You just hired your first employee. Great news! Then it hits you: how do I actually pay this person the right way?
Take a breath. Payroll sounds scary, but it's really just a set of steps. Do them in order and you'll be fine. I've seen plenty of first-time employers freeze up over this, and almost all of them figured it out within a week.
This guide covers how to set up payroll from zero. Think of it as payroll for beginners, with no confusing jargon.
What is Payroll, Really?
Payroll is how you pay your employees. But it's more than handing over money.
Every payday, you need to:
- Figure out what each person earned (hours worked or salary)
- Take out taxes from their paycheck
- Send those taxes to the government on time
- Keep records of everything
That's it. If you can do basic math and follow a checklist, you can do this. And if you'd rather not do the math at all, software can handle it for you (more on that below).
Your First-Time Payroll Setup Checklist
Here's the payroll setup checklist in one quick look:
- Get an Employer Identification Number (EIN)
- Register with your state and local tax offices
- Sort out workers: employee or contractor?
- Collect the right forms from every new hire
- Choose how often you'll pay people
- Pick your payroll method (DIY, accountant, or software)
- Set up workers' compensation insurance
- Run your first payroll
- File and pay your payroll taxes
- Keep your records safe
Now let's walk through each step.
Step 1: Get Your EIN
An EIN (Employer Identification Number) is like a Social Security number for your business. The IRS uses it to track your taxes.
- It's free to get on the IRS website
- It takes about 10 minutes if you apply online
- You need it before you can pay employees
Watch out for sites that charge you for this. The IRS never does.
Step 2: Register With Your State
The IRS isn't the only one who wants taxes. Your state does too, and the rules change depending on where you live.
Most states ask you to sign up for:
- State income tax withholding (not every state has an income tax)
- State unemployment insurance (SUI)
- Local taxes, if your city or county has them
Search "[your state] new employer registration" to find the right office. This step trips up lots of new business owners, so don't skip it.
Since this step is where beginners get lost, many small business owners let software handle the registration and filing for them. Gusto is one option that does a lot of this heavy lifting automatically.
Step 3: Employee or Contractor? Get This Right
This one matters a lot. The IRS cares about how you classify people.
Employees usually:
- Work set hours that you decide
- Use your tools and equipment
- Work mainly for you
Independent contractors usually:
- Choose their own hours and methods
- Use their own tools
- Work for several clients
Why does it matter? Employees go on payroll. Contractors don't. If you call someone a contractor when they're really an employee, you could owe back taxes and penalties. When in doubt, ask a tax pro.
Step 4: Collect the Right Forms
Every new employee needs to fill out a few forms before their first paycheck.
Here are the big ones:
- Form W-4: tells you how much federal tax to hold back from their pay
- Form I-9: proves they're legally allowed to work in the U.S. (you'll check their ID too)
- State withholding form: some states have their own version of the W-4
- Direct deposit form: if they want their money sent straight to their bank
You must also report each new hire to your state, usually within 20 days. Many states have an online portal for this.
Good payroll software sends these forms to your new hire digitally, so nobody has to dig through paper. Try Gusto's digital onboarding here if you want to see how simple it can be.
Step 5: Pick Your Pay Schedule
How often will you pay people? Common options:
- Weekly: 52 paychecks a year. Great for workers who like steady cash, but more work for you.
- Biweekly: every two weeks, 26 paychecks a year. This is the most popular choice.
- Semi-monthly: twice a month, like the 1st and 15th. That's 24 paychecks a year.
- Monthly: 12 paychecks a year. It's the least work for you, but not every state allows it.
Check your state's rules. Some states require specific schedules or limit how long you can wait between paychecks. Once you choose, stick with it. Employees plan their lives around payday.
Step 6: Choose How You'll Run Payroll
There are three main ways to handle how to run payroll:
Option A: Do it yourself (by hand)
You calculate everything, file everything, and keep all the records. It's cheap, but it's easy to make mistakes. One wrong number and the IRS can send you a penalty notice.
Option B: Hire an accountant or payroll service
A pro does it for you. That's less stress, but it usually costs more, and you may wait on them for changes.
Option C: Use payroll software
Software does the math, takes out taxes, pays your team, and files forms for you. For most small business payroll needs, this is the sweet spot. You save time and you avoid costly slip-ups.
If you only have a few employees, software is almost always the easiest path. See how Gusto handles payroll for small businesses and decide if it fits.
Step 7: Don't Forget Workers' Comp
Workers' compensation insurance pays for medical bills and lost wages if an employee gets hurt on the job. Most states require it once you have even one employee (a few states have exceptions).
Skipping it can lead to big fines. It can also leave you paying a hurt employee's bills out of pocket. Call an insurance agent or check your state's workers' comp website to get covered.
Step 8: Run Your First Payroll
Time for the main event. Here's how a paycheck gets built.
Start with gross pay. This is the total amount earned before anything comes out.
- Hourly worker: hours worked × hourly rate
- Salaried worker: yearly salary ÷ number of pay periods
Then subtract the deductions. These usually include:
- Federal income tax (based on their W-4)
- Social Security tax: 6.2%
- Medicare tax: 1.45%
- State and local taxes, where they apply
- Benefits, like health insurance or a 401(k), if you offer them
What's left is net pay, or "take-home pay." That's what lands in your employee's bank account.
Here's the part many new employers miss: you pay taxes too. You match the Social Security and Medicare amounts (that's another 7.65% on top of wages), and you pay unemployment taxes. Build that into your budget before you set pay rates.
Step 9: File and Pay Your Payroll Taxes
Taking taxes out of a paycheck isn't enough. You have to send that money to the government on time. This is where first-timers get burned.
Here's what you'll deal with:
- Depositing taxes: you'll send your withheld taxes to the IRS monthly or semi-weekly, depending on how much you owe
- Form 941: a quarterly report showing wages and taxes
- Form 940: a yearly report for federal unemployment tax (FUTA)
- Form W-2: sent to each employee (and the government) by January 31 each year
- State filings: every state has its own forms and deadlines
Miss a deadline and penalties pile up fast. That's one of the biggest reasons people switch to software. Gusto files and pays payroll taxes for you automatically, so you're not chasing due dates.
Step 10: Keep Good Records
The IRS says to keep payroll records for at least four years.
Save things like:
- Employee info and signed forms
- Hours worked and pay amounts
- Tax payments and filings
- Pay stubs
Digital storage beats a messy filing cabinet. If you ever get audited, clean records will save you a ton of stress.
Common First-Time Payroll Mistakes (And How to Dodge Them)
- Mixing up contractors and employees: double-check the rules before you hire
- Paying taxes late: set reminders or automate it
- Forgetting state taxes: federal rules aren't the only ones
- Skipping overtime: most hourly workers must get 1.5× pay after 40 hours in a week
- Poor records: save everything, always
Our Pick: Why We Recommend Gusto
After walking through all ten steps, you can see that payroll has a lot of moving parts. You don't have to juggle them alone.
We recommend Gusto for first-time employers because it's built for small businesses and it keeps things simple. It can help you:
- Run payroll in a few clicks
- Calculate, file, and pay taxes automatically
- Onboard new hires with digital forms
- Pay people by direct deposit
- Offer benefits like health insurance and retirement plans
It's friendly enough for total beginners, which makes it a good fit if this is your first time doing payroll.
Check out Gusto and see if it's right for your business →
Final Thoughts
Setting up payroll for the first time feels big, but it's really ten small steps. Get your EIN, register with your state, collect your forms, pick a schedule, choose your method, and stay on top of taxes. That's the whole game.
Do it right once, and every payday after that gets easier.
Disclosure: This post contains affiliate links. If you click a link and sign up for Gusto, we may earn a commission at no extra cost to you. We only recommend tools we believe can help small business owners. This post is for general information only and isn't legal, tax, or financial advice. Check with a qualified professional about your own situation.
