements.  This includes you if you are treated as a W-2 employee.

Simplify your small business’s payroll with Block Advisors

As you can see, the do-it-yourself method for calculating payroll taxes is involved and can be complex. It doesn’t have to be so stressful. Hand off the task to the experts at Block Advisors. See how our small business payroll services can help answer your payroll questions.

Our convenient and affordable small business products and services — taxes, bookkeeping, payroll, and business formation— can help you get back to what you love. Millions of small business clients count on us. Reach out today to discover how Block Advisors can help your small business dream come alive.

Schedule a free payroll consultation today.

This article is for informational purposes only. The content may not constitute the most up-to-date information and should not be construed as legal advice. 

Frequently asked questions about payroll set up

How do you set up payroll for beginners without making mistakes?

Beginners can set up payroll without mistakes by ensuring you have all the details in order: your federal EIN, state and local tax agencies registration, accurate worker classification and onboarding forms, and apply accurate pay schedules and rates.  

The most common beginner errors come from skipping a step — misclassifying a worker, using the wrong withholding allowances, or missing a tax deposit deadline. To avoid those pitfalls, double-check every form before your first run, use current tax tables, and deposit taxes on time through EFTPS.

How do I run payroll as a single-member LLC or S-Corp owner?

The payroll process depends on how your LLC is taxed.

If your single-member LLC is taxed as a sole proprietorship: You generally don’t put yourself on payroll. Instead, you pay yourself through owner’s draws, which are transfers of money from your business to your personal account. You’ll typically report the business’s profits on your personal tax return and pay any applicable income and self-employment taxes on those earnings.

If your LLC has elected S-Corporation tax treatment: If you provide services to the business, you’re generally required to pay yourself a W-2 wage through payroll. The IRS expects that wage to reflect reasonable compensation for the work you perform. Any remaining profits can generally be distributed separately after your salary has been paid.

Is it better to get paid through an LLC or as a 1099 contractor?

Business owners typically should not issue themselves a 1099 from their own business. If you own a single-member LLC taxed as a sole proprietorship, you generally pay yourself through owner’s draws, not a 1099. If your LLC is taxed as an S Corporation, you generally must pay yourself a W-2 salary if you actively work in the business.

Where can small businesses get help with payroll setup and tax compliance?

Small businesses can get payroll help from payroll service providers, CPAs, Enrolled Agents (EAs), bookkeeping firms, and small business tax advisors. Block Advisors offers professional small business payroll services with a 100% accuracy guarantee, so you can hand off payroll and tax filings and get back to running your business.

Do I need a separate Federal EIN to set up payroll for my business?

No. In most cases, you use your existing business EIN for payroll reporting, tax filings, and federal payroll tax deposits. If your business does not yet have an EIN and needs to run payroll or hire employees, you’ll generally need to obtain one before setting up payroll.