Step-by-Step Guide to Running Payroll for Small Businesses

If you're like most small business owners, payroll isn’t just another task—it’s a time-consuming, error-prone process that keeps you up at night. Miscalculations, tax penalties, late payments, and compliance worries can eat into your time and budget. In fact, nearly 40% of small businesses are fined every year due to payroll mistakes, with an average penalty of over $850.

But the truth is, payroll doesn’t have to be painful.

This step-by-step guide will walk you through everything you need to know to confidently run payroll accurately, legally, and efficiently, even if you’re just getting started.

Steps to Run Payroll for Small Businesses

1. Get Legal & Tax Credentials

Before you can run payroll, you need to be legally registered to do so. This includes:

• Apply for a Federal Employer Identification Number (EIN): This is your business’s tax ID, issued by the IRS.
• Register with state and local agencies: Depending on your location, you may need additional employer accounts for income tax withholding and unemployment insurance.
• Classify your workers correctly: Are they employees or independent contractors? Misclassification is a common and costly mistake.

Getting these credentials in order lays the legal foundation for payroll and protects you from compliance issues down the road.
Once your business is registered, it’s time to gather employee-specific details.

2. Gather Employee Information and Documentation

Next, you’ll collect and organize key documents from every new hire. These include:

• Form W‑4 (for federal tax withholding preferences)
• Form I‑9 (to verify employment eligibility)
• State withholding forms (if applicable)
• Social Security numbers
• Bank details for direct deposit

You’ll also want to clearly define whether each employee is hourly or salaried, and whether they’re exempt or non-exempt from overtime.

Accurate data collection now will prevent errors when calculating pay later.
With paperwork in hand, it’s time to decide how often you’ll run payroll.

3. Know the Difference Between Independent Contractors and Employees

Independent contractors have control over how, when, and where they complete their work. They typically work for multiple clients and are responsible for their own taxes, including self-employment taxes. Contractors do not receive employee benefits such as health insurance or paid time off.

Employees, on the other hand, work for a single employer and follow the employer's direction on how, when, and where tasks are completed. Employers withhold taxes (Social Security, Medicare, and income tax) from employees' wages and provide benefits like health insurance and paid leave.

Correctly classifying contractors vs employees is crucial for payroll. Employees receive W-2 forms, with taxes withheld, while independent contractors receive 1099-NEC forms, as they handle their own taxes. Misclassification can lead to penalties.

4. Choose a Pay Schedule

Your payroll frequency determines how often employees get paid. Common options include:

• Weekly
• Bi-weekly
• Semi-monthly
• Monthly

Your choice should balance cash flow, employee preferences, and state payroll laws (some states mandate minimum pay frequencies). Once you decide, you’ll build your entire payroll calendar around this schedule.

Now that your schedule’s set, let’s look at how you’ll track time and calculate wages.

5. Track Time and Calculate Pay

Accurate time tracking is essential, especially for hourly workers. You can use:

• Time-tracking apps
• POS systems
• Manual time sheets (not recommended for scale)

Once hours are confirmed, calculate:

• Gross pay (hours × rate or salary)
• Overtime
• Bonuses or commissions
• Deductions (401(k), health benefits, wage garnishments)
• Taxes (federal, state, local)

A small mistake in these calculations can result in costly errors or unhappy employees.
After calculating net pay, it’s time to actually move the money.

6. Process Payments and Withhold Taxes

Now, you’ll distribute pay through:

• Direct deposit (fast, secure, preferred by most employees)
• Paper checks (less common but still an option)

At the same time, withhold the required taxes and deductions from each paycheck. You’ll deposit these funds later to the appropriate agencies.

Accuracy here is essential—mistakes can lead to fines or back taxes.
Once you’ve paid your team, you need to report those taxes to the government.

7. File Payroll Taxes and Submit Year-End Forms

As an employer, you’re responsible for filing:

• Federal payroll tax deposits via EFTPS
• Quarterly forms (e.g., Form 941)
• Annual forms (e.g., Form 940 for FUTA)
• W‑2s for employees and 1099-NECs for contractors by January 31st

Some states also require quarterly wage reports and state-specific withholding returns.

Keeping up with these filing deadlines is non-negotiable; missed filings can result in penalties.
To stay audit-ready, good recordkeeping is the next essential step.

8. Maintain Records and Stay Compliant

The Fair Labor Standards Act (FLSA) and state laws require you to retain payroll records for several years. This includes:

• Pay stubs
• Tax filings
• Time records
• Employee information

You should also stay on top of changing tax rates, minimum wage laws, and labor regulations to avoid compliance gaps.

At this point, you might be wondering if there’s a better way to manage it all. There is.

9. Consider Payroll Software or Outsourcing

Manual payroll is possible, but rarely practical long term. Most small businesses either:

• Use payroll software
• Outsource to a payroll provider or Employer of Record (EOR) like Wisemonk

Benefits of payroll outsourcing or automation include:

• Time savings
• Reduced errors
• Built-in tax compliance
• Scalability as your team grows

If payroll is pulling your focus away from growing your business, it may be time to let a trusted partner handle the heavy lifting.

Conclusion

Running payroll for your small business may feel complex at first, but by following these steps and using the right tools, it becomes a manageable, repeatable process:

1. Register your business legally
2. Collect employee documents
3. Set a pay schedule
4. Track time and calculate pay
5. Pay your team and withhold taxes
6. File tax forms
7. Stay compliant with good records
8. Automate or outsource as needed

If you’re looking to simplify your payroll without compromising compliance, Wisemonk’s Employer of Record services help you run compliant, automated payroll and beyond, so you can focus on growth, not paperwork. Book a consultation with us today!