Setting up payroll is one of the most crucial steps when growing a small business in the US. A well-structured payroll system not only ensures employees are paid accurately and on time—it also protects your business from IRS penalties, legal issues, and compliance risks.

Whether you’re a first-time employer, a freelancer hiring help, or a startup scaling operations, this 2025 guide breaks down the payroll process into clear, manageable steps with up-to-date legal, tax, and software insights.

Step 1: Get a Federal Employer Identification Number (EIN)

Before anything else, you need to obtain an Employer Identification Number (EIN) from the IRS. This unique number identifies your business for tax purposes and is required to report payroll taxes.

How to apply:
Apply for free at the official IRS website: IRS EIN Application

Step 2: Classify Your Workers Correctly

Proper classification is critical. The IRS treats employees and independent contractors differently, especially when it comes to tax withholdings and benefits.

Key 2025 IRS Guidelines:

• Employees: Must receive W-2 forms; employers are responsible for withholding income tax, Social Security, and Medicare.
  
• Contractors: Receive 1099-NEC forms; they handle their own taxes.
  

Risk: Misclassification can result in audits, fines, and back taxes.

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Step 3: Choose a Payroll Schedule

You must choose a consistent pay period to align with federal and state labor laws.

Common options:

• Weekly: Preferred by hourly employees
  
• Bi-weekly: Every two weeks, popular for small businesses
  
• Semi-monthly: Twice a month, easier for monthly reporting
  

State compliance: Check your state’s labor department for minimum pay frequency requirements.

Step 4: Select a Payroll System or Software

You can manage payroll manually, use software, or outsource to a provider.

Option	Pros	Cons
Manual Payroll	Low-cost, control	Time-consuming, error-prone
Payroll Software	Automation, tax filing, integrations	Monthly cost
Outsourcing	Hands-free, compliance support	Expensive for early-stage businesses

Top-rated Payroll Software (2025):

• QuickBooks Payroll – Ideal for small businesses already using QuickBooks
  
• Gusto – Great for beginners; includes HR tools
  
• Patriot Software – Affordable and U.S.-based customer support
  

Step 5: Collect Employee Documentation

To legally run payroll, you must collect the following:

• Form W-4 – Federal tax withholding
  
• Form I-9 – Employment eligibility
  
• State-specific forms – Based on your business location
  

Tip: Store all documents securely—digitally if possible—to comply with data privacy laws.

Step 6: Calculate & Withhold the Right Amounts

Each paycheck must have proper withholdings for:

• Federal income tax
  
• Social Security & Medicare (FICA)
  
• Federal Unemployment Tax (FUTA)
  
• State/local income taxes (if applicable)
  

Tool: Use the IRS 2025 Tax Withholding Estimator to get accurate deductions.

Step 7: Pay Employees and File Payroll Taxes

Once calculations are complete:

• Pay employees: Via direct deposit or printed checks
  
• File payroll taxes: Usually monthly or quarterly (Form 941, 940, state returns)
  
• Send year-end forms: W-2 for employees, 1099 for contractors
  

Deadlines matter: Late filings can result in hefty IRS penalties.

Step 8: Keep Payroll Records

You’re legally required to retain payroll documents for at least 3–4 years, depending on the document type.

Best practices:

• Use cloud-based payroll systems for recordkeeping
  
• Back up regularly
  
• Limit access to authorized personnel
  

Step 9: Stay Compliant with Federal & State Laws (2025 Updates)

Laws affecting payroll change frequently. As of 2025, small businesses should watch for:

• Minimum wage hikes in over 30 states
  
• Mandatory paid leave policies in states like CA, NY, WA
  
• ACA reporting thresholds: Stay updated if you cross 50 employees
  
• Remote work tax implications in multi-state setups
  

Stay informed via your state labor department and the U.S. Department of Labor (DOL).

Bonus Tips: Scaling Payroll as Your Business Grows

• Integrate payroll with accounting software like QuickBooks or Xero
  
• Automate benefits and HR onboarding with platforms like Gusto
  
• Know when to outsource: As your team grows or your tax situation becomes complex, consider hiring a payroll service provider or CPA
  

FAQs 

Q1: How long does it take to set up payroll for a small business?
A: With the right tools, it can take 1–2 business days to fully set up payroll after gathering EIN and employee documents.

Q2: Can I do payroll myself as a small business owner?
A: Yes, especially with software. But manual payroll is risky unless you understand tax rules and deadlines.

Q3: What’s the cheapest way to run payroll in the US?
A: Using basic payroll software like Patriot or doing it manually—though the latter risks errors and fines.

Q4: Do I need payroll for only one employee?
A: Yes. Even one W-2 employee requires full payroll compliance, including tax filings and documentation.

Conclusion

Setting up payroll may seem daunting, but with the right steps, tools, and guidance, it becomes a manageable—and essential—part of running a successful small business. Always prioritize compliance, accuracy, and employee satisfaction. If you’re unsure, consult a payroll expert or CPA to protect your business long-term.

Pro Tip: Download our free 2025 Payroll Setup Checklist to keep your setup organized and compliant from day one.