How to Do Payroll: A Step-by-Step Guide for 2024 | TechRepublic

Doing payroll isn’t simply about writing checks; it’s a complex process involving calculating employee wages, withholding the correct taxes, making timely payments, and filing required tax forms with both federal and state agencies. In fiscal year 2024, the Internal Revenue Service (IRS) assessed billions of dollars in civil penalties, with errors in employment tax accounting being a frequent issue for businesses. According to IRS documentation, navigating these requirements can be challenging, but essential for compliance.

Successfully managing payroll requires several key steps: registering for tax accounts, correctly classifying workers, collecting necessary forms, establishing a pay schedule, and choosing between manual calculation or payroll software. This guide provides a step-by-step approach to setting up payroll for the first time, outlining the information needed and how to maintain compliance with federal, state, and local regulations.

What’s the easiest way to do payroll?

The most straightforward approach to payroll management is utilizing payroll software that automates wage calculations, tax withholdings, and form filings. Even as manual calculation using spreadsheets and IRS tax tables is possible, it’s time-consuming and significantly increases the risk of errors, missed deadlines, and potential compliance penalties. TechRepublic highlights common payroll mistakes that can be avoided with automation.

Modern payroll platforms, such as Gusto, streamline key processes like tax withholdings, direct deposit, benefits deductions, and payroll tax filings. This reduces administrative burden and helps small businesses stay compliant with various regulations. Even for very small businesses looking to minimize costs, payroll software can save time and money in the long run.

How to set up payroll

1. Get an Employer Identification Number

An Employer Identification Number (EIN) is a federal tax ID issued by the IRS to identify your business for payroll tax filing and reporting. You cannot legally file employment tax forms, such as Form 941 (Employer’s Quarterly Federal Tax Return), without an EIN. You can apply for an EIN online through the IRS website using the online EIN Assistant. In most cases, the EIN is issued immediately upon application validation, allowing you to register for payroll tax accounts and commence setup.

You may require your EIN before opening a business bank account or setting up payroll software, as most financial institutions require it for account verification and ACH processing.

2. Register for state payroll tax accounts

In addition to the federal EIN, most businesses must register for state payroll tax accounts before running payroll. This typically includes a state income tax withholding account (if your state has income tax) and a state unemployment insurance (SUTA) account. Without these accounts, you cannot legally withhold state income taxes or pay required unemployment taxes on behalf of your employees.

Registration requirements vary by state. Visit your state’s Department of Revenue and Department of Labor websites to determine which accounts you must open and how to apply. Some states also require recent hire reporting and additional local payroll tax registrations. For example, California requires employers to report newly hired or rehired employees to the California New Employee Registry within 20 days of hire.

If you hire employees in a different state from where your business is registered, you generally must register for payroll tax accounts in that employee’s function state, even without a physical office there. Consulting a licensed accountant or payroll professional can ensure you meet all state and local payroll compliance requirements.

3. Classify your employees

Before running payroll, determine whether each person you pay is an employee or an independent contractor. This classification directly affects how you calculate wages, withhold taxes, and file payroll forms. Employees require federal and state income tax withholding, Social Security and Medicare taxes (FICA), unemployment taxes (FUTA and SUTA), and year-end Form W-2 reporting. Independent contractors are typically responsible for paying their own income and self-employment taxes and receive Form 1099-NEC instead of a W-2.

The IRS uses a common-law test evaluating behavioral control, financial control, and the nature of the working relationship to determine proper classification. Some states, like California, employ stricter standards, such as the ABC test. Misclassifying employees as contractors can result in back taxes, penalties, and interest. If you’re unsure, you can review IRS guidance or file Form SS-8 to request an official determination.

4. Gather employee documents

Collect all required payroll and tax documentation before issuing the first paycheck. Missing or incomplete forms can delay processing and create compliance risks. For employees, gather their full legal name and address, Social Security number, date of birth, employment start date, pay rate, Form W-4 (for federal income tax withholding), and Form I-9 (to verify employment eligibility).

5. Obtain workers’ compensation insurance

Most states require employers to carry workers’ compensation insurance as soon as they hire their first employee. This coverage pays for medical expenses and lost wages if an employee is injured or becomes ill due to work-related activities. Requirements vary by state; California requires nearly all employers to carry coverage, while Texas does not require most private employers to do so. Check your state’s Department of Labor or workers’ compensation board website to confirm requirements.

6. Develop a decision about benefits

Determine whether you will offer employee benefits and how those benefits will be deducted from paychecks. Many benefits require pre-tax payroll deductions, which directly affect how you calculate taxable wages. Common benefits include health insurance, dental and vision insurance, retirement contributions, and Health Savings Accounts (HSAs). Pre-tax deductions reduce an employee’s taxable income for federal income tax and sometimes for Social Security and Medicare.

7. Select a pay schedule

Decide how often you will pay employees. Common pay schedules include weekly, biweekly, semimonthly, and monthly. Your pay schedule affects cash flow, administrative workload, and overtime calculations. Some states have minimum pay frequency laws, so review your state’s requirements.

8. Create a payroll policy and employee handbook

Document your payroll practices in an employee handbook or standalone payroll policy. This ensures employees understand when they will be paid, how wages are calculated, and what deductions will appear on their paycheck. Your policy should outline pay frequency, overtime eligibility, holiday pay, bonus structures, benefits deductions, and direct deposit procedures.

9. Open and fund a dedicated payroll bank account

Before issuing paychecks, open a business bank account specifically for payroll. This helps prevent accidental spending of payroll tax withholdings, simplifies reconciliation, and improves internal controls.

10. Decide who will manage payroll

Designate someone responsible for processing, reviewing, and approving payroll each pay period. Even if you outsource payroll, someone within your company should review payroll reports and confirm wage calculations.

11. Choose software and review the software setup guide

Select a payroll system that aligns with your compliance needs, workforce structure, and budget. Consider pricing, tax filing services, multi-state support, contractor payments, benefits administration, and integrations with other software. Carefully follow the provider’s setup guide and review all tax settings before running your first payroll.

12. Upload everything into the payroll software

Enter all required business and employee information into the payroll software, including EIN, state tax account numbers, employee pay rates, and tax withholding settings. If transitioning from another provider, ask about data migration tools.

How to run payroll each pay period

Once your system is set up, payroll becomes a repeatable process. Each pay period involves collecting and approving time worked, reviewing variable pay and adjustments, confirming deductions and benefits, reviewing gross-to-net calculations, approving and funding payroll, and confirming tax liabilities and reports. Even with automated software, always review reports before final approval to prevent errors.

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