Setting Up Payroll: A Complete Guide for Small Businesses

Remember your first hire? That mix of excitement and mild panic! You've built something successful enough to need help, but now you're responsible for someone else's paycheck. Between dealing with suppliers, handling customer service, and maybe even jumping in to cover a shift or two the last thing you need is a payroll headache.

We've helped thousands of small business owners set up their payroll systems, and we know it can feel overwhelming at first.. Whether you're transitioning from paper timesheets or hiring your first employee, setting up payroll and calculating employee wages is easy as long as you follow our step-by-step guide.

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How to properly set up payroll for your small business

Let's break down payroll set up into manageable steps that will keep you compliant and your team happy.

Step 1: Choose your payroll schedule.

The first big decision when setting up payroll is when you'll pay your team. Weekly? Every other week? Monthly? Most small businesses choose bi-weekly payments because it's easier to manage cash flow while keeping employees happy. Plus, it means you'll run payroll about 26 times per year instead of 52, saving you from expensive processing fees.

Consider these factors when deciding your pay periods...

• Your cash flow (especially if you run a seasonal business)
• Your state's payday requirements
• Your team's preferences (most employees prefer frequent payments)
• Processing fees from your payroll provider

Pro tip: Whatever schedule you choose, stick to it. Your team relies on consistent paydays to keep a roof over their heads. Never miss a payday with Homebase, which automates your payroll schedule.

Step 2: Set up your payment methods.

Let's talk about employee paychecks. Paper checks are a simple solution, until they get lost and cause all kinds of trouble and headache. 

Most small businesses go with direct deposit for employee paychecks because...

• Employees get their money faster.
• You don't have to worry about lost or stolen checks.
• There are clear records for payroll tax obligations.
• Most employees expect and prefer it.

Pro tip: Even if you offer direct deposit, keep paper checks as a backup. Sometimes new hires need a paper check while their direct deposit is being set up. Homebase lets you manage both payment methods easily, and automatically generates digital pay stubs that employees can access anytime.

Step 3: Collect employee information and tax forms.

This is where many small business owners get stuck. There's a lot of paperwork involved in hiring. For each new employee, you'll need...

• W-4 form for federal tax withholding
• I-9 form to verify work eligibility
• State tax withholding forms (requirements vary by state)
• Direct deposit authorization form
• Emergency contact information
• Any benefit enrolment forms

Pro tip: Don't wait until payday to gather these forms. Make this part of your onboarding process and collect everything before your new hire's first day. Missing or incorrect paperwork is one of the biggest reasons first payrolls get delayed and payroll taxes get complicated.

Step 4: Classify your workers correctly.

The IRS pays close attention to worker classification, and mistakes here can often trigger audits and penalties. Here's how to avoid the fuss:

Employees (W-2 workers)

Your core team who runs your business day-to-day.

What defines an employee:

• You control their schedule and provide their tools.
• They're integral to your core business.
• You withhold their taxes.
• Example: Servers, cooks, or retail associates.

Contractors (1099 workers)

Independent professionals you hire for specific projects or occasional work.

What defines a contractor:

• Set their own schedule and use their own tools.
• Usually contractors work for multiple businesses.
• They handle their own taxes.
• Example: A website designer or maintenance person.

Non-exempt vs. Exempt

Here's the simple breakdown of who gets overtime pay and who doesn't:

• Non-exempt: Most hourly workers who get overtime pay (like servers and retail staff)
• Exempt: Usually salaried managers or professionals who don't get overtime (must earn at least $684/week)

Pro tip: Don't classify workers as contractors just to avoid payroll taxes. This isn't a workaround, it's a mistake that can lead to huge penalties. With Homebase, you can stay on top of overtime and worker classifications automatically.

Step 5: Setting up payroll taxes.

When you're already pulling all-nighters just to keep your business afloat and your team organized, the last thing you need is to spend hours figuring out tax calculations. Here's how to handle payroll taxes for federal, state, and local authorities:

Employee withholdings

Every time you run pay your team, you'll need to calculate income taxes and hold back a portion of each employee's earnings while processing payroll:

• Federal income tax (based on their W-4)
• Social Security and Medicare (FICA taxes)
• State income tax (where applicable)
• Any local taxes your city requires

Your employer share

On top of processing employee deductions, you're also responsible for paying these employer taxes:

• Matching FICA taxes (6.2% for Social Security, 1.45% for Medicare)
• Federal and state unemployment insurance
• Workers' compensation insurance

Pro tip: Don't lose sleep calculating these taxes manually. Payroll software like Homebase automatically calculates and withholds the right amount of taxes, keeping you compliant without the headache of spreadsheets and tax tables.

Step 6: Keep accurate payroll records.

The IRS requires you to maintain detailed payroll records, and for good reason. These records protect you during tax audits, help resolve employee pay disputes, and make sure you're meeting minimum wage and overtime requirements. Plus, when tax season rolls around, having organized payroll records makes filing your returns much easier.

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Your record-keeping system needs to track every part of employee pay and time worked. Make sure you're storing:

• Time cards and work schedules
• Payroll records and pay stubs
• Tax forms (W-2s, 1099s)
• Employee details (SSN, address, tax forms)
• Wage rate changes and raises
• PTO accrual and usage

Different records have different retention requirements. Here's how long you need to keep each type...

• Payroll processing records: 3 years
• Tax records: 4 years
• Employment records: 3 years after termination
• Benefits information: 6 years

Switching to payroll software might feel overwhelming at first, but having the right system in place makes all the difference—making your team happy and keeping your stress levels in check.

How to implement a new payroll system

Now that you understand what goes into setting up payroll for small businesses, let's talk about actually putting a system in place. Whether you're switching from manual calculations or changing software providers, implementing a new payroll system doesn't have to disrupt your business.

Step 1: Review your current payroll process.

Before making any changes, take a hard look at your current payroll process. What's causing you the biggest headaches? Some common problems when processing payroll include...

• Spending hours manually calculating overtime
• Missing tax deadlines because dates aren't tracked
• Making payroll processing errors that upset employees
• Struggling to keep up with changing tax laws
• Having trouble tracking PTO and sick leave
• Storing paper records that are hard to find later

Write down everything that frustrates you about your current system. Now you know exactly what needs to change when looking for new payroll software to address these problems.

Step 2: Choose the right payroll software.

The right payroll system can give you hours back each week. Imagine a world where you can get calculations, tax filings, and record keeping done in a few clicks. But not all payroll software is created equal, especially when you're running a business with hourly workers.

Must-have features for small businesses

Your payroll software should make your life easier, not more complicated. Here are the essential features that actually matter for businesses like yours:

• Automatic tax calculations and filings
• Direct deposit and digital pay stubs
• Employee self-service for tax forms and pay history
• Time tracking that syncs directly with payroll
• PTO tracking and approval workflows
• Basic HR tools for onboarding and documentation

Red flags to watch out for

Don't get locked into the wrong systems or payroll providers. Here are the warning signs that a payroll provider isn't right for small businesses:

• Long-term contracts with cancellation fees
• Extra charges for basic tax filings
• No live customer support
• Complicated pricing with hidden fees
• Enterprise features you'll never use

A system designed for large corporations might be overkill for your small business. Look for a system designed specifically for small businesses with hourly workers, like Homebase's payroll.

Step 3: Transfer your payroll data.

The key to an easy switch is making sure none of your important payroll history gets left behind when you transfer over to the new system—because you'll need it for tax season and compliance!

What to transfer

Before you move to your new system, nab these records:

• Current employee information (pay rates, tax withholdings, benefits)
• Year-to-date payroll totals for tax reporting
• PTO balances and overtime records
• Past pay stubs and tax filings
• Contractor payment history
• Direct deposit information

Common transfer mistakes to avoid

Be careful of...

• Not double-checking YTD totals before the switch
• Forgetting to transfer PTO balances
• Missing historical tax records
• Not backing up old payroll data
• Rushing the transition during a busy period

Homebase makes this entire process disappear. Automatically import your data from most payroll systems, verify the information for accuracy, and ensure nothing gets lost in the transition.

Step 4: Get your systems talking to each other.

You know how annoying it is to enter the same information three different times. That stops with  getting a payroll system that shares data automatically. When your time tracking feeds directly into payroll, and your payroll flows into accounting, you can finally stop playing data-entry catch-up.

Connect the essentials

Think of these as your must-have connections. Each one saves you hours of manual work.

• Time tracking and scheduling (so hours worked flow straight to payroll)
• Accounting software (to keep your books accurate)
• POS system (especially if you handle tips)
• Your business bank account
• Benefits systems (if you offer them)

Before you run your first payroll

A quick setup now saves you a lot of trouble later...

• Double-check all employee pay rates and tax settings.
• Test your time tracking sync with a sample timesheet.
• Verify your bank account connection with a micro-deposit.
• Run a practice payroll to catch any integration gaps.
• Set up your payroll schedule to run automatically.

With Homebase, your systems are connected automatically, which means your payroll basically runs itself.

Step 5: Test your payroll setup.

A test run helps you catch any issues before you process your first real payroll. The most expensive mistakes happen when businesses skip testing because they're in a hurry to get started.

What to verify in your test run

Here's what experienced payroll managers always double-check:

• Correct hourly rates and overtime calculations
• Accurate tax withholdings and gross pay deductions
• PTO accruals and benefits deductions
• Final net pay amounts
• State tax settings and shift differentials

Take your time with testing. Your employees rely on accurate, on-time paychecks to pay their bills and support their families. A few extra minutes spent double-checking your setup now will save you hours of corrections (and awkward conversations) later.

Step 6: Keep your system running smoothly.

Getting your payroll set up is just the beginning. Tax rates change, minimum wages increase, and labor laws get updated. Here's how to stay on top of all these changes:

Key areas to monitor

Check these items regularly to say on top of updates:

• Payroll tax rates and filing deadlines
• Employee classification and pay rate changes
• New hire reporting requirements
• State and local labor law updates
• Time off accruals and balances
• Benefit deduction changes

Paying employees accurately while running a business is demanding enough without worrying about missed deadlines or compliance issues. A good payroll system helps you set reminders for important dates. Make it a habit to review your payroll settings whenever tax laws or labor regulations change in your area.

Step 7: Get your team on board.

Whether it's managers approving timesheets or employees checking their pay stubs, everyone needs to knowtheir part in making payroll run without a hitch.

Essential training topics

Make sure everyone knows how to handle payroll responsibilities like...

• How to clock in and out correctly
• Where to find digital pay stubs
• How to request and approve time off
• When to submit timesheets
• Who to contact for payroll questions
• How to update personal information

Remember that different people learn differently, and some team members might need extra help with technology. Create simple written instructions, offer one-on-one training when needed, and be patient as everyone adjusts to the new system. A well-trained team means fewer mistakes and questions on payday.

Setting up payroll for a small business doesn't have to be complicated

Setting up payroll might feel like a big task, but breaking it down into steps makes it manageable. The key is choosing the right tools from the start—ones that grow with your business and take care of the complicated parts of payroll for you.

Ready to make payroll easier? Start with Homebase's free payroll tools designed specifically for small businesses like yours.

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