How to Do Payroll (2026): A Step-by-Step Guide for Small Business

To do payroll, you get an EIN, classify each worker as an employee or contractor, collect their tax forms, calculate gross pay, subtract tax withholdings and deductions to reach net pay, pay your workers, then deposit the withheld taxes with the IRS and your state and file the required forms. It’s a repeatable cycle: set up once, then run the calculate-pay-withhold-deposit loop every pay period and file quarterly and at year-end.

I do this for my own small team, and the steps below are the exact order I follow. Doing it by hand is possible for one or two employees; beyond that, software pays for itself by handling the tax math and filings automatically.

Step 1: Get an EIN and register with your state

Before paying anyone, get a federal Employer Identification Number (EIN) from the IRS — it’s free and you can apply online in minutes. You’ll also register with your state’s department of revenue (for income tax withholding) and your state’s labor or unemployment agency (for state unemployment tax, or SUTA). If you pay employees in a city with local income tax, register there too.

Step 2: Classify each worker

Decide whether each person is a W-2 employee or a 1099 independent contractor. This isn’t a preference — the IRS uses behavioral and financial control tests to determine it, and misclassifying an employee as a contractor to dodge payroll taxes carries real penalties. Employees get taxes withheld; contractors are paid gross and handle their own.

Step 3: Collect tax and onboarding forms

For every employee, collect a completed Form W-4 (so you know how much federal income tax to withhold), the equivalent state withholding form, and Form I-9 to verify work eligibility. For contractors, collect a Form W-9. Get direct deposit details (a voided check works) at the same time.

Step 4: Calculate gross pay

Gross pay is what someone earns before any deductions. For hourly workers, multiply hours by their rate and add overtime (typically 1.5× for hours over 40 in a week under federal rules). For salaried workers, divide the annual salary by the number of pay periods. Add any bonuses or commissions.

Step 5: Calculate withholdings and deductions

From gross pay, subtract the following to reach net (take-home) pay. Here’s the typical order:

Remember that you, the employer, also owe a matching share of Social Security and Medicare plus federal (FUTA) and state (SUTA) unemployment tax — those are your cost, not deducted from the employee. For the full breakdown, see payroll taxes explained.

Step 6: Pay your workers

Net pay is gross pay minus all employee withholdings and deductions. Pay it by direct deposit (the standard) or check on your set schedule, and give each employee a pay stub showing gross pay, every deduction, and net pay. If you haven’t set up direct deposit yet, here’s how to set up direct deposit.

Step 7: Deposit taxes and file the forms

The money you withheld isn’t yours — you must deposit it with the IRS (and your state) on a schedule the IRS assigns you, usually monthly or semi-weekly. Then file on time:

• Form 941 — quarterly, reporting wages and federal taxes withheld
• Form 940 — annually, reporting FUTA tax
• State unemployment and withholding returns — on your state’s schedule
• W-2s for employees and 1099-NECs for contractors — at year-end (due by January 31)

Late deposits and missed filings are where penalties pile up, so calendar these or let software handle them.

Step 8: Keep records

Keep payroll records — time sheets, pay stubs, tax filings, W-4s — for at least four years (the IRS standard; some states require longer). You’ll want them for audits, loan applications, and workers’ comp audits.

Making payroll easier with Gusto

Steps 4 through 8 are exactly where mistakes and missed deadlines happen, and exactly what payroll software removes from your plate. I use Gusto because it’s full-service: it calculates gross-to-net pay, withholds the right amounts, pays employees by direct deposit, and automatically deposits and files your federal, state, and local payroll taxes — including year-end W-2s and 1099s. It runs unlimited payrolls for a flat $49/month plus $6 per employee (or $35/month, free for six months, for contractors only).

Gusto’s referral offer is worth grabbing if you’re signing up anyway: through a referral link, after your first paid payroll you get a Visa gift card — $100 for fewer than 10 employees, $200 for 10 or more — plus three months free, with no coupon to enter. For a new small business, that effectively covers much of the first year. Compare the options in our best payroll software guide.

Frequently asked questions

How do I do payroll myself for a small business?

Get an EIN, register with your state, classify and onboard each worker, then each pay period calculate gross pay, subtract tax withholdings and deductions to get net pay, pay your workers, and deposit the withheld taxes with the IRS and state. File Form 941 quarterly and W-2s/1099s at year-end.

Can I run payroll without software?

Yes, for one or two employees, using IRS withholding tables and a spreadsheet. But you take on all the tax-deposit and filing deadlines yourself, and penalties for errors are steep. Most owners move to software once they hire a third person.

How often do I have to deposit payroll taxes?

The IRS assigns you a monthly or semi-weekly deposit schedule based on your past tax liability. You must follow it precisely — late deposits trigger penalties even if you eventually pay in full.

What forms do I need to file for payroll?

Quarterly Form 941, annual Form 940 for unemployment tax, your state’s withholding and unemployment returns, and year-end W-2s for employees and 1099-NECs for contractors (both due January 31).

More guides are in the blog, and the current referral offer is on the home page.