Before the offer: two decisions
Confirm it's actually an employee
If there's any question of 1099 vs W-2, settle it now, misclassifying the first hire sets a pattern that compounds with every one after. The test and the stakes: 1099 or W-2? The Tests That Decide, and the Penalties If You're Wrong . When it's genuinely borderline, W-2 is the safe harbor.
Know the real cost before you promise a wage
An employee costs wages plus roughly 10–15% before benefits: employer Social Security and Medicare (7.65%), federal and state unemployment tax, and workers' comp premiums that vary enormously by industry, office roles cost pennies; roofing and tree work cost serious percentages. Run the full math before the offer, not after. (Complete breakdown: What Payroll Really Costs Per Employee .)
The registration layer
- Federal EIN, if you somehow don't have one, it's free and immediate at irs.gov. Never run payroll under a Social Security number.
- State withholding account, registers you to withhold and remit state income tax (in states that have one)
- State unemployment (SUI) account, every state; this is where your unemployment tax rate gets assigned
- Local registrations where they exist, city or county payroll taxes (municipal income taxes, local services taxes) apply in a surprising number of places, and they're the layer out-of-state bookkeepers miss
- Workers' compensation policy, required in nearly every state from the first employee (a few give tiny thresholds). Get it before day one: an uninsured first-week injury is an existential event, and state fines for gaps are their own problem
The paperwork layer (per employee)
- Form W-4, federal withholding elections, completed on or before day one; plus your state's equivalent where applicable
- Form I-9, employment eligibility verification, completed within three days of start, with the document review the form requires. Kept on file, not mailed anywhere, until an audit asks
- State new-hire report, every state requires reporting new hires within ~20 days (it powers child-support enforcement); your payroll software usually files it, but confirm
- Written pay terms, rate, schedule, overtime status. Several states require a formal wage notice; all relationships benefit from one
The system layer
Choose how payroll actually runs: software (Gusto, QuickBooks Payroll, ADP and peers: $40–$150/month for small teams) or a bookkeeping firm that runs it for you. What the system must do, whoever drives it: calculate withholding, pay by direct deposit on a fixed schedule, deposit federal and state taxes on the right calendar (monthly or semi-weekly, assigned by the IRS based on your liability), file quarterly 941s and state returns, and produce W-2s in January.
Set your pay frequency deliberately, biweekly is the small-business default; some states set minimum frequencies for certain workers. And open a separate rhythm for the tax money: payroll taxes aren't yours from the moment wages are paid. Businesses that treat withheld taxes as float are the ones that meet the IRS's trust-fund recovery penalty, which pierces the business and lands on the owner personally.
The mistakes that generate penalty letters
- Late tax deposits, the single most common first-year payroll penalty; the schedule is unforgiving and automatic
- Skipped quarterly filings, a 941 is due even for quarters with little activity once you're registered
- Overtime 'agreements', non-exempt employees get overtime over 40 hours regardless of what anyone agreed; 'salaried' doesn't automatically mean exempt
- Paying 'off the books' for the trial period, creates unreported wages, uninsured injury exposure, and an unemployment-claim time bomb, all to save two weeks of setup
- Forgetting the local layer, municipal taxes are small until the discovery letter arrives with three years of them
Frequently asked questions
How long does setup take?
With decisions made: registrations and software configuration typically land inside one to two weeks, some states issue accounts instantly, others take days. Start the moment the offer is accepted.
Can I run payroll myself?
With modern software, mechanically yes, the software calculates and files. What it can't do is classify workers, set up multi-state correctly, catch the local layer, or notice when something's off. The failure mode isn't math; it's setup and judgment.
What does it cost to have someone run it entirely?
Typically $100–$300/month at small headcounts as part of a bookkeeping relationship, which also means wages land correctly in your job costing, not just your bank statement. That's our model: payroll as part of the books, not beside them. Payroll Administration for Small Businesses
Primary sources