How to Run Payroll: US Small Business Guide [First Timer]

Quick Answer: What Does "Running Payroll" Actually Mean?

Running payroll means calculating employee compensation, withholding the correct taxes, paying employees on time, and depositing taxes with federal and state agencies. It is one of the most regulated functions in a business -- getting it wrong can result in IRS penalties, state penalties, and employee lawsuits.

Here is the high-level process:

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Step 1: Get Your Employer Identification Number (EIN)

Before you can hire employees or run payroll, you need an Employer Identification Number (EIN) from the IRS. This is the business equivalent of a Social Security Number.

How to Apply

• Online: Apply at IRS.gov (available Monday-Friday, 7 a.m. - 10 p.m. Eastern). You receive your EIN immediately
• Fax: Submit Form SS-4 by fax. Processing takes about 4 business days
• Mail: Submit Form SS-4 by mail. Processing takes 4-6 weeks

You need an EIN even if you are a sole proprietor once you hire employees. The EIN is used on all tax forms (941, W-2, W-3), state filings, and bank accounts.

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Step 2: Register With Your State

In addition to the federal EIN, you must register with your state for:

State Income Tax Withholding

Most states require employers to withhold state income tax from employee paychecks. As of 2026, 9 states have no state income tax:

Alaska, Florida, Nevada, New Hampshire (dividends/interest only), South Dakota, Tennessee, Texas, Washington, and Wyoming.

All other states require registration with the state tax authority (e.g., California Employment Development Department, New York Department of Taxation and Finance).

State Unemployment Tax (SUTA)

Every state has an unemployment insurance program. You must register for a state unemployment tax account even if your state has no income tax. New employers are typically assigned a standard rate until they establish a claims history:

Other State Registrations

Depending on your state, you may also need to register for:

• Workers' compensation insurance (see our separate guide)
• State disability insurance (CA, HI, NJ, NY, RI)
• Paid family leave (CA, CO, CT, DE, MA, MD, MN, NJ, NY, OR, RI, WA)
• Local payroll taxes (NYC, Philadelphia, San Francisco, and others)

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Step 3: Collect Employee Paperwork

Before running your first payroll, collect these forms from each employee:

Federal Form W-4 (Employee's Withholding Certificate)

The W-4 tells you how much federal income tax to withhold. The current form (revised 2020) uses a five-step process:

1. Step 1: Filing status (single, married filing jointly, head of household)
2. Step 2: Multiple jobs or spouse works (checkbox or worksheet)
3. Step 3: Claim dependents ($2,000 per qualifying child, $500 per other dependent)
4. Step 4: Other adjustments (other income, deductions, extra withholding)
5. Step 5: Signature

The IRS provides Publication 15-T (Federal Income Tax Withholding Methods) with the tax tables and percentage method you use to calculate withholding based on the W-4 information.

State Withholding Form

Most states with income tax have their own withholding form (e.g., California DE 4, New York IT-2104). Some states accept the federal W-4.

Form I-9 (Employment Eligibility Verification)

Required for every employee within 3 business days of their start date. This verifies identity and work authorization.

Direct Deposit Authorization

While not legally required, 94% of US employees receive pay via direct deposit (American Payroll Association). Collect bank routing and account numbers plus a signed authorization form.

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Step 4: Choose Your Pay Frequency

Your pay frequency determines how often you process payroll and when employees get paid. The four standard options:

Important: Some states regulate minimum pay frequency. For example:

• California: Semi-monthly or more frequent (Labor Code section 204)
• New York: Manual workers must be paid weekly (Labor Law section 191)
• Connecticut: Weekly (with exceptions for some classifications)

Check your state's Department of Labor website for specific requirements.

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Step 5: Calculate Gross-to-Net Pay

This is the core of payroll -- converting an employee's gross earnings into their net (take-home) pay. Here is every deduction in order:

The Gross-to-Net Waterfall

Starting with an example: Salaried employee earning $60,000/year, paid biweekly, single filer, no dependents, contributing 5% to 401(k), in California.

Federal Income Tax Withholding

Use IRS Publication 15-T to calculate federal income tax withholding. The two methods:

1. Wage bracket method: Look up the amount in a table based on filing status, pay period, and adjusted wage
2. Percentage method: Apply the tax rate schedule to the adjusted wage (used by most payroll software)

For the 2026 tax year, the federal income tax brackets (single filer) are:

FICA Taxes (Social Security + Medicare)

FICA is split equally between employer and employee:

The employer pays an additional 7.65% on top of what is withheld from the employee. This is a real cost of employment -- on a $60,000 salary, the employer's FICA is $4,590/year.

State Income Tax

Each state with an income tax has its own withholding tables and methods. Some states use flat rates (e.g., Pennsylvania at 3.07%, Illinois at 4.95%) while others have progressive brackets similar to the federal system (California, New York, New Jersey).

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Step 6: Deposit Payroll Taxes

After running each payroll, you must deposit the withheld taxes plus the employer's share with the IRS and your state.

Federal Deposit Schedules

The IRS assigns you a deposit schedule based on your total tax liability in the lookback period (the 12-month period ending June 30 of the prior year):

New employers with no lookback period history are monthly depositors by default.

How to Deposit

• Electronic Federal Tax Payment System (EFTPS): Required for all businesses. Enrol at eftps.gov. Deposits must be made electronically -- paper coupons are no longer accepted
• Same-day wire: Available through your bank for next-business-day emergencies

Penalties for Late Deposits

These penalties compound quickly. A $10,000 tax deposit that is 16 days late triggers a $1,000 penalty. The IRS takes payroll tax compliance extremely seriously -- the Trust Fund Recovery Penalty (IRC section 6672) can hold business owners, officers, and even bookkeepers personally liable for unpaid payroll taxes.

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Step 7: File Quarterly Returns (Form 941)

Every quarter, you must file Form 941, Employer's Quarterly Federal Tax Return, reporting:

• Total wages paid
• Federal income tax withheld
• Social Security and Medicare taxes (employee + employer shares)
• Tax deposits made during the quarter
• Any balance due or overpayment

If you deposited all taxes on time and in full, you get an automatic 10-day extension (e.g., Q1 due May 10 instead of April 30).

FUTA (Form 940)

In addition to Form 941, you must file Form 940 annually to report Federal Unemployment Tax. FUTA is an employer-only tax at 6.0% on the first $7,000 of each employee's wages. With the maximum state unemployment tax credit of 5.4%, the effective FUTA rate is typically 0.6% ($42 per employee per year).

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Step 8: Year-End Filing (W-2s and W-3)

By January 31 following the tax year, you must:

1. Issue Form W-2 to every employee who received wages during the year
2. File Copy A of all W-2s plus a transmittal Form W-3 with the Social Security Administration (SSA)

What Goes on the W-2

Filing Methods

• Business Services Online (BSO): Free SSA electronic filing at ssa.gov/bso
• Payroll software: Most payroll systems file W-2s/W-3 electronically on your behalf
• Paper: Only for employers filing fewer than 10 W-2s (reduced from 250 starting with 2024 returns per IRS regulations)

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Common Payroll Mistakes (and How to Avoid Them)

1. Misclassifying Employees as Independent Contractors

The IRS uses a multi-factor test to determine worker status. Misclassification means you owe all unpaid FICA (both shares), federal income tax, penalties, and interest. The DOL's 2024 independent contractor rule uses a six-factor economic reality test.

2. Missing Tax Deposit Deadlines

Set up automatic reminders. Better yet, use payroll software that calculates deposit amounts and initiates payments automatically via EFTPS.

3. Using the Wrong Tax Tables

The IRS updates withholding tables annually. Using last year's tables means you are withholding the wrong amount. Verify your rates at the start of each calendar year.

4. Ignoring State and Local Taxes

Federal compliance is not enough. You need to register, withhold, and deposit in every state (and sometimes city) where your employees work. Remote employees working from a different state may create a nexus requiring registration.

5. Not Keeping Records

The IRS requires payroll records for at least 4 years after the due date of the return (longer than the standard 3-year statute of limitations for income tax). State requirements vary but can be up to 7 years.

6. Paying Employees Late

Many states impose penalties for late payment. California charges $100 per employee per day as a waiting time penalty (Labor Code section 203) for failing to pay wages on time.

7. Forgetting About Supplemental Wages

Bonuses, commissions, and severance are subject to different withholding rules. The IRS flat rate for supplemental wages under $1 million is 22% (or 37% for amounts over $1 million). Do not just add the bonus to regular pay and apply normal withholding.

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Payroll Software Options for Small Businesses

For most small businesses with 5-50 employees, dedicated payroll software pays for itself in time savings and penalty avoidance within the first quarter.

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How Grove HR Simplifies Payroll

Grove HR integrates employee data, time tracking, and payroll preparation so you never have to re-enter data:

• Employee profiles store W-4 information, pay rates, deductions, and direct deposit details
• Payroll export generates ready-to-file data for your payroll provider
• Leave tracking automatically calculates PTO accrual and usage
• New hire checklists ensure W-4, I-9, and state forms are collected before the first payroll

Take the guesswork out of payroll. Get started with Grove HR.