Paying employees when you’re starting a business means more than cutting checks: you register for federal and state tax accounts, collect specific paperwork from every hire, calculate each paycheck with the right withholdings, and deposit those withheld taxes with the IRS on a fixed schedule. Get any one of those pieces wrong at the start and the penalties compound quickly, sometimes personally against you. What follows is the federal baseline. State rules vary, so confirm your own state’s labor and revenue agency requirements before your first payday.
First, Confirm They Are Actually Employees
You only run people through payroll if they’re employees. Independent contractors get a Form 1099-NEC at year’s end and handle their own taxes. Misclassifying an employee as a contractor is one of the most expensive mistakes a new owner can make, because the IRS can hold you liable for every payroll tax you should have been withholding, plus penalties and interest.
The IRS weighs behavioral control (who decides when, where, and how the work gets done), financial control (who provides tools, sets pay, and bears the risk of profit or loss), and the type of relationship (ongoing and central to the business, or a defined project).1Internal Revenue Service. Independent Contractor (Self-Employed) or Employee? If most of the evidence shows you controlling the work, the person is an employee.
Set Up Tax Accounts and Workers’ Comp Before the First Payday
Get an EIN
Your Employer Identification Number is the nine-digit identifier the IRS uses to track your business’s tax obligations.2eCFR. 26 CFR 301.6109-1 – Identifying Numbers Apply online at irs.gov and you’ll get one immediately. It goes on every payroll tax form you’ll ever file.
Register for State Unemployment and Withholding
With your EIN in hand, register with your state’s labor or revenue department for two accounts: state unemployment insurance (SUTA) and state income tax withholding. New employers typically get a starting SUTA rate somewhere between 2% and 4% of taxable wages, which adjusts over time based on your claims history. Most states let you handle both registrations through one online portal.
Buy Workers’ Compensation Coverage
Nearly every state requires workers’ compensation as soon as you hire your first employee. The policy pays medical costs and partial wages for on-the-job injuries and shields your business from most workplace-injury lawsuits. Operating without coverage can bring fines, criminal charges, and stop-work orders. Premiums depend on your industry, payroll, and claims history, so get quotes early and build the cost into your labor budget.
Collect the Right Paperwork From Every New Hire
Form W-4
Each employee fills out a Form W-4 on or before day one. It tells you how much federal income tax to withhold based on filing status, other jobs, and dependents.3Office of the Law Revision Counsel. 26 USC 3402 – Income Tax Collected at Source The employee’s full Social Security number goes on the form; a truncated version isn’t allowed.4eCFR. 26 CFR 31.3402(f)(2)-1 – Furnishing of Withholding Allowance Certificates Pull the current version off irs.gov each year, because the IRS revises it.
Form I-9
Federal law requires you to verify that every new hire is authorized to work in the U.S. Complete Form I-9 within three business days of the start date. You physically examine the employee’s original, unexpired identity and work-authorization documents (a passport, or a combination like a driver’s license plus a Social Security card) and confirm they reasonably appear genuine.5U.S. Immigration and Customs Enforcement. Form I-9 Inspection Under Immigration and Nationality Act 274A Paperwork errors on I-9s carry per-form fines that can run into the thousands, so check every field.
Direct Deposit Authorization
If you’re using direct deposit, get a signed authorization with the employee’s bank name, account number, and routing number. Many employers also ask for a voided check to confirm the details.
New Hire Reporting
Federal law requires you to report every new employee to your state’s new-hire directory within 20 days of the start date, and some states set shorter deadlines. Send the employer’s name and EIN and the employee’s name, Social Security number, address, and first day of work.6Administration for Children and Families. New Hire Reporting – Answers to Employer Questions A copy of the completed W-4 often satisfies the requirement. The data feeds the national database used to enforce child-support orders.
Set Pay Rates and a Schedule
Minimum Wage and Overtime
The federal minimum wage has been $7.25 per hour since 2009, but many states and cities set higher floors, and you pay whichever is higher.7Office of the Law Revision Counsel. 29 USC Chapter 8 – Fair Labor Standards Under the Fair Labor Standards Act, non-exempt employees who work more than 40 hours in a workweek get overtime at one and a half times their regular rate. Employees can’t waive that by agreement.
Exempt vs. Non-Exempt
To be exempt from overtime, an employee must clear a salary threshold and meet duties tests. The Department of Labor is currently enforcing the 2019 salary level of $684 per week, or $35,568 per year, after a federal court vacated a 2024 rule that would have raised it.8U.S. Department of Labor. Earnings Thresholds for the Executive, Administrative, and Professional Exemptions Salary alone isn’t enough. The employee’s primary duties must fit within the executive, administrative, or professional categories. Misclassifying a non-exempt worker as exempt exposes you to back-pay claims for unpaid overtime plus liquidated damages that can double what you owe.
Pay Frequency
Pick a consistent schedule: weekly, biweekly, or semimonthly (often the 1st and 15th). State law sets the minimum frequency and how quickly you must pay after a pay period ends. Check your state labor agency’s payday rules and stick to the schedule once you’ve set it.
Run Each Paycheck From Gross to Net
Every pay cycle follows the same three steps: calculate gross pay, subtract withholdings and deductions, deliver net pay.
For hourly employees, gross pay is total hours times the hourly rate, with overtime hours at the premium rate. Salaried employees receive their annual salary divided by the number of pay periods. From gross pay, subtract federal income tax based on the W-4, Social Security at 6.2% of wages, and Medicare at 1.45%.9Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Then subtract any state and local income taxes and employee-elected deductions like health insurance premiums or retirement contributions.
Here’s the part that surprises new employers. You owe your own matching share of Social Security (6.2%) and Medicare (1.45%) on top of what you withhold from the employee. That’s an additional 7.65% of each employee’s wages coming out of your pocket, not theirs. The Social Security portion applies only to the first $184,500 of wages per employee in 2026; there’s no cap on Medicare.10Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security Whatever’s left after all withholdings is net pay, delivered on payday by direct deposit or paper check.
Deposit Withheld Taxes on Schedule
Withholding is only half the job. You have to deposit those taxes with the IRS on a fixed schedule, and falling behind is where the real damage happens. The IRS treats withheld income tax and both shares of Social Security and Medicare as trust fund taxes: you’re holding government money in trust. Delaying those funds, even by accident, triggers some of the harshest penalties in the tax code.
Your deposit frequency depends on the size of your payroll. If you reported $50,000 or less in employment taxes during the four-quarter lookback period, you’re a monthly depositor and everything accumulated in a calendar month is due by the 15th of the following month. Above $50,000, you’re on a semiweekly schedule tied to each payday.11Internal Revenue Service. Notice 931 – Deposit Requirements for Employment Taxes Most new businesses start as monthly depositors. All deposits go through the Electronic Federal Tax Payment System (EFTPS), and you must schedule payment by 8 p.m. Eastern the day before the due date.12Electronic Federal Tax Payment System (EFTPS). Welcome to EFTPS Online
Late-deposit penalties escalate fast:
- 1 to 5 days late: 2% of the unpaid deposit
- 6 to 15 days late: 5% of the unpaid deposit
- More than 15 days late: 10% of the unpaid deposit
- More than 10 days after an IRS notice: 15% of the unpaid deposit
The percentages replace each other rather than stacking, but 10% or 15% of a payroll deposit adds up quickly.13Internal Revenue Service. Failure to Deposit Penalty Worse, if the IRS finds that you willfully failed to pay over withheld taxes, it can assess a trust fund recovery penalty equal to 100% of the unpaid amount, and it can assess that penalty personally against any responsible individual, not just the business entity.14Office of the Law Revision Counsel. 26 USC 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax Owners of failed businesses often discover the hard way that a corporate structure doesn’t shield them from payroll tax debts.
File Your Quarterly and Annual Returns
Form 941 (Quarterly)
Every quarter, you file Form 941 to report total wages paid, federal income tax withheld, and both shares of Social Security and Medicare.15Internal Revenue Service. About Form 941, Employer’s Quarterly Federal Tax Return The deadlines are April 30, July 31, October 31, and January 31 for the prior year’s fourth quarter.16Internal Revenue Service. Employment Tax Due Dates The IRS matches your 941s against your deposit records, so any mismatch triggers a notice.
Form 940 (Annual FUTA)
Federal unemployment tax comes entirely from your funds, not the employee’s. The statutory rate is 6.0% on the first $7,000 of wages paid to each employee.17Office of the Law Revision Counsel. 26 USC 3301 – Rate of Tax If your state’s unemployment program is in good standing, you get a credit of up to 5.4%, bringing the effective rate to 0.6%, or $42 per employee per year.18Employment and Training Administration. FUTA Credit Reductions Report FUTA on Form 940 by January 31, and make quarterly deposits any time your accumulated FUTA liability exceeds $500.
Form W-2 (Annual)
By February 1, 2027, you must give each employee a Form W-2 showing 2026 wages and taxes withheld, and file copies with the Social Security Administration by the same date, whether on paper or electronically.19Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3 Per-form penalties for late or incorrect W-2s grow the longer you wait.
Keep the Records
Federal law requires you to keep payroll records, including wage rates, hours worked, and withholding details, for at least three years.20U.S. Equal Employment Opportunity Commission. Recordkeeping Requirements Records explaining pay differences between employees (job evaluations, merit systems) must be kept at least two years. I-9 forms follow their own rule: three years after the hire date or one year after the employee leaves, whichever is later. Simplest approach: hold all payroll and employment records for at least four years, which also covers the IRS’s general statute of limitations for auditing employment tax returns.
When You Receive a Wage Garnishment Order
Sooner or later you’ll get a court order or government notice directing you to withhold part of an employee’s pay for child support, student loans, or a creditor judgment. For ordinary consumer debts, federal law caps the garnishment at 25% of the employee’s disposable earnings per workweek, and if disposable earnings are at or below 30 times the federal minimum wage ($217.50 per week at $7.25), you can’t garnish anything.21eCFR. 5 CFR 582.402 – Maximum Garnishment Limitations Child support and tax levies follow different, usually higher, limits. Respond promptly to any order you receive. Ignoring one can make you personally liable for the amount you failed to withhold.