Setting up payroll for the first time is a huge milestone for any startup. It means you’re growing, building a team, and turning your vision into a reality. To set up payroll, you primarily need to get federal and state tax IDs, gather employee forms like W-4s, choose a pay schedule, and select a payroll system to process payments and file taxes. Getting it right from day one is crucial for keeping your team happy and staying on the right side of the law.

This guide breaks down exactly how to set up payroll, step by step. We’ll cover everything from getting the right tax IDs to choosing a system and running your very first pay cycle.

Step 1: Get Your Employer Identification Number (EIN)

Before you can do anything else, you need a federal Employer Identification Number, or EIN. Think of it as a Social Security number for your business. The IRS uses this unique nine digit number to track your company’s payroll tax reporting and payments.

Getting an EIN is a non negotiable first step in how to set up payroll. You’ll need it to file federal tax returns, issue W-2s to employees, and open a business bank account. The good news is that applying for an EIN is free and can be done online directly with the IRS, often giving you the number immediately. With a surge of over 5 million new business applications filed annually in recent years, each requiring an EIN, it’s a well trodden path for new founders.

Step 2: Register for State and Local Tax IDs

Once you have your federal EIN, you need to register with the tax authorities in every state where you have employees. This process gets you a state tax ID number, which you’ll use for two main things:

• State Income Tax Withholding: If the state has an income tax, you’re required to withhold it from your employees’ paychecks and send it to the state.
• State Unemployment Insurance (SUI): You’ll pay SUI taxes, which fund unemployment benefits for workers who lose their jobs.

Every state has its own registration process. For example, in California, you register with the Employment Development Department (EDD), while in New York, you deal with both the Department of Labor and the Department of Taxation. If you hire in multiple states, you’ll need to register in each one. Don’t forget to check for local taxes too; some cities or counties have their own payroll tax requirements.

Step 3: Classify Your Workers Correctly

One of the most critical decisions you’ll make when figuring out how to set up payroll is classifying your workers as either employees (W-2) or independent contractors (1099). This distinction determines your legal obligations. Employees are entitled to minimum wage, overtime, and benefits, and you must withhold and pay payroll taxes for them. Contractors are not.

Misclassifying an employee as a contractor can lead to severe penalties, including back taxes and fines. The IRS and Department of Labor look at the degree of control you have over the worker to make a determination. While an estimated 10 to 30 percent of employers misclassify workers, the risk is not worth it. If you’re hiring globally and want to treat someone as an employee without setting up a foreign legal entity, an Employer of Record (EOR) service can be a lifesaver.

Platforms like Bolto offer EOR services in over 100 countries, ensuring you stay compliant while expanding your team internationally.

Step 4: Collect Key Employee Forms and Information

To set up payroll for a new hire, you need to gather some essential paperwork and personal details. Having a solid onboarding process makes this seamless.

Employee Withholding Certificate (Form W-4)

Every U.S. employee must complete a Form W-4. This IRS form tells you how much federal income tax to withhold from their paycheck based on their filing status, dependents, and other adjustments. You are required to collect a W-4 from every employee. If they don’t provide one, you must withhold taxes at the highest possible rate (single with no adjustments). Keep the completed W-4s in your records; they don’t get sent to the IRS.

Employment Eligibility Verification (Form I-9)

You must also complete Form I-9 for every new hire to verify their identity and authorization to work in the United States. The employee presents specific documents (like a passport or a driver’s license and Social Security card), and you examine and record them on the form. This must be done within three business days of their start date. Like the W-4, you keep the I-9 on file and must be able to produce it during an audit.

Personal and Banking Information

Finally, you’ll need each employee’s:

• Full legal name and address
• Social Security Number (SSN)
• Direct deposit information (bank account and routing number)

Over 90% of American employees receive their pay via direct deposit, so collecting this info upfront is standard practice.

Step 5: Document Compensation Terms Clearly

Before you can calculate pay, you need to define it. A key part of how to set up payroll involves documenting compensation terms in writing, typically in an offer letter or employment agreement. This prevents misunderstandings and legal disputes down the road. You can speed this up with compensation templates and onboarding checklists.

Your documentation should clearly state the:

• Base salary or hourly wage rate
• Pay schedule (e.g., biweekly)
• Details on any bonus, commission, or stock option plans
• Eligibility for overtime pay

Some states, like California and New York, legally require employers to provide new hires with a written notice of their pay rate and payday. Clear documentation builds trust and ensures you’re meeting wage laws.

Step 6: Choose a Pay Schedule

A pay schedule is the regular frequency at which you pay your employees. Your choice impacts your company’s cash flow and your team’s personal budgeting. The most common pay schedules in the U.S. are:

• Biweekly: Every two weeks (26 paychecks per year). This is the most popular schedule, used by nearly 46% of U.S. businesses.
• Weekly: Once a week (52 paychecks per year). Common for hourly workers and used by about 32% of companies.
• Semimonthly: Twice a month, on specific dates like the 15th and 30th (24 paychecks per year).
• Monthly: Once a month (12 paychecks per year). This is the least common option.

Many states have laws dictating minimum pay frequency, so check your local requirements. Once you choose a schedule, stick to it. Timely and predictable pay is critical, as one survey found that 49% of employees would face financial trouble if their paycheck was just one week late.

Step 7: Set Up Benefits Enrollment

Offering benefits like health insurance and a 401(k) is a powerful way to attract and retain talent. Benefits enrollment is the process of signing employees up for these programs.

About 58% of small private employers provide health insurance to their staff. If you have 50 or more full time employees, the Affordable Care Act (ACA) mandates that you offer health insurance or face a penalty. Most companies have an annual “open enrollment” period when employees can make changes to their benefits. Modern HR platforms often integrate benefits administration, which simplifies the process by automatically deducting premiums from payroll.

Step 8: Select a Payroll System

You need a reliable method to calculate pay, withhold taxes, and make payments. While you could do it manually with spreadsheets, this approach is prone to errors. An estimated 45% of small businesses still process payroll manually, which is where most mistakes and IRS penalties occur.

Given that 88% of small business owners find payroll taxes too complex to handle alone, investing in a payroll system is a smart move. See Bolto’s plans and pricing. A good payroll system will:

• Calculate gross pay, taxes, and deductions automatically.
• Process payments via direct deposit.
• Generate pay stubs for employees.
• Handle tax filings and payments for you.

For startups, an all in one platform that combines payroll with HR and recruiting can save a ton of administrative work. Solutions like Bolto’s U.S. payroll platform are built specifically for startups, offering a single system to manage U.S. payroll, global hiring, and compliance.

Step 9: Establish Payroll Recordkeeping Practices

Federal and state laws require you to maintain detailed payroll records. This isn’t just a best practice; it’s a legal obligation and a crucial part of knowing how to set up payroll correctly.

• The Fair Labor Standards Act (FLSA) requires you to keep payroll records for at least three years.
• The IRS requires you to keep all employment tax records for at least four years after the tax is due or paid.

Your records should include everything from employee W-4s and I-9s to pay rates, hours worked, gross pay, deductions, and proof of tax payments. Using a digital payroll system is the easiest way to ensure all this information is stored securely and is accessible for audits.

Step 10: Run Your First Payroll

You’ve done the prep work, and now it’s time to run your first payroll. This is where all the pieces come together.

1. Enter Hours: For hourly employees, input the number of hours worked during the pay period, including any overtime.
2. Run Calculations: Your payroll system will calculate each employee’s gross pay, deduct the correct amount for taxes and benefits, and determine their net pay.
3. Review and Approve: Always review the payroll preview before finalizing. The average payroll accuracy rate globally is only 78%, so catching errors early is key.
4. Distribute Pay: Process payments, which for direct deposit often means initiating the transfer a couple of days before payday.
5. Provide Pay Stubs: Ensure every employee receives a pay stub detailing their earnings and deductions.

Congratulations, you’ve officially paid your team!

Step 11: Handle Payroll Tax Reporting and Depositing

Running payroll doesn’t end on payday. You are also responsible for reporting and depositing the taxes you withheld, plus your own employer tax contributions.

Federal payroll taxes contribute an estimated $1.71 trillion to government funds annually, so compliance is monitored closely. You’ll need to:

• Deposit Taxes: Remit federal income, Social Security, and Medicare taxes to the IRS on either a monthly or semi weekly schedule. Most businesses must do this electronically.
• File Quarterly Reports: File Form 941, the Employer’s Quarterly Federal Tax Return, to report the wages and taxes for the quarter.
• File Annual Reports: File Form 940 annually for federal unemployment (FUTA) taxes.
• Handle State Filings: Follow the reporting and deposit schedules for your state income and unemployment taxes.

Missing a deadline can result in significant penalties. A robust payroll platform will automate these filings and payments, which is why many founders choose Bolto to handle the complexities of tax compliance from the start.

Frequently Asked Questions

What is the very first step to set up payroll?

The absolute first step is to obtain a federal Employer Identification Number (EIN) from the IRS. You cannot legally hire and pay employees in the U.S. without one.

How long does it take to set up payroll?

If you have all your business and employee information ready, you can set up payroll with a modern software provider in a day or two. The longest lead times are typically waiting for state tax ID registrations, which can vary from instant to a few weeks depending on the state.

Can I run payroll myself without software?

Yes, you can run payroll manually using spreadsheets. However, it is not recommended. Manual calculations are time consuming and highly susceptible to errors, which can lead to costly IRS penalties and unhappy employees.

What are the most important documents needed to set up payroll for an employee?

For each new employee, you must have a completed Form W-4 for tax withholding, a completed Form I-9 to verify work eligibility, their Social Security number, and their bank details for direct deposit.

How often do I need to pay payroll taxes?

The deposit schedule for federal payroll taxes is determined by your total tax liability and is either monthly or semi weekly. State tax deposit schedules vary. Your payroll provider can manage these deadlines for you.

What’s the difference between an employee and a contractor?

The key difference is the level of control. Employees (W-2) are directed by the employer regarding how, when, and where they work. Independent contractors (1099) typically have more control over their own work. The distinction has significant tax and legal implications.

Do I need a separate bank account for payroll?

While not always legally required, it is a highly recommended best practice to have a dedicated bank account for payroll. It simplifies accounting, helps with cash flow management, and provides a clear audit trail.

How do I handle payroll if I have remote employees in different states?

If you have employees in multiple states, you must register for tax IDs in each state and comply with each state’s withholding, unemployment, and labor laws. This is a complex area where using a payroll service with multi state capabilities, like the one offered by Bolto, is extremely valuable.