How To Run and Process Payroll for Your Small Business

Processing payroll is an essential part of operating any business with employees. But it doesn’t come without challenges. The more employees you have, the more complicated the payroll process can become. If things go wrong, the consequences can be costly.

To prevent this from happening at your company, explore this guide on how to do payroll for your small business, from setup to filing taxes, and your options for getting it done.

How To Set Up Payroll for Your Small Business

Once you have hired employees, you must pay them for the work they perform and withhold applicable taxes each pay period. These and other related responsibilities comprise the payroll process. You can manage payroll in-house, or you can partner with an accountant or payroll provider who can handle these tasks for you.

Setting up payroll starts with collecting all the necessary information, including business details, employees, pay and benefits, and your payroll bank account. Follow the steps below to set up employee payroll for your small business.

1. Gather Required Business Information

Before getting started with payroll basics, take care of the following business items:

• Obtain a Federal Employer Identification Number (FEIN): The IRS assigns this 9-digit number and uses it to identify a business entity. You need this number to pay federal taxes, hire employees, open certain bank accounts, and apply for business licenses and permits. You can apply online on the IRS website.
• Register With Your State and Local Government: Depending on your business structure and location, you may need to register for a state ID number to pay your business’s state taxes. Tax obligations and steps to get an ID number differ at the state and local levels, so check with the appropriate agencies.
• Look Into Workers’ Compensation Coverage: Nearly every state requires businesses with employees to carry workers' compensation insurance, although some states exempt very small businesses. The number of employees that triggers the requirement varies by state. Even if your state doesn't require coverage for a business your size, it can help protect your employees if they're injured on the job and help protect your business from the cost of work-related injury claims.
• Report New Hires: You'll need to report each new hire to the appropriate agency in your state. See below for the specific details and deadlines.

2. Ensure You Have All Employee Information Needed To Process Payroll

Along with business details, you'll need to gather information for each employee before you run payroll. This includes:

• Worker Classification: Before you add someone to payroll, confirm whether they're an employee or an independent contractor. Independent contractors aren't paid through payroll, and misclassifying employees as contractors can lead to back taxes and penalties. For employees, you'll also need to determine whether they're exempt or nonexempt from overtime and minimum wage protections under federal, state, and local law.
• New-Hire Documents (Form W-4, Form I-9, etc.): Although nearly all new hires complete certain forms, they may vary from company to company due to industry-specific regulations, company benefits, and policies. If you have more than one location, different state and local laws may require employees at certain worksites to complete specific documents.
• Payment Method: Depending on applicable law and your available options, you will need to choose a method to deliver employee pay, whether that’s via direct deposit, paper checks, or a paycard. Learn more about employee pay options that may be available to your business.

3. Choose Desired Pay Periods

Companies can typically choose which pay period(s) they want to set up for paying employees, such as weekly, biweekly, semimonthly, or other cycle frequencies. There can also be different pay schedules for different employees. You may choose one type for salaried employees and another for hourly employees.

Remember that the state(s) in which you operate may have specific pay requirements, such as a deadline by which an employee must receive payment for earned wages after a pay period ends. Depending on the laws that apply to your business, you may choose different pay periods for groups of employees, but the frequencies should stay consistent.

4. Factor in Any Employee Benefits

The payroll process includes deducting benefits contributions from each employee’s paycheck each pay cycle. These can include statutory benefits and any supplemental benefits you might offer, such as health insurance, disability coverage, and retirement plans. How much to withhold depends on the benefits plan type, the coverage level an employee chooses, and whether the deductions are pretax or post-tax.

5. Create a Payroll Bank Account

It’s a good idea to set up a separate bank account from any other business account for paying employees and making tax payments. It’s not required as part of the payroll setup process, but it’s a valuable bookkeeping practice that can help you keep accurate payroll records.

How To Process and Run Payroll

Employees depend on and expect timely, accurate paychecks. Disruptions or errors can keep your process from running smoothly and could lead to turnover. To run payroll, you’ll need to understand the following foundational basics.

1. Accurately Track Hours Worked

Processing payroll effectively relies on accurately tracking the time worked by employees. You can track employee hours in various ways, including manual time tracking or time and attendance software that integrates with your payroll system. Like manual payroll, manual time-tracking methods can lead to inaccuracies. This is why, when evaluating your payroll process, you may also want to assess whether a time and attendance solution is a good fit for your business.

2. Understand Gross Pay vs. Net Pay

Before you can calculate your employees’ wages, you need to understand the difference between gross pay and net pay so you can reduce errors and compliance risk.

• Gross Pay: An individual’s total earnings, including base pay, incentives, and overtime, before taxes and other deductions are withheld for a given pay period.
• Net Pay: The amount an individual takes home after taxes and deductions have been withheld from gross pay.

3. Calculate Employee Wages

To calculate employee wages, you’ll need to know each employee’s pay rate, deductions, overtime, wage garnishments, and any relevant compliance requirements. Follow these steps:

• Determine Your Business’s Payroll Schedule: A payroll schedule sets employee pay dates based on state pay-frequency laws, tax payment due dates, tax return filing deadlines, etc. You’ll also want to factor in special payrolls for seasonal or annual bonuses.
• Calculate Wages: Calculate wages in compliance with applicable federal, state, and local laws.
• Account for Overtime Pay: Under federal law, nonexempt employees who work more than 40 hours in a workweek are eligible for overtime pay. State and local overtime requirements can vary, so check the rules where your employees work. Beginning with the 2026 tax year, the One Big Beautiful Bill Act also requires you to report qualified overtime compensation separately on employees' Forms W-2.
• Comply with Wage Garnishments: A wage garnishment is any legal or equitable procedure where some portion of a person’s earnings is withheld by an employer for the payment of a debt. This may include alimony, child support, student loan default, or other circumstances. If an enforcement agency notifies you, immediately begin the wage garnishment process to ensure that payments go to the appropriate agency or creditor. This helps protect the business from any legal repercussions for not responding to the order.
• Factor in Benefits Contributions: Account for benefits contributions such as workplace-sponsored retirement plans, health, life, or disability coverage, and flexible spending accounts. Calculate and deduct each employee’s individual contributions from each paycheck.

4. Deduct Payroll Taxes

Employers generally must withhold federal and state income tax from all employees’ taxable wages based on what employees enter on their withholding form(s). Here’s a brief explanation of some mandatory payroll taxes:

• Federal Income Tax: This is withheld from an employee’s wages, reported to the federal government, and applied to the employee’s calculated tax liability at the end of the year.
• Social Security and Medicare Taxes: Employers and employees generally contribute equally to fund these programs.
• Federal Unemployment Tax: Employers pay this tax, and it's never deducted from employees' wages. It funds unemployment compensation for workers who lose their jobs.

Some employers must also pay state unemployment (SUI) tax. SUI taxes are not typically deducted from an employee’s wages, although requirements are different in a few states. Be sure you understand the tax requirements for every state where you have workers.

Advanced Tax Handling Techniques

Handling payroll taxes can become complex with multi-state workers, remote workers, and tax credits. Here’s a quick breakdown:

• Multi-State Taxes: Employers must navigate state income tax and unemployment insurance for employees working across state lines. Reciprocal agreements may simplify withholding, while apportionment is needed for employees working in multiple states.
• Expatriate/Remote Worker Taxes: U.S. workers abroad may qualify for the Foreign Earned Income Exclusion (FEIE), which can reduce their U.S. tax liability. However, employers must still handle Social Security and Medicare unless covered by a totalization agreement.
• Tax Credits: Qualified small businesses may be able to apply part of the research and development (R&D) tax credit against their payroll taxes. Talk with your tax advisor about which credits your business may qualify for.

Expert Tip: Use payroll software like Paychex to automate compliance and track complex tax scenarios.

5. Pay Your Employees

After you’ve deducted the proper taxes and withheld any deductions from employees’ gross pay, their take-home or net pay is what remains. You’ll pay employees according to their pre-selected method, whether that’s direct deposit, a paper check, or a paycard.

Depending on your jurisdiction, you may need to include specific information on the paystubs you provide when you pay wages. Employees should review their pay stubs and report any payroll mistakes.

6. Deposit Taxes and File Returns

Once you have deducted taxes from your employees’ paychecks, file them with the appropriate tax agencies. Depending on your business, you'll use some or all of the following forms to report wages and withholdings to the IRS:

• Form W-2: Reports each employee's annual wages and tax withholdings. You must give copies to employees and file them with the Social Security Administration by Jan. 31.
• Form W-3: Summarizes all of your Forms W-2 when you file them with the Social Security Administration.
• Form 940: An employer’s annual FUTA tax return.
• Form 941: An employer’s quarterly tax return reporting withholding and the employer’s share of FICA.
• Form 943: An employer’s annual return for agricultural employees.
• Form 944: Used for small employers eligible to pay employment taxes annually rather than depositing them according to a schedule.
• Form 945: A federal income tax return used to report non-payroll payments, including pension distributions.

Federal tax deposits must be made electronically, most commonly through the Electronic Federal Tax Payment System (EFTPS), a free service from the U.S. Department of the Treasury. Your deposit schedule is generally monthly or semiweekly, depending on your past tax liability, and new employers start on a monthly schedule. Employers with a small quarterly liability may be able to pay with their return instead of depositing. Paying by check when an electronic deposit is required can result in a penalty. For state employment taxes, check with your state to learn how to report and deposit them.

7. Properly Document and Store Payroll Records

Accurate payroll records help you prepare tax returns, respond to audits, and apply for financing. At the federal level, the IRS requires you to keep employment tax records for at least four years, and the Fair Labor Standards Act (FLSA) requires you to keep payroll records for at least three years. Some states require longer, so check the rules where your employees work.

8. Report Any New Hires

All employers must follow the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of 1996, which requires employers to report all new hires to the appropriate state agency within a predetermined period as part of the onboarding process. Most of this information is on the W-4 once an employee is hired, but always check all paperwork to ensure it is correct.

Federal law requires employers to report newly hired and rehired employees within 20 days of the date of hire. Employers that report electronically must submit reports at least twice monthly. Individual states may impose different or more stringent reporting requirements and deadlines.

Noncompliance with new hire reporting regulations could result in monetary or non-monetary civil penalties by the state.

Should a Small Business Owner Put Themselves on Payroll?

How you pay yourself as a business owner depends on your business structure. If you own an S corporation or C corporation and work in the business, you generally must pay yourself a reasonable salary through payroll, with taxes withheld like any other employee. Sole proprietors, partners, and most LLC owners aren't considered employees, so they typically take an owner's draw instead and cover their taxes through quarterly estimated payments.

How Long Does Payroll Take to Process?

The payroll processing timeline can vary depending on your payroll schedule, the bank’s policies, and the employee pay method. For example, once you’ve completed the initial setup for direct deposit and processed a successful payroll, employees can see funds posted up to two days before the check date and no later than the check date, depending on the banking institution. Most banks can also accommodate real-time or same-day ACH. With paper checks, employees may have to wait for the check to arrive in the mail and then take it to the bank to deposit, which can take more time.

Can You Do Payroll Yourself?

Yes, you can run payroll yourself, but it takes time and a working knowledge of payroll terms, tax rules, and federal, state, and local laws. Mistakes can be costly. Unpaid taxes or wages can lead to penalties, and paycheck errors can hurt employee morale and your business's reputation.

Whichever method you choose, catching errors before payday helps. Some payroll providers offer a pre-check service, such as Paychex Pre-check℠, that lets employees review their paychecks in advance so you can fix problems before they're paid.

Is Doing Payroll Yourself Worth It?

Because processing payroll is complex, handling it yourself can cost more than you may save at first. It takes valuable time out of your schedule, and the process gets more complex as you add more employees to the payroll.

In Paychex’s 2026 Priorities for Business Leaders Survey, nearly one-third of respondents said their top compliance concern involved wages and hours. The survey also found that 24% of businesses spend 6-10 hours per week on HR, and payroll processing eats up 17% of that time.

Payroll software can reduce that time investment significantly by automating key parts of the process. You can also outsource the payroll process entirely, freeing you to focus on running and growing your business.

Why Integrate Payroll With Other Business Systems?

Integrating payroll with your HR management, accounting software, and employee scheduling tools can provide seamless data flow and real-time updates, minimizing repetitive tasks and manual data entry. An integrated system can help you:

• Streamline Operations: By connecting payroll to systems like HR and scheduling, you can improve data consistency across departments and reduce redundant work and administrative burden.
• Reduce Errors: Automate data transfer between systems to eliminate manual entry errors, ensuring accurate payroll calculations and regulatory compliance.
• Save Time: Automate processes like calculating pay rates by location or role to free up time and ensure precise, timely payroll processing.

Payroll Considerations by Industry

Each industry has unique payroll challenges that require tailored solutions. Here are some key aspects to consider for eight different industries, highlighting factors that can help make payroll more efficient and effective for each. Note, however, that many of the following factors may apply across multiple industries.

Restaurants and Hospitality

Tipped staff, shifting schedules, and seasonal hiring make restaurant and hospitality payroll more complex than a standard hourly setup. Here's what to watch for:

1. Tip Reporting: Employers must accurately report tips and ensure compliance with IRS regulations, including calculating taxes on tips.
2. Variable Schedules: Manage fluctuating work hours, part-time shifts, and overtime due to irregular schedules.
3. Seasonal Workers: Hiring spikes during peak seasons require an adaptable payroll system to quickly onboard and offboard staff.
4. Compliance With Tip Credits: Federal law lets employers count part of a tipped employee's tips toward the minimum wage, which is known as a tip credit. Some states limit or prohibit tip credits, and the rules vary where they're allowed. If you take a tip credit, track it each pay period to confirm that employees' cash wages and tips together meet the minimum wage. If they fall short, you're responsible for making up the difference.

Professional Services

Accounting, legal, consulting, and marketing firms often balance salaried and hourly staff while tracking time and expenses for client work. Keep these factors in mind:

1. Salaried vs. Hourly Staff: Many firms have a mix of salaried and hourly employees, which require different payroll processes.
2. Client-Based Expense Reimbursements: Expenses incurred on behalf of clients may need to be integrated into payroll for quick reimbursement.
3. Overtime Exemptions: Professional services often involve salaried employees exempt from overtime. Classifying employees correctly helps you stay compliant.

Healthcare

Patient care doesn't stop at 5 p.m., so healthcare payroll has to keep pace with rotating shifts, varied credentials, and a mix of employment types. Key considerations include:

1. Multiple Shifts and Overtime: Healthcare involves rotating shifts and frequent overtime. Payroll systems must handle shift differentials accurately.
2. Employee Mix: Payroll must account for per diem staff, as well as part-time and full-time employees, each with different tax and benefit structures.
3. Credential-Based Pay: Pay can vary depending on the qualifications or certifications of healthcare workers, such as nurses or technicians.
4. Compliance With Wage and Hour Laws: Stringent employment laws govern healthcare, requiring accurate time tracking and proper overtime calculation.

Skilled Trades

Construction, plumbing, electrical, and HVAC businesses often pay crews across multiple job sites, so payroll needs to connect labor hours to the right project. Consider these factors:

1. Job Costing: Tracking labor costs by project or job is a core part of payroll in skilled trades like construction or plumbing. For instance, construction companies may need to track hours across multiple jobs, and large clients may need to distribute earnings across several departments.
2. Union Dues and Benefits: For unionized workers, payroll must manage deductions for dues and ensure employees are paid in accordance with any collective bargaining agreements.
3. Apprenticeship Programs: Payroll may need to track apprentice wages, which often change based on hours worked or milestones reached.

Retail

Retail payroll rises and falls with customer demand, from holiday hiring surges to frequent turnover and sales-based pay. Plan for these challenges:

1. Shift Differentials: Retail businesses often have employees working varying shifts, requiring accurate payroll calculations for shift differentials and overtime.
2. High Turnover: Managing payroll for frequent new hires and terminations is a common retail challenge.
3. Commission and Bonuses: Sales-based roles often involve commission structures, which you must integrate into the payroll system.
4. Seasonal Workforce: Retail businesses often need to scale payroll systems to handle the influx of temporary employees during peak seasons.

Senior Living

Senior living communities share many of healthcare's staffing demands, including round-the-clock coverage and certification-based roles. Factor in the following:

1. Round-the-Clock Shifts: Like healthcare, senior living requires payroll systems flexible enough to account for multiple shifts, overtime, and varying schedules.
2. Certification-Based Pay: Pay rates may vary depending on staff certifications, such as CNAs or registered nurses.
3. Benefits Management: Many senior living facilities offer healthcare, retirement, and other benefits, so payroll needs to track deductions and contributions accurately.

Manufacturing

Manufacturers often pay different rates for different roles, shifts, or machines, which adds complexity to overtime calculations. Key considerations include:

1. Multiple Pay Rates: Employees working in different roles or on different machines may be paid different rates, which you will need to manage accurately.
2. Overtime and Shift Differentials: Manufacturing payroll often includes frequent overtime and shift differentials that need precise tracking. When an employee works at two or more pay rates in the same workweek, federal law generally requires you to calculate overtime using a weighted average of those rates.
3. Unionized Workforce: If unionized, manufacturing businesses must manage complex payroll structures involving dues and negotiated pay increases.
4. Job Costing and Labor Allocation: Payroll must often account for time spent on specific projects or product lines.

Nonprofits

Many nonprofits fund positions through grants and donations, so payroll often needs to show how labor costs map to each funding source. Keep these factors in mind:

1. Grant and Donor Funding: Payroll may need to allocate labor costs to specific grants or to donor-restricted funds that pay for certain roles.
2. Volunteer and Employee Mix: Many nonprofits rely on both paid staff and volunteers. Volunteers aren't paid through payroll, but you'll need to track any stipends or expense reimbursements. Be careful when paid employees volunteer, too. If they do the same type of work they're paid for, you may owe them wages for that time.
3. Tax-Exempt Benefits: 501(c)(3) organizations don't pay federal unemployment tax, but they still withhold income taxes and pay Social Security and Medicare taxes for employees. State unemployment rules vary, and many states let nonprofits choose between paying SUI tax and reimbursing the state for benefits paid to former employees.

Benefits of Outsourcing Payroll

There’s too much at stake for business owners to commit time-consuming (and potentially expensive) payroll processing errors. A professional payroll service provider can lift that burden and give you peace of mind about accuracy and compliance. Consider the benefits of using payroll services:

• Compliance: Outsourcing payroll can help lighten the burden of payroll tax compliance, including mitigating your business’s risk of penalties for late or inaccurate payments.
• Time Savings: Payroll outsourcing can make the entire process more efficient. No matter how many employees a business has, processing payroll demands time and attention to detail. This costs valuable time that could be spent on more pressing business priorities. Outsourcing payroll to a reputable provider gives owners more time to focus on what matters most.
• Greater Efficiency: Look for a provider that allows you to import multiple files at one time from one location, so you don’t need to wait for each file to complete before processing a new one.
• Cost Savings: Outsourcing to a payroll service provider saves costs on printing and distributing paychecks and generating reports for in-house and accountant use.
• Greater Security: Protection against identity theft, embezzlement of funds, and tampering with records for personal gain.
• Professional Know-How: Payroll providers offer expertise and can help you at any point in the process.