Last updated: March 2026

How to Pay Employees for the First Time

Paying employees wrong costs more than paying them right. The IRS assesses over $7 billion in payroll penalties every year, and most of those hit small businesses making first-timer mistakes: late deposits, wrong withholding amounts, missed filing deadlines. If you are figuring out how to set up payroll for the first time, the process below is the way a Certified Payroll Professional would build it, not the simplified version that skips the parts where things go wrong.

This is not the version that assumes you already know the difference between a W-4 and a W-2, or that explaining state unemployment registration does not help sell payroll software. This is every step a first time employer needs to pay employees legally from day one, including the ones most guides leave out.

Before you pay anyone: get your accounts

You need four things before your first payroll run. An Employer Identification Number from the IRS, which you get by filing Form SS-4 online at irs.gov. A state withholding tax account in every state where your employees will work, which you get through each state's tax agency. A state unemployment insurance account in every state where your employees work, which is sometimes the same registration as withholding and sometimes separate. And a workers comp insurance policy, which you buy from an insurance carrier or your state's workers comp fund.

The EIN takes minutes. State accounts take one day to three weeks depending on the state. Workers comp can bind same-day through most brokers. Start all four on the same day. The mistake that catches most new employers: they hire someone Monday, pay them Friday, and do not have state accounts set up until the following month. The paycheck clears. The employee is happy. But the employer has no mechanism to deposit the taxes they should have withheld, and those taxes accrue penalties starting the day they were due.

Open a dedicated bank account for payroll.

Separate from your operating account. Every dollar that goes in should be for wages and tax deposits. Every dollar that goes out should be a paycheck, a direct deposit, or a tax payment. When the IRS asks to see your payroll records, and at some point they will, a clean payroll account turns a three-hour reconciliation into a 20-minute confirmation. This is wrong when you are an S corp officer paying only yourself a salary with no other employees, because a dedicated payroll account adds unnecessary overhead when there is only one recurring payment to one person from one source.

Classify your workers correctly

Before you write a single check, determine whether each person is an employee or an independent contractor. This classification controls whether you withhold taxes, pay employer taxes, provide workers comp coverage, and file W-2s or 1099s. Getting it wrong does not just create tax problems. It creates lawsuits.

The IRS uses a behavioral, financial, and relationship test. If you control how, when, and where the work is done, the worker is an employee. If you only control the result and the worker controls the method, they might be a contractor. State tests are often stricter. California's ABC test presumes every worker is an employee unless the hiring entity proves three specific conditions. Several other states have adopted similar presumptions.

Misclassification is the most expensive payroll mistake a small business can make.

The IRS assesses the employer's share of FICA taxes on every dollar paid to the misclassified worker, plus penalties, plus interest, going back as far as three years. States add their own unemployment tax assessments. Workers comp carriers add premium audits. If the worker files for unemployment or gets injured, the exposure multiplies. One misclassified worker paid $50,000 over two years can generate $15,000 or more in back taxes, penalties, and insurance adjustments. This is wrong when you hire a licensed professional who sets their own hours, uses their own tools, and works for multiple clients simultaneously, because that pattern typically supports contractor status under both the IRS common law test and most state tests.

Collect the right paperwork

Every employee completes three forms before their first paycheck. Form W-4 tells you how much federal income tax to withhold. Your state's withholding certificate, which is a separate form in most states, tells you how much state income tax to withhold. Form I-9 verifies the employee's identity and work authorization. You do not send the I-9 to anyone. You keep it on file for three years after the hire date or one year after termination, whichever is later.

You also need a signed direct deposit authorization if you are paying electronically, which you should be. Paper checks cost more to print, take longer to process, and create reconciliation headaches. Most business bank accounts offer ACH direct deposit for $5 to $15 per month.

New hire reporting is required in every state. You submit basic information about each new employee to your state's directory within 20 days of the hire date in most states. This feeds the child support enforcement system. Skipping it triggers fines that range from $25 to $500 per missed report depending on the state. Most payroll providers handle new hire reporting automatically. If you are paying employees manually, you file through your state's online portal.

Choose your pay schedule

State law dictates your options. Some states allow any frequency. Others mandate minimum pay frequencies. California requires semi-monthly or more frequent pay periods for most employees. Some states require weekly pay for certain industries like restaurant workers. Check your state's requirements before committing to a schedule.

The four common schedules: weekly (52 pay periods per year), biweekly (26 pay periods), semi-monthly (24 pay periods), and monthly (12 pay periods). Biweekly is the most common for small businesses because it balances employee preference with administrative workload. Semi-monthly is popular for salaried employees because each check is exactly one-twenty-fourth of annual salary. Monthly is the cheapest to administer but most states restrict it, and employees dislike waiting a full month between paychecks.

Pick one schedule and stick with it.

Changing pay frequencies mid-year creates a transition pay period where overtime calculations, benefit deductions, and tax withholdings all need manual adjustment. It is doable but annoying enough that most companies avoid it. This is wrong when you have both salaried exempt and hourly nonexempt employees with different scheduling preferences, because some companies run semi-monthly for salaried staff and biweekly for hourly staff without issue as long as the payroll system supports dual schedules.

Calculate gross pay

For salaried employees, divide the annual salary by the number of pay periods. A $52,000 salary on a biweekly schedule equals $2,000 gross per pay period. For hourly employees, multiply hours worked by the hourly rate. Hours over 40 in a workweek earn overtime at 1.5 times the regular rate under federal law. Some states, like California, also require daily overtime for hours over 8 in a single day.

The overtime calculation sounds simple until you add complexity. An employee who earns $20 per hour for regular work and $25 per hour for a different job code in the same week has a blended regular rate that is neither $20 nor $25. The overtime premium applies to the weighted average, not the rate they were earning when they crossed 40 hours. Most payroll software handles this automatically. If you are calculating by hand, Publication 15 (Circular E) from the IRS and your state's wage and hour guidelines spell out the formulas.

Withhold and deposit taxes

From every paycheck, you withhold federal income tax based on the employee's W-4 using the IRS withholding tables in Publication 15-T. You withhold Social Security tax at 6.2% of gross wages up to $176,100 in 2026. You withhold Medicare tax at 1.45% of all gross wages with no cap. You withhold state income tax according to your state's formula or table. You withhold local taxes if applicable.

As the employer, you also owe taxes on every dollar of wages. You pay a matching 6.2% Social Security and 1.45% Medicare. You pay federal unemployment tax at 0.6% on the first $7,000 per employee after the FUTA credit. You pay state unemployment tax at a rate your state assigns, typically 1% to 5% for new employers.

Deposit federal taxes through EFTPS on the schedule the IRS assigns you. Monthly depositors send accumulated taxes by the 15th of the following month. Semi-weekly depositors follow a Wednesday/Friday schedule based on payday. Deposit late by even one day and the penalty starts at 2% of the amount due. Miss it by 16 days or more and you are at 10%. Ignore the first IRS notice and you are at 15%.

The most common first-timer mistake: calculating the employee withholdings correctly but forgetting the employer match. Your employees' net pay looks right. Your tax deposit is exactly half of what it should be. Six months pass before the IRS sends a notice, and by then you owe the shortfall plus penalties plus interest on every pay period you underpaid.

Pay your employees

Direct deposit is the standard. Set up ACH payments through your bank or payroll provider. Most direct deposits take one to two business days to process. Gusto's Plus plan offers next-day direct deposit. Some providers offer same-day for an additional fee. If an employee does not have a bank account, you can issue a paper check or use a payroll debit card, which most providers offer as an alternative.

Every paycheck must include a pay stub showing gross wages, each tax and deduction itemized, and net pay. Most states require pay stubs by law. Even states that do not require them expect you to provide wage statements on request. Your payroll software generates these automatically. If you are running payroll yourself, you create them manually or use a stub generator, but you are still responsible for the accuracy of every line.

File your returns and year-end forms

Quarterly, you file Form 941 reporting total wages, federal income tax withheld, and Social Security and Medicare taxes. You file state unemployment reports quarterly in most states. Annually, you file Form 940 for federal unemployment tax. You prepare W-2s for every employee and distribute them by January 31. You file W-2s with the Social Security Administration by January 31. For contractors paid $600 or more, you file Form 1099-NEC by January 31.

A full-service payroll provider handles every one of these filings. That is the main reason to use one. The payroll calculation is the easy part. The compliance calendar with 20 or more filing deadlines per year is where DIY payroll breaks down. Gusto, OnPay, or Patriot Software's full-service plan files everything for you starting at $37 to $40 per month plus $5 to $6 per employee.

When to use a payroll provider versus doing it yourself

If you have one or two employees in a single state with no benefits and you are comfortable filing tax forms, you can run payroll yourself for $17 to $20 per month using a self-service tool. The moment you add a third employee, a second state, a pre-tax deduction, or your first garnishment, the time and risk exceed the savings. A full-service provider at $50 to $100 per month eliminates 80 to 120 hours of annual compliance work and carries errors and omissions insurance you do not have.

For startups, the math is simple. Your time is worth more than $40 per month. Spend it on revenue, not on reading IRS publications. Start with a provider on day one and never look back. Compare providers on our payroll provider hub.

Written by a Certified Payroll Professional with 30 years of experience.

This is not legal or financial advice. Consult a qualified professional for your specific situation.