How to Set Up Payroll

Step 1: Get an EIN Before You Hire

Every employer needs an Employer Identification Number from the IRS to report and deposit payroll taxes. Apply directly with the IRS, for free, before you bring on your first employee, since you'll need it on every tax form and deposit from that point forward.

Step 2: Collect Form I-9 and Form W-4 From Each New Hire

Form I-9 verifies an employee's identity and authorization to work in the U.S., and it's required for every employee, citizen or not. The employee completes Section 1 no later than their first day of work, and the employer completes Section 2, reviewing original identity and work authorization documents, generally within three business days of the start date. Separately, collect a signed Form W-4 from each new employee to determine federal income tax withholding; if an employee doesn't submit one, the IRS instructs employers to withhold as if the employee were single, with no other adjustments.

Step 3: Report the New Hire to Your State

Federal law requires employers to report every new and rehired employee to the state new hire directory where the employee works, within 20 days of the hire date, though some states set a shorter deadline. States forward this information to the National Directory of New Hires, which is used primarily to help enforce child support orders, so this step is a legal requirement even if it feels administrative.

Step 4: Register for State Unemployment Insurance

Before your first payroll, register with your state's unemployment insurance agency, separate from the IRS and separate from new hire reporting. This registration sets your state unemployment tax rate and account, which you'll use to report wages and pay state unemployment taxes going forward.

Step 5: Set Your Federal Deposit Schedule

The IRS assigns employers either a monthly or semi-weekly deposit schedule for federal income tax withholding and Social Security and Medicare taxes, based on your reported tax liability in a prior lookback period; check Publication 15 to determine which schedule applies to you. All federal tax deposits must be made electronically, typically through the Electronic Federal Tax Payment System (EFTPS). Separately, federal unemployment tax (FUTA), reported annually on Form 940, only requires a deposit when your cumulative quarterly FUTA liability exceeds $500.

Step 6: File Form 941 Quarterly

Most employers report federal income tax withholding and Social Security and Medicare taxes quarterly on Form 941. A small number of very small employers instead qualify for Form 944, an annual version, if the IRS has notified them they qualify. At year-end, you'll also issue Form W-2 to each employee and file it with Form W-3 to the Social Security Administration by January 31.

Step 7: Apply the FLSA's Wage and Overtime Rules

The federal Fair Labor Standards Act (FLSA) sets a minimum wage of $7.25 an hour and requires overtime pay, at 1.5 times the regular rate, for nonexempt employees working more than 40 hours in a workweek. Many states set their own, higher minimum wage, and employees are entitled to whichever rate is higher. Certain executive, administrative, and professional employees can be classified as exempt from overtime rules under specific criteria, but classify employees carefully, since misclassifying a nonexempt employee as exempt is a common and costly payroll mistake.

Step 8: Decide How You'll Actually Run Payroll

You can run payroll manually, use payroll software, or hire a payroll service to handle calculations, filings, and deposits on your behalf. Whichever you choose, the underlying legal requirements, EIN, I-9/W-4 collection, new hire reporting, deposit schedules, and FLSA compliance, apply regardless of who's pressing the buttons.

Keep Records

Keep Form I-9 for the later of three years after the date of hire or one year after employment ends, and keep employment tax records for at least four years, per the IRS. Good recordkeeping from the start avoids a scramble if the Department of Labor or IRS ever asks to see your records.

Workers' Compensation Insurance Is a Separate Requirement

Most states require employers to carry workers' compensation insurance once they have employees, separate from unemployment insurance and separate from federal payroll taxes. Check your specific state's requirement, since thresholds for when it kicks in vary.

Independent Contractors Are Not on Payroll

If you're paying independent contractors rather than employees, different rules apply: no I-9, no withholding, and no new hire reporting in most states, but you generally issue Form 1099-NEC instead for payments of $600 or more in a year. Classifying a worker correctly as an employee or contractor matters, since misclassification carries its own penalties.

Payday Requirements Vary by State

Beyond federal minimum wage and overtime rules, many states set their own requirements for how often employees must be paid and what must appear on a pay stub. Check your specific state labor agency's rules in addition to federal requirements.

Payroll Software Doesn't Remove Your Responsibility

Even when a payroll service handles calculations and filings, the employer remains legally responsible for accurate withholding, timely deposits, and compliance with wage and hour law. Review what you're submitting rather than treating a payroll service as fully hands-off.

This Is Not Legal or Tax Advice

Payroll rules involve multiple federal and state agencies, and penalties for errors can be significant. Talk to a payroll professional or accountant when setting up payroll for the first time, especially if you have employees in more than one state.