A Step-by-Step Guide to Payroll for Small Business Owners

Date15 Oct 2025

As a small business owner, the last thing you want is a payroll headache. Yet, for many entrepreneurs, payday brings more stress than satisfaction.

Payroll is more than just writing checks—it involves navigating complex tax laws, calculating withholdings, and ensuring every deadline is met.

The fears are real: what if you miscalculate taxes? What if you miss a deadline and face costly fines? And beyond compliance, payroll can eat up valuable time you’d rather spend running and growing your business.

The good news is payroll doesn’t have to feel overwhelming. With the right system in place, you can run payroll confidently and accurately.

This guide will walk you step-by-step through the payroll process, from setup to reporting, and highlight common mistakes to avoid.

The Foundation: Setting Up Your Payroll System

Before you pay your first employee, you need to lay the groundwork.

Step 1: Get Your Employer Identification Number (EIN)

An EIN is like a Social Security number for your business. It’s issued by the IRS and required for reporting taxes and paying employees.

You can apply for one online for free at the IRS website. Without it, you cannot legally process payroll.

Step 2: Collect Necessary Employee Information

Next, gather essential documentation from each employee:

Form W-4: Determines how much federal income tax to withhold.
Form I-9: Verifies the employee’s eligibility to work in the U.S.
Personal details: Full name, address, and Social Security number.
Direct deposit information: If you plan to pay employees electronically.

Keeping these records organized ensures smooth payroll processing.

Step 3: Choose a Payroll Method

You have several options for managing payroll:

Manual Payroll: Suitable for very small businesses with only one or two employees. While inexpensive, it’s time-consuming and prone to errors.
Payroll or Accounting Software (e.g., QuickBooks, Gusto): Automates calculations, tax withholdings, and recordkeeping. A beneficial middle ground for small businesses.
Full-Service Payroll Provider: Handles everything from calculations to tax filing. While more costly, this option saves time and ensures compliance.

The right choice depends on your budget, comfort with numbers, and business size.

The Pay Cycle: Running Payroll Step-by-Step

With your system set up, you can proceed to run payroll.

Determine a Pay Period

Common pay cycles include:

Weekly: Employees are paid every week. Great for hourly workers, but more frequent processing.
Bi-weekly: Every two weeks. The most common option for U.S. businesses.
Semi-monthly: Twice a month (e.g., the 15th and last day). Predictable but slightly more complex.
Monthly: Once a month. Easiest to manage but harder for employees who rely on regular income.

Choose a cycle that balances compliance, cost, and employee needs.

Calculate Gross Pay

Gross pay is the total amount earned before deductions. For hourly employees, multiply hours worked by their hourly rate. For salaried employees, divide their annual salary by the number of pay periods.

Calculate Deductions and Withholdings

There are two types of deductions:

Mandatory Deductions:
- Federal income tax (based on W-4).
- State and local income taxes (where applicable).
- FICA taxes (Social Security and Medicare).
Voluntary Deductions:
- Health insurance premiums.
- 401(k) or retirement plan contributions.
- Other employee benefits.

Calculate Net Pay

Net pay is what the employee takes home after all deductions. This is the amount you deposit or issue as a paycheck.

Post-Payroll: The All-Important Reporting and Tax Payments

Your responsibilities don’t end once employees are paid.

Pay Your Employees

The most common method is direct deposit, which is fast and reliable. Some businesses still use paper checks or pay cards, but timeliness is essential—late paychecks can erode trust.

Pay Your Payroll Taxes

Employers are responsible for withholding and remitting taxes. This includes federal and state income taxes, Social Security, and Medicare. Key forms include:

Form 941: Quarterly reporting of federal income tax and FICA withholdings.
Form 940: Annual reporting for federal unemployment tax (FUTA).

File Your Tax Forms

Deadlines vary by state and tax type, so it’s critical to stay organized and calendar important dates.

Maintain Records

The IRS requires you to keep payroll records for at least four years. These should include timesheets, tax forms, pay stubs, and records of tax deposits. Good recordkeeping protects you in case of an audit.

Common Payroll Mistakes to Avoid

Even small mistakes can lead to major headaches. Here are four to watch for:

Mistake #1: Misclassifying Workers

Treating employees as independent contractors may seem easier, but if the IRS disagrees, you could face penalties and back taxes. Always classify correctly.

Mistake #2: Missing Deadlines

Late tax deposits or filings result in hefty fines. Setting reminders—or using payroll software—can help you avoid costly slip-ups.

Mistake #3: Not Keeping Accurate Records

Failing to track hours, deductions, or tax payments creates compliance risks. Organized documentation is non-negotiable.

Mistake #4: Ignoring State and Local Laws

Payroll laws vary by state—and sometimes even by city. Ignoring local requirements could leave you vulnerable to penalties.

Speak to a Payroll Expert

Payroll doesn’t have to be a source of stress. With the right system, accurate recordkeeping, and an understanding of your responsibilities, you can turn payroll from a dreaded chore into a confident, repeatable process.

To recap:

Set up your payroll foundation with an EIN, employee records, and a payroll method.
Run payroll step-by-step—calculating gross pay, deductions, and net pay.
Complete post-payroll responsibilities like paying taxes, filing forms, and keeping records.
Avoid common mistakes like misclassifying workers or missing deadlines.

But here’s the truth: while you can manage payroll yourself, it takes time and carries risk. That’s why many small businesses choose to hand it off to experts.

At E3 Bookkeeping, we offer expert payroll services that ensure accuracy, compliance, and timeliness—so you can focus on growing your business without the worry.