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This step-by-step guide explains how to calculate wages, withhold payroll taxes, pay employees, and keep payroll records.
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Learning how to do payroll is essential once your business starts hiring. Before paying employees, you’ll need to understand payroll setup, wage calculations, tax withholding, contractor payments, and payroll tax deadlines.
This guide walks through how to do payroll step by step, from getting an EIN to paying employees and filing payroll taxes.
Table of Contents
Payroll processing is the process of calculating and paying employee wages, withholding payroll taxes, managing deductions, paying contractors, and keeping payroll records.
Payroll affects your business’s budget, tax obligations, and employee compliance. Businesses must pay workers accurately, on time, and in accordance with federal, state, and local laws.
Running payroll involves setting up your employer accounts, collecting employee tax forms, calculating wages and deductions, paying workers, and filing payroll taxes.
The steps below walk through the payroll process from setup to payday.
Before running payroll, you’ll need an Employer Identification Number, or EIN. An EIN is a federal tax ID the IRS uses to identify your business for tax reporting and payroll purposes.
If you don’t already have one, you can apply for an EIN through the IRS online, by fax, by mail, or by phone if you’re an international applicant.
Before running payroll, make sure your business is properly registered with any required state or local tax agencies. Requirements vary by business structure, location, and whether you have employees.
You may also need to register for state payroll tax accounts, including income tax withholding and unemployment insurance.
Most businesses should use a dedicated business bank account for payroll. While requirements vary, a separate business account makes it easier to track payroll expenses, manage your budget, and keep business and personal finances separate.
Many payroll providers also require a business bank account to process employee payments and payroll tax withdrawals. If you don’t already have one, you may need an EIN to open the account.
Before running payroll, collect the required tax and employment forms from your new hire. Employees must complete Form I-9 to verify their identity and employment eligibility, and Form W-4 so you can determine federal income tax withholding.
If your business works with independent contractors, request a completed Form W-9 from each contractor. You’ll use the information on the W-9 to prepare Form 1099-NEC if required at the end of the tax year.
Before calculating payroll, determine which deductions need to be withheld from each employee’s pay.
Form W-4 helps you calculate federal income tax withholding. You may also need to account for benefit-related deductions, such as health insurance premiums, retirement plan contributions, and other voluntary deductions.
Some employees may also be subject to involuntary deductions, such as court-ordered wage garnishments.
Review these deductions before each payroll run to ensure employees are paid accurately and the correct amounts are withheld.
Choose how often you’ll pay employees, such as weekly, biweekly, semimonthly, or monthly. Before setting your schedule, review your state’s payday laws, since many states have minimum pay frequency requirements. The Department of Labor maintains a state payday requirements chart that can help you confirm the rules for your location.
You may also want to consider industry norms and employee expectations. For example, BLS data shows biweekly pay is the most common pay period among private employers, while weekly pay is especially common in construction.
Independent contractors typically don’t need to follow the same pay schedule as employees. Contractor payment timing is usually based on the contract or invoice terms.
Decide how you’ll pay employees before your first payroll run. Common payment methods include direct deposit, paper checks, and payroll cards.
Direct deposit is typically the easiest option for both employers and employees, but you’ll need to confirm your state’s rules and give employees any required payment options or notices.
Avoid paying employees in cash unless you have a reliable payroll recordkeeping process in place. Cash payments can make it harder to track wages, deductions, and payroll taxes accurately.
Gross pay is the total amount an employee earns before taxes, benefits, and other deductions are withheld. To calculate gross pay, add the employee’s regular wages plus any supplemental earnings, such as overtime, commissions, or bonuses.
For hourly employees, multiply hours worked by the hourly rate. For salaried employees, divide the annual salary by the number of pay periods in the year.
Once you calculate gross pay, you can move on to deductions and tax withholding.
Pre-tax deductions are taken from an employee’s gross pay before certain payroll taxes are calculated. Common examples include health insurance premiums, HSA contributions, commuter benefits, and eligible retirement plan contributions.
If an employee has pre-tax deductions, subtract those amounts before calculating applicable taxes. Be sure to list each deduction clearly on the employee’s pay stub and remit the withheld amounts according to your benefits provider or plan requirements.
After calculating gross pay and pre-tax deductions, calculate the payroll taxes that apply to each employee’s taxable wages.
Common payroll taxes include federal income tax, Social Security, Medicare, FUTA, and any required state or local payroll taxes. Use the employee’s Form W-4 and the current IRS withholding tables to calculate federal income tax withholding. State and local tax rules vary by location.
Employers are generally responsible for withholding employee-paid payroll taxes, contributing employer-paid payroll taxes, and remitting those amounts to the appropriate tax agencies. Because payroll tax rates, wage limits, and deposit rules can change, check the latest IRS guidance or use payroll software to apply the correct rates.
In addition to federal payroll taxes, your business may also be responsible for state and local payroll taxes, such as:
Rules vary by location, so check your state and local payroll tax requirements before running payroll. You can also use our state payroll tax guides to get started:
Post-tax deductions are withheld from an employee’s pay after payroll taxes are calculated. These deductions may be voluntary, such as Roth retirement contributions, disability insurance, or charitable donations, or involuntary, such as wage garnishments.
Wage garnishments may be required for child support, debt repayment, court judgments, or other legal obligations. If your business receives a garnishment order, you’ll need to withhold the required amount and send payments to the appropriate agency or recipient.
Net pay is the amount an employee takes home after taxes and deductions are withheld. To calculate net pay, subtract payroll taxes, pre-tax deductions, and post-tax deductions from the employee’s gross pay.
Once net pay is calculated, pay employees using your chosen payment method, such as direct deposit, paper check, or payroll card. Make sure payments are issued on time based on your payroll schedule and any applicable state payday laws.
After each payroll run, employers are responsible for depositing withheld payroll taxes and any employer-paid payroll taxes with the appropriate tax agencies.
Federal payroll tax deposits are generally made on a monthly or semiweekly schedule, depending on the business’s IRS deposit schedule. Your schedule is based on the amount of payroll taxes your business reported during the IRS lookback period.
You’ll also need to file required payroll tax forms, such as federal employment tax returns, and follow any state or local payroll tax filing deadlines. Because deadlines and deposit schedules can vary, check current IRS guidance and your state payroll tax agency before running payroll.
After withholding employee deductions, send the required payments to the appropriate providers or agencies. This may include health insurance premiums, retirement plan contributions, garnishments, or other benefit-related payments.
Track each payment deadline carefully to avoid penalties, missed contributions, or benefits issues for employees.
Keep accurate payroll records for each employee, including wages paid, hours worked, tax forms, pay stubs, deductions, payroll tax filings, and payment records.
Federal recordkeeping rules vary by record type. The IRS generally requires employers to keep employment tax records for at least four years, while the Department of Labor requires most payroll records to be kept for at least three years. State rules may require longer retention periods, so check your state requirements as well.
To do payroll manually, you’ll need to calculate wages, withhold taxes and deductions, pay employees, file payroll taxes, and maintain payroll records without relying on payroll software.
Manual payroll may work for very small businesses with only a few employees or contractors, but it requires careful recordkeeping and a strong understanding of payroll tax rules.
Payroll software helps automate parts of the payroll process, including wage calculations, tax withholding, employee payments, payroll tax filings, and recordkeeping.
You’ll still need to set up your business, enter employee information, review payroll before it runs, and make sure your payroll settings are accurate.
When choosing payroll software, look for a system that fits your budget, payroll needs, and business size.
Key factors to consider include:
The right payroll solution depends on your budget, team size, payroll complexity, and how much work you want to handle yourself.
Very small businesses with simple payroll needs may be able to run payroll manually, but payroll software can save time, reduce errors, and help with tax filings and recordkeeping. If you want a more hands-off option, you may want to consider outsourcing payroll through a PEO, accountant, or payroll service provider.
No matter which option you choose, it’s still important to understand basic payroll rules, deadlines, and recordkeeping requirements.
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