How to Do Payroll for a Small Business: A Step-by-Step Guide (2026)

Hiring your first employee is a milestone — and then reality hits: now you have to run payroll. Between tax withholding, deposit deadlines, and government forms, it feels intimidating. The good news? Payroll is really just a repeatable process. Once you understand the steps, it’s manageable (and easy to automate).

Here’s how small business payroll works, start to finish.

Step 1: Get your EIN and register

You’ll need a federal Employer Identification Number (EIN) from the IRS (free) before you can run payroll. Depending on your state, you’ll also register for a state withholding account and state unemployment insurance (SUTA). These registrations are what let you legally withhold and remit payroll taxes.

Step 2: Classify your workers correctly

This is the step that trips owners up the most. Every worker is either:

• An employee (W-2) — you control how and when they work; you withhold taxes and pay employer payroll taxes.
• An independent contractor (1099) — they control how they do the work; you don’t withhold taxes, and you issue a 1099 at year-end.

Misclassifying an employee as a contractor is a costly mistake with back-tax and penalty risk. When in doubt, get it checked. (1099 rules shifted recently — see our 2026 tax changes guide.)

Step 3: Collect the right paperwork

Before anyone’s first paycheck, collect:

• Form W-4 — so you know how much federal tax to withhold.
• Form I-9 — to verify work eligibility.
• State withholding forms and direct-deposit details.

Step 4: Choose how you’ll run payroll

You have three realistic options:

• By hand — cheapest, but error-prone and time-consuming. Not recommended once you have real employees.
• Payroll software — tools like Gusto, QuickBooks Payroll, or others automate the calculations, tax deposits, and filings.
• A bookkeeper or payroll service — you hand it off entirely and stay compliant without lifting a finger.

Step 5: Set a pay schedule

Pick a consistent frequency — weekly, biweekly, semimonthly, or monthly — that fits your cash flow and complies with your state’s pay-frequency rules. Consistency matters for both employees and compliance.

Step 6: Run each payroll (gross to net)

For every pay period you’ll:

1. Calculate gross pay (hours × rate, or salary).
2. Subtract withholdings — federal and state income tax, plus the employee’s share of Social Security and Medicare (FICA).
3. Subtract any benefit deductions (health insurance, retirement).
4. Pay the employee their net pay.

Step 7: Pay and file payroll taxes

This is the part people underestimate. Beyond what you withhold from employees, you (the employer) also owe payroll taxes — the matching half of Social Security and Medicare, plus federal and state unemployment. You must:

• Deposit withheld and employer taxes on the IRS’s schedule (often monthly or semiweekly).
• File Form 941 quarterly (and Form 940 annually for unemployment).
• Meet your state’s deposit and filing requirements too.

Missing these deadlines is where penalties pile up. Our 2026 tax deadline calendar lays them out.

Step 8: Handle year-end forms

After year-end you’ll issue W-2s to employees and 1099-NECs to qualifying contractors, and file copies with the government — typically by the end of January. Clean payroll records all year make this a non-event.

Common payroll mistakes to avoid

• Misclassifying employees as contractors.
• Missing tax deposit deadlines (instant penalties).
• Forgetting the employer share of payroll taxes when budgeting.
• Not setting aside withheld taxes — that money isn’t yours to spend.
• Sloppy records that make quarter-end and year-end a nightmare.

Should you run payroll yourself?

If you have one or two salaried employees and good software, DIY is doable. But payroll penalties are unforgiving, and the employer tax filings add up fast — so many owners hand it off once they’re past a couple of people, or the moment they elect S-corp status and have to put themselves on payroll. (More on that in our S-corp vs LLC guide.)

Frequently asked questions

How much does an employee really cost beyond their wage?

Budget for roughly 10–15% on top of gross wages for employer payroll taxes and unemployment, before any benefits.

Do I need payroll if I’m the only owner?

A sole proprietor or default LLC owner doesn’t run payroll for themselves. But if you elect S-corp status, you must pay yourself a reasonable W-2 salary — which means running payroll.

What happens if I miss a payroll tax deposit?

The IRS charges penalties that escalate the longer it’s late, plus interest. Payroll taxes are one area where being on time really matters.

This article is general information for US small business owners, not tax or legal advice. Payroll rules vary by state and change over time — please confirm specifics with a qualified professional (or ask us).