Setting up payroll for a new business follows a fixed order: get a federal Employer Identification Number, register for federal and state unemployment and withholding tax accounts, collect the right forms from every hire, classify each worker correctly, pick a pay schedule, then calculate wages, withhold taxes, deposit them on time, and file quarterly and annual returns. This payroll setup checklist walks through each step in the sequence you’ll actually hit it, along with the penalties for getting it wrong. Late tax deposits alone trigger penalties that start at 2% of the shortfall and climb to 15%, and misclassifying an employee as a contractor can leave you owing every payroll tax you should have withheld, plus the employer share, plus interest.
Get an Employer Identification Number
Everything else waits on this. You need an EIN before you can open a business bank account, register for state tax accounts, or file a single employment tax return. Submit Form SS-4 to the IRS online, by fax, or by mail.1Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN) The application asks for your entity’s legal name, business structure, and the responsible party’s taxpayer identification number.2Internal Revenue Service. Instructions for Form SS-4, Application for Employer Identification Number
Apply online and the nine-digit number arrives in minutes. Apply by mail and you’re looking at four to six weeks, during which you can’t file employment tax returns. Use the online option unless there’s a reason you can’t.
Register for Federal and State Tax Accounts
Federal Unemployment (FUTA)
FUTA is an employer-only tax at a statutory rate of 6.0% on the first $7,000 of wages paid to each employee per year. Pay your state unemployment taxes on time and you receive a credit of up to 5.4%, which drops the effective FUTA rate to 0.6% and caps the annual cost at about $42 per worker.3Internal Revenue Service. Topic No. 759, Form 940, Employers Annual Federal Unemployment Tax Return If your state has outstanding federal loans for its unemployment fund, that credit shrinks and your FUTA bill goes up.
State Unemployment
Register with your state’s unemployment insurance agency. Each state sets its own taxable wage base, tax rate schedule, and registration process. New employers usually receive a default rate based on industry classification, then that rate adjusts over time based on how often former employees file unemployment claims. Expect to provide your EIN, business structure, and a North American Industry Classification System code.
State Income Tax Withholding
If your state collects income tax on wages, set up a withholding account with the state revenue department while you’re registering for unemployment. A few states have no wage income tax at all, so check before assuming you need one. Some localities also levy their own payroll or earnings taxes. Discovering a local obligation after you’ve already been paying employees is worse than one extra phone call now.
Collect Forms From Every New Hire
Form W-4
Every employee fills out a Form W-4 before their first paycheck. The form tells you filing status, whether the employee holds multiple jobs, dependents claimed, and any additional withholding the employee wants taken from each check.4Internal Revenue Service. Topic No. 753, Form W-4, Employees Withholding Certificate You use that information with IRS withholding tables to calculate each paycheck’s federal income tax. If an employee never submits a W-4, withhold as though they checked “Single” with no other entries.5Internal Revenue Service. Publication 15 (2026), (Circular E), Employers Tax Guide
Form I-9
Federal law requires you to verify that every new hire is authorized to work in the United States. The employee completes Section 1 of Form I-9 on or before their first day, and you complete Section 2 within three business days of that date by physically examining original identity and work-authorization documents.6U.S. Citizenship and Immigration Services. Completing Section 2, Employer Review and Attestation Acceptable documents fall into three lists. A List A document like a U.S. passport proves both identity and work authorization by itself; a List B document must be paired with a List C document. A Social Security card alone is not enough — it proves work authorization but not identity.
Penalties for missing or improperly completed I-9s are steep and grow with repeat violations. Treat this as one of the highest-risk items on the whole checklist.
Direct Deposit and Voluntary Deductions
Ask employees paying by direct deposit for a voided check or a written authorization confirming the routing and account numbers. Protect that data: paired with a name and Social Security number, it’s enough for identity fraud.
You also need written authorization before withholding anything beyond legally mandated taxes. That includes health insurance premiums, 401(k) contributions, life insurance, and similar benefit deductions. Deducting without signed consent creates legal exposure. Keep those authorizations on file alongside the W-4 and I-9.
Report Every New Hire to the State
Federal law requires you to report every new and rehired employee to your state’s new-hire directory within 20 days of the start date, and some states set a shorter window.7Administration for Children and Families. New Hire Reporting The report includes seven data elements: the employee’s name, address, and Social Security number; the date of hire; and your business name, address, and EIN. States use the data primarily to enforce child support orders, so expect withholding orders to arrive quickly if a new hire has an existing obligation.
Classify Each Worker Correctly
Employee or Independent Contractor
An employee works under your direction and control. You set the schedule, provide the tools, and dictate how the work gets done. An independent contractor controls their own methods and typically serves multiple clients.8Internal Revenue Service. Independent Contractor Defined You withhold income tax, Social Security, and Medicare from an employee’s pay. You do none of that for a contractor. Instead, you report contractor payments on Form 1099-NEC if you pay $600 or more in a year.
The IRS evaluates the relationship on three categories: behavioral control, financial control, and the nature of the working relationship.9Internal Revenue Service. Form 1099-NEC and Independent Contractors If the IRS decides you’ve misclassified an employee as a contractor, you’ll owe all the payroll taxes you should have withheld, plus the employer share, plus penalties and interest.
Exempt or Non-Exempt
Every employee falls into one of two categories under the Fair Labor Standards Act. Non-exempt employees are entitled to overtime pay at one and one-half times their regular rate for every hour worked beyond 40 in a workweek.10Office of the Law Revision Counsel. 29 USC 207 – Maximum Hours Exempt employees, typically in executive, administrative, or professional roles, are not entitled to overtime but must meet both a duties test and a salary test to qualify.
The salary threshold for exemption is $684 per week, or $35,568 per year. The Department of Labor attempted to raise that figure in 2024, but a federal court vacated the new rule, and the 2019 threshold remains in effect.11U.S. Department of Labor. Earnings Thresholds for the Executive, Administrative, and Professional Exemptions Paying someone a salary doesn’t automatically make them exempt. The duties must also fit within an FLSA exemption category. Misclassifying a non-exempt worker as exempt exposes you to back pay for all unpaid overtime plus an equal amount in liquidated damages.
Pick a Pay Schedule
Choose a payroll frequency and stick with it. The common options are weekly, biweekly, and semimonthly (twice a month on fixed dates). Most states regulate how frequently you must pay employees and how many days after the pay period the check must arrive.12U.S. Department of Labor. State Payday Requirements Check your state’s labor department before committing. Some states prohibit monthly pay for non-exempt workers, and others require written notice of payday changes. A consistent schedule also simplifies your tax deposit obligations, because your deposit due dates track your paydays.
Know the Payroll Taxes You’ll Withhold and Owe
Social Security and Medicare
You and your employees split Social Security and Medicare. Social Security is 6.2% for the employer and 6.2% for the employee, applied to wages up to $184,500 in 2026.13Social Security Administration. Contribution and Benefit Base Once an employee hits that ceiling, you stop withholding Social Security for the rest of the year. Medicare has no wage cap: 1.45% each for employer and employee on all covered wages.14Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
An additional 0.9% Medicare tax applies to any individual employee’s wages that exceed $200,000 in a calendar year, regardless of filing status. It’s the employee’s responsibility, not a matching employer share, but you must withhold it.5Internal Revenue Service. Publication 15 (2026), (Circular E), Employers Tax Guide
Federal and State Unemployment
FUTA is entirely the employer’s cost at an effective 0.6% for employers who pay state unemployment on time. State unemployment rates and wage bases vary by state and industry, and the state will supply the applicable schedule when you register.
State and Local Income Tax
Most states impose their own income tax withholding on wages, with rates that vary widely. Your state’s revenue or taxation department provides withholding tables after you register for a state employer account.
Run the First Payroll
Start with gross pay. For hourly workers, multiply hours worked by the hourly rate and add overtime premiums for any hours over 40 in the workweek. For salaried employees, divide the annual salary by the number of pay periods.
Then subtract, in order:
- Federal income tax, from the employee’s W-4 and IRS withholding tables.
- Social Security tax at 6.2% of gross wages, up to the $184,500 wage base.13Social Security Administration. Contribution and Benefit Base
- Medicare tax at 1.45% of all gross wages, plus 0.9% on wages exceeding $200,000.14Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
- State and local income taxes, per the applicable withholding tables.
- Voluntary deductions the employee has authorized in writing.
What’s left is net pay, distributed by direct deposit or check. Every payment should include an itemized pay stub showing gross wages, each deduction, and the net amount. Most states require this, and where it isn’t mandated, it’s still your best protection against wage disputes.
If you receive a court order or withholding notice for an employee, you’re legally required to deduct the specified amount. For ordinary consumer debts, federal law caps the garnishment at the lesser of 25% of disposable earnings or the amount by which weekly disposable earnings exceed 30 times the federal minimum wage.15U.S. Department of Labor. Fact Sheet 30, Wage Garnishment Protections of the Consumer Credit Protection Act Child support orders allow higher percentages and take priority over nearly every other type of garnishment.
Deposit Withheld Taxes on the Right Schedule
Withholding is not paying. You must deposit those taxes with the IRS on a strict schedule using the Electronic Federal Tax Payment System.16Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System Your frequency depends on tax liability during a lookback period.
If you reported $50,000 or less in employment taxes during the lookback period, you’re a monthly depositor and taxes on wages paid in a month are due by the 15th of the following month. If you reported more than $50,000, you’re a semiweekly depositor. Taxes on Wednesday-through-Friday paydays are due the following Wednesday, and taxes on Saturday-through-Tuesday paydays are due the following Friday.17Internal Revenue Service. Topic No. 757, Forms 941 and 944, Deposit Requirements New employers with no lookback history usually start as monthly depositors. If your accumulated tax liability hits $100,000 on any single day, you must deposit by the next business day regardless of your normal schedule.
Late deposit penalties escalate under the tax code: 2% if the deposit is one to five days late, 5% if six to fifteen days late, 10% if more than fifteen days late, and 15% if the tax remains undeposited after the IRS sends a demand notice.18Office of the Law Revision Counsel. 26 USC 6656 – Failure to Make Deposit of Taxes They apply to the shortfall, and they compound quickly.
File Quarterly and Annual Returns
Most employers file Form 941 every quarter to report wages, tips, federal income tax withheld, and both shares of Social Security and Medicare.19Internal Revenue Service. About Form 941, Employers Quarterly Federal Tax Return Deadlines are April 30, July 31, October 31, and January 31 for the prior fourth quarter. If a due date falls on a weekend or holiday, the deadline moves to the next business day.20Internal Revenue Service. Employment Tax Due Dates
Very small employers whose total annual employment tax liability is $1,000 or less may qualify to file Form 944 once a year instead of Form 941 quarterly.21Internal Revenue Service. About Form 944, Employers Annual Federal Tax Return The IRS must notify you that you’re eligible; you can’t switch on your own.
At year end, furnish each employee a Form W-2 showing total wages and withholdings, and file copies with the Social Security Administration by January 31. Employers filing 10 or more information returns must file electronically.22Internal Revenue Service. Topic No. 752, Filing Forms W-2 and W-3 File Form 940 annually to report FUTA liability.
Keep Payroll Records for at Least Four Years
The IRS requires you to keep all employment tax records, including W-4s, payroll registers, and deposit receipts, for at least four years after the tax becomes due or is paid, whichever is later.23Internal Revenue Service. Employment Tax Recordkeeping The FLSA imposes shorter retention on some records, but the four-year rule covers everything in practice and also holds up in most state audits. Digital storage is fine as long as the records are organized and retrievable.
Post the Required Workplace Notices
Federal law requires employers to display specific workplace posters depending on which statutes apply. Most employers need posters covering the Fair Labor Standards Act, the Family and Medical Leave Act, the Employee Polygraph Protection Act, and equal employment opportunity requirements.24U.S. Department of Labor. Workplace Posters The Department of Labor’s Poster Advisor tool identifies which notices apply to your business based on size and industry. Your state will have its own poster requirements as well.
Watch for Thresholds as You Grow
Two obligations kick in with headcount. Workers’ compensation insurance is required in nearly every state once you have employees, though which employers are covered, how many employees trigger it, and whether you can self-insure vary by state.25U.S. Department of Labor. Workers Compensation Contact your state’s workers’ compensation board before your first hire. Operating without required coverage can bring criminal penalties in some states.
If your business averages 50 or more full-time employees (including full-time equivalents) over the prior year, you become an Applicable Large Employer under the Affordable Care Act and must offer qualifying health coverage or face a penalty.26Internal Revenue Service. Determining if an Employer Is an Applicable Large Employer Full-time means 30 or more hours per week. Track headcount even when you’re well below the threshold, because crossing it without noticing means penalties accumulate without warning.