How to Run Payroll: A Step-by-Step Guide

You have hired someone, payday is on Friday, and you have realized that you do not actually know what running payroll involves. Not conceptually. Procedurally. What do you do, in what order, and by when?

This page answers exactly that. Not a definition of payroll, which the payroll guide covers. This is the procedure: what has to exist before your first run, the nine steps of an actual run, the calendar you have to work backwards from, and the checklist to go through every single time.

The single most useful thing I can tell you before you start is this: payroll does not end when your employees are paid. It feels like it does. It does not, and careful small businesses pick up penalties in the gap between the two.

I build FirstHR, which holds the employee records payroll consumes. One caveat: this is tax territory, figures change annually, and I am not a tax professional.

What a Payroll Run Is

A payroll run is one complete cycle of paying your employees for a pay period: calculating what each person earned, withholding the correct taxes and deductions, paying them the remainder, and remitting the withheld money plus your employer contribution to the IRS and your state.

Note where that sentence ends. It does not end at paying them. The run includes handing the government its money, and that step happens on a completely different schedule from the one you just paid people on.

Before Your First Run

None of the nine steps can happen until this list exists. And two items on it take days or weeks, not minutes, which is why the correct time to start is the day you decide to hire rather than the week the person shows up.

Start with state registration, the first amber row. It can take days to weeks depending on the state, and you need one set per state where an employee actually works, which is their location and not your office.

The second amber row is EFTPS, the Electronic Federal Tax Payment System. Enrollment ends with a PIN sent by mail, which IRS Publication 966 says arrives five to seven business days after you enroll online. If your first employee starts in two weeks and neither this enrollment nor the state registration has begun, you are going to be late for something.

The item people forget entirely is the last one on the list. Every state requires new hires to be reported to a state directory, and federal law sets the outside deadline at twenty days from the date of hire, while a number of states set a shorter one (Office of Child Support Enforcement). Filing takes minutes, and skipping it carries penalties.

The red row has the tightest clock. Form I-9 is due within three business days of the date employment begins, and a busy week of hiring does not buy you extra days (USCIS Handbook for Employers). Collect it, along with the W-4 and the bank details, during onboarding rather than chasing it afterward.

What a Payroll Account Is

When people say they need to set up a payroll account, they usually mean one of two different things, and both matter before your first run. The first is your employer tax accounts. The second is a bank account used only for payroll.

The tax accounts are the registrations above: your employer identification number (EIN) with the IRS, your EFTPS enrollment for federal deposits, and a withholding account plus an unemployment account with every state where an employee works. Each one gets its own account number and its own filing frequency. That set of accounts is what payroll registration produces, and no run is legal without them.

The separate bank account is optional and I recommend it anyway. You move net pay plus every tax you withheld and every employer tax you owe into it on run day, then pay everything out of it. The money you owe the government stops looking like operating cash, which is the single cheapest defense against the trust fund problem described further down this page.

Many first-run failures are setup that was almost done, and almost done is invisible until the run fails. Write the numbers and dates down as each one is issued, on one page, so the difference between an account and an application is impossible to miss.

How to Set Up a Payroll System

A payroll system is the accounts above plus four decisions: who is an employee and who is a contractor, how often you pay, how approved hours reach whoever builds the run, and who runs it when that person is unavailable. Software is a fifth decision, and the least consequential of the five.

Classification comes first, because everything downstream inherits it. An employee gets withholding, a deposit obligation, and a W-2. A contractor gets an invoice, plus a 1099-NEC once you pay them $2,000 or more in a year. Guess wrong and the error repeats every period until an agency finds it, so settle the W-2 versus 1099 question before you set a rate.

Then fix the pay frequency and write the year out on a calendar: period end, hours approval, submission, payday, deposit due, filing due. Biweekly suits most small teams. That calendar is the system. Whatever you use to calculate the numbers is arithmetic running against it.

The last two decisions are about inputs and backup. Hours should arrive as an approved timesheet rather than a message on payday, and rate changes, new hires, and leavers should reach payroll from one place. Name a backup, then have that person build one live run before you need them to.

The Nine Steps

Every payroll run at every business in the country is a version of this. The order matters, because each step feeds the next and getting the sequence wrong changes the answer.

Step two has a wrinkle worth knowing before you hit it: overtime is 1.5 times the regular rate, which is not the same thing as 1.5 times the hourly wage. The two diverge the moment a nondiscretionary bonus (one promised in advance) or a shift differential enters the week, and the rule reaches only non-exempt employees.

Steps three and seven are why the order matters: pre-tax and post-tax deductions hit different tax bases, so one set has to come out before tax is calculated and the other after.

Steps two through seven are arithmetic, and they are the part everybody worries about. They are not the risk. A spreadsheet does them, a payroll system does them better, and if you get one wrong you find out quickly because someone's paycheck looks odd.

Step nine is the risk. It is invisible, it happens weeks after the visible work is done, and nothing about your day reminds you it is due.

A Worked Example, Gross to Net

Here is how to calculate payroll for one person, with the nine steps applied in order. The employee is non-exempt, paid $22.00 an hour, and worked 45 hours in the week. They pay into a Section 125 health plan, which takes premiums out before tax, and a Roth retirement account, which takes contributions after it.

The two withholding lines marked illustrative are the only ones you cannot compute from a rate. Federal income tax comes from a table lookup against the W-4 on file, and state tax depends on where the person works. Everything else in the table is arithmetic that will come out the same for anyone.

Now the part the table does not show: what you owe on top of that $1,045.00. Matching Social Security and Medicare come to $76.88. Federal unemployment tax (FUTA) at 0.6 percent of $1,005.00 is $6.03. State unemployment tax at an assumed 2.0 percent is $20.10.

The employee cost you $1,148.01 this week, not $1,045.00, and roughly $103 of that is employer tax you never see on the pay stub.

Working Backwards From Payday

Working backwards means starting from payday and counting back to the day the hours have to close. The run builds toward payday, and running it as though payday is the starting gun is how people end up paying their staff late.

The submission timing is the thing nobody tells you. Direct deposit is not instant. According to Nacha, which writes the rules for the Automated Clearing House (ACH) network that carries direct deposits, a credit settles the same day, the next banking day, or two banking days after it is sent.

Your bank also sets its own submission cutoff ahead of that settlement. Run payroll on Friday morning intending to pay people Friday, and you have almost certainly missed. Find out your bank's lead time before your first run, not during it.

Then build your payroll calendar backwards from payday. If payday is Friday and your bank needs two business days, your submission deadline is Wednesday, which means your hours have to be closed and approved by Tuesday. That is your actual schedule, and it starts earlier than you think.

Step one depends on something outside payroll entirely: your timesheets. If the hours are wrong, everything downstream is wrong, and no amount of care in step five fixes a bad number in step one.

How the Money Actually Reaches People

Direct deposit is the default and the cheapest to run, but it is not the only disbursement method and you will eventually need a second one. Someone will start without a bank account, someone will be terminated mid-period and need paying before the next ACH file goes out, and someone will simply refuse to hand over their routing number.

Three methods cover almost every case. Direct deposit, which settles within two banking days of being sent and needs the lead time built into your calendar. A paper check, which is instant to issue and slow to reconcile, and which suits a final paycheck that cannot wait for the next direct deposit file. And a payroll card, which is the usual answer for employees without a bank account.

Two rules apply whichever method you use. State wage payment law governs what you can require, so confirm with your state labor agency before making any single method mandatory. And whether you must also hand over a pay stub is a state question, not a federal one.

The Department of Labor says the Fair Labor Standards Act (FLSA) requires accurate records of hours worked and wages paid but does not require an employer to hand employees pay stubs (DOL FLSA Advisor). Where your state requires one, it is an obligation separate from the payment itself, and where it does not, you still need the record.

What You Withhold

What you withhold comes down to the 2026 rates below, the numbers you apply in steps four through six. They are worth having in one place, because a surprising number of published pages still show last year's.

Federal income tax is the one that is not a rate. It comes from the employee's W-4 and the tables in IRS Publication 15-T. For manual payroll, the Wage Bracket Method is the practical approach: find the table for your pay frequency, find the row for their wages and the column for their filing status, and the number in that cell is what you withhold.

One trap worth naming: if there is no W-4 on file, you do not withhold zero. You withhold as single with no adjustments, which is generally more than the employee expected. A missing form does not mean a missing obligation.

Then You Deposit It

The money you withheld has a deadline, and that deadline has nothing to do with when you paid your employees. This is step nine, and it is the whole reason this article keeps hammering the same point.

Federal deposits must be made by electronic funds transfer, through EFTPS, IRS Direct Pay, or your IRS business tax account (IRS Publication 15). There is no paper deposit option. EFTPS is the route that needs a mailed PIN before first use, which is why its enrollment is on the pre-flight checklist rather than something you sort out later.

How often you pay is a separate decision from all of this, and it deserves a deliberate choice rather than whatever you happened to set up first.

Put every one of the dates in that table on a calendar, today, for the whole year. Not in your head. The calendar is what keeps you compliant; the spreadsheet only does the arithmetic. A deposit penalty does not require a refusal to pay your taxes. It only requires the deadline to arrive while you are busy and nobody has written it down.

Your First Run

The first one is different, because nothing is routine yet and you have no prior period to compare against. Three things to do differently.

Every input to that first run came from onboarding, not from payroll: the W-4, the pay rate, the work location, the bank details. A payroll system will not tell you one is missing until the run fails or, worse, succeeds on the wrong number.

And expect the first paycheck to look strange to the employee, because it usually does. A mid-period start means they are paid for the days they worked rather than a full period. A benefit that has not begun yet means a deduction they expected is missing. Say so in advance, because an unexplained first paycheck is a worried message you did not need to receive.

Running It Manually

Doing payroll by hand is entirely legal, and genuinely practical for a handful of employees in a single state. Nothing requires you to use software or a service. The IRS cares that the numbers are right and deposited on time; it does not care who did the arithmetic.

What you need: the tax guide for employers in IRS Publication 15, the current withholding tables in Publication 15-T, a spreadsheet you trust, an EFTPS enrollment, and a calendar with every deadline already on it. That last item is not optional and it is not decoration. It is the thing that actually keeps you compliant.

The bottom two rows are the honest part. Neither column has a check mark. Software does not catch a wrong rate you typed, and it does not assume your legal liability. If a provider fails to deposit your taxes, the IRS pursues you.

The legal liability is explicit in IRS guidance. Employers stay ultimately responsible for withheld income tax and for both shares of Social Security and Medicare tax. The one exception is narrow: in certain situations, the customer of a Certified Professional Employer Organization is relieved of that responsibility (IRS outsourcing payroll). Outsourcing moves the work; it does not move the obligation.

Manual payroll stops working at a fairly predictable point: when you add hourly staff with overtime, when you add a second state, or when the run starts taking long enough that the fee is obviously cheaper than your time. When you do move to software, what you are buying is deadline compliance rather than arithmetic.

Can You Pay Employees Without Payroll?

You can pay employees without payroll software or a payroll service. You cannot pay them without running payroll. Those sound like the same sentence, and the difference between them is where small businesses get into trouble that takes years to unwind.

Withholding, depositing, reporting, and issuing a W-2 are obligations attached to employing someone, not to owning a particular tool. Handing over cash or writing a personal check with nothing withheld does not simplify payroll; it creates unpaid trust fund tax, an unfiled 941, and an employee with no record of earnings. Our guide to doing payroll yourself walks through the version that is both cheap and legal.

The one genuine exception is that a contractor is not an employee. You pay them on an invoice with no withholding, plus a 1099-NEC at year end if you paid them at or above the reporting threshold. That is a real and common arrangement.

Contractor classification is also a judgment call with a price on getting it wrong: the IRS says an employer with no reasonable basis for treating an employee as a contractor may be held liable for that worker's employment taxes (IRS worker classification). Read up on worker misclassification before you decide someone is a contractor because it is easier.

The Every-Time Checklist

Go through these five checks before you release each run. They take about five minutes and catch most of what goes wrong.

The first item is the highest-value thing in this entire article after the deposit calendar. Compare this run to the last one. Payroll is remarkably stable period to period, which means anything that moved is either explicable or wrong, and finding out which takes about a minute.

If you find an error after the run has gone out, the correction is retro pay, and it has its own arithmetic and its own tax treatment. Catching it before you release beats fixing it afterward every time.

Managing Payroll Between Runs

Payroll management is everything that happens when you are not in the middle of a run: keeping the records, meeting the deposit and filing deadlines, reconciling what you reported against what you paid, and making sure one person being on vacation does not stop payday. The run is the visible part. This is the part that keeps it correct.

The payroll management process at a small business comes down to four standing jobs. One named owner, with a second person who can run it. A calendar holding every deposit and filing date for the year. A reconciliation each quarter. And a January reset when the rates change.

Payroll Records and How Long to Keep Them

Keep payroll records for at least four years. Two different agencies set two different clocks on the same paperwork, and the practical answer is to keep everything for the longer of them. Nobody has ever regretted holding payroll records too long.

The Department of Labor requires employers to preserve payroll records for at least three years and the underlying time cards and schedules for two (DOL Fact Sheet 21). The IRS asks you to keep all employment tax records for at least four years after you file the fourth quarter return (IRS employment tax recordkeeping). The IRS clock is the longer one, so it sets your minimum.

Off-Cycle Payroll Runs

An off-cycle run is any payroll outside your normal schedule: a correction to a paycheck that was wrong, a final paycheck for someone who left mid-period, a signing bonus, or a commission payout that could not wait. It follows the same nine steps and it creates the same tax liability, which is the detail people miss.

Two things change. The withholding on a supplemental payment such as a bonus can follow different rules from regular wages, so check the treatment before you run it. And the deposit obligation attaches to the date you paid, not to your usual cycle, which can pull a semiweekly depositor into a deadline they were not expecting.

Reconciling and Resetting

Reconcile once a quarter, before you file the 941. Total the gross wages and each withheld tax across every run in the quarter and compare them against what the Form 941 reports and what you actually deposited. Those three numbers should match. A gap caught in March costs you an afternoon. The same gap found the following January costs you an amended return.

At year end the same check runs across all four quarters, because the totals on your W-2s have to agree with the sum of the four 941s. A standing payroll audit once a year catches the drift that quarterly checks miss, such as a deduction that kept running after the benefit ended.

Every January, three things move: the Social Security wage base, the federal withholding tables, and your state unemployment rate, which arrives as a notice you have to actually open. Minimum wage changes often land the same week. Put a single reset task on the calendar for the first payroll of the year and work through all four.

What Goes Wrong

Six failures keep recurring, and the first one on the list below catches employers who did everything else right. It is a deposit problem, and deposit problems are not rare: the IRS assessed roughly 1.2 million failure-to-deposit penalties on employment taxes in fiscal year 2025, according to IRS Data Book Table 4-2.

The last one is the one that ends businesses, and it needs saying plainly. The money you withhold from an employee's paycheck is trust fund money. It is not revenue and it is not working capital. When a cash crunch arrives, that money is sitting in the account looking exactly like every other dollar, and it is not yours.

Unpaid trust fund taxes can be assessed personally against the individuals responsible, so the corporate form (the limited liability your company normally gives you) does not protect you the way it does for ordinary debts.

That personal assessment, the Trust Fund Recovery Penalty, reaches withheld income tax plus the employee share of Social Security and Medicare, though not the employer match (IRS Trust Fund Recovery Penalty).

Your own share is a separate cost, and it is easy to underestimate. The employer share you owe on top of wages, meaning the matching FICA and the unemployment tax, is the statutory benefits floor: the minimum the law makes you fund. FICA alone puts it at 7.65 percent of wages before unemployment tax or a single voluntary benefit.

The Bureau of Labor Statistics also counts workers' compensation as a legally required benefit, and the total climbs. Its Employer Costs for Employee Compensation survey (June 2026) puts legally required benefits at $3.40 an hour for private employers, against $32.82 in wages, a little over 10 percent on top of pay (BLS ECEC Table 4).

If you are ever choosing between paying the taxes and paying a vendor, pay the taxes. That is the one bill where the consequence of not paying follows you home.

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