How to Set Up Payroll for Your Small Business in 8 Easy Steps

🌟 KEY TAKEAWAYS

Getting an EIN comes first. You’ll need it to register with your state and run your first payroll.

State registration can take a couple of weeks, so start that process as soon as you get an EIN.

Misclassifying an employee as an independent contractor can lead to back taxes, penalties, and interest.

Whether you’re about to hire your first employee, or you just registered as an S corporation with the IRS and need to put yourself on the payroll, there are eight steps to set up payroll for your small business. The good news is, most of them are things you only have to do once.

What you need before you set up payroll

Before you run your first payroll, it’s helpful to gather some basic information. Having it ready up front keeps the process moving instead of stalling out while you search for paperwork you didn’t know you needed.

Start with your business details

Gather the details of the people you'll pay

Decisions to make before your first payroll run

How to set up payroll in 8 steps

These eight steps take you from having no payroll system to running one on schedule. Steps 1 through 4 cover what you need to have in place before you can pay anyone. Steps 5 through 8 cover running payroll regularly.

Step 1: Apply for an EIN or BN

In the U.S., the IRS assigns an EIN to businesses. It’s a nine-digit number, similar to an SSN, you use to file payroll taxes, open a business bank account, and identify your business on tax forms. In Canada, the equivalent is a BN issued by the Canada Revenue Agency (CRA).

You need an EIN or BN before you can do anything else on this list, so tackle it first, even if you’re a few weeks out from paying anyone.

You apply for an EIN online at IRS.gov or through the mail by submitting Form SS-4. When you apply online, you get your EIN immediately. Getting an EIN through the mail takes 4 to 5 weeks.

In Canada, you register for a BN through the CRA’s Business Registration Online service. If you can’t or don’t want to register online, you can apply via mail using Form RC1. It usually takes a few weeks to get your BN through the mail.

Step 2: Register for state and local payroll tax accounts

Most U.S. states require two separate registrations when you hire employees. You need a withholding account to remit the state income tax you deduct from paychecks and a state unemployment insurance (SUI) account for the employer-paid tax that funds unemployment benefits. Some states combine both into a single registration, but some states require you to register with two different agencies. Cities and counties may layer on their own local tax requirements as well.

Eight U.S. states don’t have a personal income tax. Those are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. Washington doesn’t tax regular income, but levies a capital gains tax on high earners. In these states, you generally only have to worry about SUI registration.

Check out the IRS’s list of state government websites to find the relevant agencies in your state.

Here’s how payroll registration works in the five states with the most FreshBooks users, as of August 2026.

Every state has different rules for when you should register, so contact your state to confirm.

In Canada, the equivalent is a CRA payroll program account. You can open one online through My Business Account and receive your number immediately. You also need to register with your province’s workers' compensation board. Quebec employers register separately with Revenu Québec.

Step 3: Classify your workers correctly

Before you pay someone, you need to know whether they’re an employee or an independent contractor. This determines whether you need to withhold taxes from their paycheck and what form you send them at year-end. You withhold taxes from employees' pay and send them a W-2 at year-end. Independent contractors handle their own taxes and get a 1099-NEC.

In the U.S., the IRS uses a common-law test built around three categories:

Some states apply a stricter test on top of the federal one. For example, California’s ABC test presumes a worker is an employee unless you can prove otherwise on all three counts.

In Canada, the CRA looks at similar factors:

No single factor decides it.

For example, say you run a small landscaping business, and you hire your first crew member to help with jobs. You supply the mower and truck. You tell them which yards to do and when. Even if you have them sign an independent contractor agreement and give them a 1099 at year-end, this setup looks like an employee relationship under both the IRS and CRA tests because you control how and when the work happens and you supply the equipment.

If the IRS or CRA decides you misclassified an employee as a contractor, you’re generally on the hook for the taxes you should have withheld or paid, plus penalties and interest. You may also face additional penalties and fines for willful or repeated violations.

If you have trouble deciding whether a worker is an employee or an independent contractor, you can request an official determination. In the U.S., you use Form SS-8. But the IRS can take at least 6 months to decide, so it’s not a same-day fix. In Canada, you can request a CPP/EI ruling.

Step 4: Collect employee paperwork and details

Once someone accepts a job offer, you need to handle some paperwork before you issue their first paycheck.

In the U.S., you need:

For independent contractors, you collect a Form W-9 instead. This form gives you the information you need to issue a 1099-NEC at year-end.

In Canada, employees fill out a TD1 form for both federal and provincial purposes.

You’ll also need a direct deposit authorization form if you pay electronically. 

Different U.S. states might have their own new-hire forms. Federal law requires you to report basic information on new and rehired employees to the state within 20 days of hire, but some states have shorter deadlines.

Canada doesn’t have an equivalent new-hire reporting system.

Beyond the forms, you need to keep some information on file for each worker, including their full name, SSN or SIN, address, start date, and agreed-upon compensation. Store this data securely, since it includes sensitive information.

Step 5: Choose your pay schedule

Your pay schedule is how often you run payroll and issue paychecks. You generally have four options:

Federal law doesn’t require a certain pay frequency, but most U.S. states do. Some states mandate a specific frequency for all workers. Others set different rules by industry or job classification. Check your state’s payday requirements before you pick a schedule.

In Canada, provinces and territories set minimum pay frequencies, so check your local employment standards.

Keep cash flow in mind when setting a pay schedule, too. Weekly frequent pay runs mean money leaves your account more often. That can be tougher on your cash flow than fewer, larger outflows.

Step 6: Decide how you'll run payroll

You generally have four ways to process payroll each pay period:

Before deciding, consider whether you want to handle payroll tax filings or have someone handle it for you. If you use software, a full-service payroll provider, or an accountant, make sure they support direct deposit, since nearly 93% of employees prefer to be paid that way. Also, your solution should meet your needs now and scale as you grow so you don’t have to find a new service the next time you hire.

FreshBooks Payroll powered by Gusto is built into your FreshBooks account, so you run payroll from the same place you invoice clients and track expenses. It calculates and files payroll taxes each pay run for supported tax agencies and jurisdictions, and there’s no limit on the number of payroll runs you can process, with no additional fee for extra runs.

You can pay owners, employees, and contractors through the same workflow. Direct Deposit usually takes 2 to 4 business days.

Step 7: Run your first payroll

A payroll run follows the same basic sequence every time, whether you handle it manually or use software.

Consider doing a test payroll run before your first live run. This lets you run the numbers through your new process without issuing a real payment, so you can check the results against what you expect. It lets you catch setup errors, like a misconfigured tax rate or the wrong pay schedule, before they show up in someone’s paycheck.

Step 8: File and deposit payroll taxes on schedule

Running payroll is only half the job. You also have to deposit withheld taxes and file payroll tax returns on a monthly or semiweekly schedule.

In the U.S., new employers start as monthly depositors by default. If you’re not new to running payroll, you generally have to deposit on a semiweekly schedule if your total payroll liabilities were greater than $50,000 during a certain lookback period. You can find your lookback period using IRS Publication 15.

All federal deposits go through the Electronic Federal Tax Payment System (EFTPS). Enrolling in EFTPS takes 5 to 7 business days, so set it up well before your first payroll run.

Here’s the federal filing calendar as of August 2026:

State deposit and filing schedules run separately from federal schedules and vary by state, so confirm your state revenue agency’s calendar.

In Canada, you remit source deductions (CPP, EI, and income tax) to the CRA on a schedule based on your average monthly withholding amount. New small employers with lower withholding often start on a quarterly schedule. Established small businesses may have to remit monthly, by the 15th of the following month. At year-end, you file T4 slips and the T4 Summary by February 28.

Ongoing payroll responsibilities after setup

Once you have payroll up and running, you have a few more responsibilities that continue as long as you have employees.

How to set up payroll for an LLC or S corporation

A single-member LLC with no employees doesn’t need to run payroll at all. You pay yourself through owner draws rather than a paycheck, and there’s no withholding involved.

An LLC with employees follows the same eight steps outlined above, regardless of how many members it has.

An S corporation owner who works in the business has different rules. The IRS requires you to pay yourself reasonable compensation through payroll before taking any additional profit as a distribution. Unfortunately, the IRS doesn’t offer a formula for determining what’s reasonable. They consider what you’d pay someone else to do your job, based on factors like your role, time commitment, and comparable wages in your industry.

If you pay yourself too little, the IRS can reclassify some or all of your distributions as wages and charge penalties and interest. Working with a tax professional to figure out reasonable compensation can help you stay on the right side of the IRS.

Canada has no S-corp equivalent, but incorporated owner-managers also need to balance salary and dividends. The CRA generally doesn’t challenge salary paid to an active owner-manager the way the IRS scrutinizes S-corp compensation, but salary paid to family members must be reasonable for the work they do.

Frequently asked questions

How do I set up my own payroll?

Setting up your own payroll involves getting an EIN, registering for state payroll tax accounts, and choosing a pay schedule. Start by getting an EIN, since you’ll need it for the other steps.

How do you do payroll for beginners?

For a first-time employer, the simplest path is payroll software. You enter hours or salaries, and it calculates withholding and generates pay stubs. Some platforms also file payroll tax returns for you.

How to create a simple payroll?

The simplest option is to get an EIN or BN, decide on a pay schedule, and use payroll software to handle the tax calculations and filing for you. Having employees in multiple states complicates payroll, since each state has different tax rates, rules, and forms.

How do I run payroll in an LLC?

Running payroll in an LLC follows the same steps as any other business structure. The exception is a single-member LLC with no employees. These businesses don’t need payroll, since the owner gets paid through owner draws instead of a paycheck.

How long does it take to set up payroll?

It’s a good idea to get the process started two or three weeks ahead of your first pay date. You can get an EIN immediately if you apply online at IRS.gov, but state tax registrations can take anywhere from a few days to a few weeks, depending on your location.

How much does payroll setup cost?

Setup itself is usually free. There’s no fee for an EIN, and most state payroll tax registrations are free as well. If you choose to use payroll software, you’ll usually pay a base fee of around $40 plus $4 to $12 per employee per month. Fees go up if you work with a full-service payroll provider or outsource payroll to a bookkeeper or accountant.