Let’s be honest – processing payroll is probably not the most exciting part of running a startup business. It’s also time-consuming, challenging, and critical to early-stage success. But by partnering with a payroll service provider, startup business owners can help ensure they pay their employees and file their taxes correctly. That often means they spend less time worrying about payroll management and more time doing what they love.

Table of Contents

How to set up payroll for startups

Startup business owners processing payroll for the first time typically follow these steps:

1. Get an employer identification number (EIN)

Just as individuals need Social Security numbers to file personal taxes, business owners need EINs to file payroll taxes. One can be obtained online for free by completing Form SS-4, Application for Employer Identification Number.

2. Obtain state and local business identification numbers (ID)

State and local governments may require a business ID separate from the federal EIN. Some also require a state unemployment ID number. Employers can contact the applicable state or local agency for specific details. Having a federal EIN handy will help expedite the process.

3. Collect employee documentation

New hires must complete Form I-9, Employment Eligibility Verification and Form W-4, Employee’s Withholding Certificate. In states with income tax, a separate state tax withholding certificate may be required. Employees must also provide their home addresses and Social Security numbers for payroll purposes.

4. Classify employees

Employers must classify their workers as employees or independent contractors. Generally, a worker is considered an independent contractor if the employer has the right to direct the result of the work, but not what will be done or how it will be done. If it’s determined that the worker is an employee, the employer must then classify that individual as either exempt or nonexempt according to the Fair Labor Standards Act (FLSA). Under the FLSA, nonexempt employees are entitled to at least minimum wage and overtime pay when working more than 40 hours in a workweek.

Note: Most public and private employers in the United States are subject to the FLSA, which establishes minimum wage, overtime pay, record keeping and child labor standards affecting full- and part-time workers. In addition, many states and localities have enacted wage and hour laws of their own. Employers must review the differences in each law applicable to their workforce to ensure they meet the requirements.

5. Choose pay frequency

The more often employers process payroll, the more fees they incur. But cost isn’t the only deciding factor. Some states require specific pay frequencies for certain types of industries or circumstances. Employers should always check with their state’s department of labor before creating a payroll calendar.

Common pay periods include:

  • Weekly pay — Best for nonexempt employees; required in some jurisdictions for manual labor jobs
  • Biweekly pay — Frequently used for exempt and nonexempt employees
  • Semi-monthly pay — Ideal for employees classified as exempt due to its consistency and cash flow predictability
  • Monthly pay — Typically reserved for executives

It is not a best practice to use semi-monthly pay for nonexempt employees due to the burdens of reconciliation and accurate overtime payments under federal and state laws. In addition, the FLSA applies on a workweek basis, which means it's easier for nonexempt employees to understand how their overtime is calculated when the workweek aligns with the pay period.

6. Purchase business insurance

The need for business insurance and when it’s bought depends on many factors, including the stage of business (new vs. established), number of employees, industry and location. For example, states typically require employers to carry workers’ compensation insurance when they hire their first employee. This coverage helps protect companies and employees against financial loss in the event of a work-related injury or illness.

7. Offer benefits to employees

Competitive benefits, like group health and dental insurance, can help attract and retain top talent. Typically, employers deduct a portion of the cost from the employee’s wage payment. The total deduction depends on the plans offered and the employee’s elections.

Additionally, as startup businesses grow, they may become subject to the Affordable Care Act (ACA), which has requirements for benefits coverage and cost. Employers should consult a benefits or HR expert to determine their ACA obligations.

8. Open a payroll bank account

Some startup businesses opt to open a payroll bank account, separate from their business account, to pay employees and fulfill payroll tax payment obligations. This practice can make it easier to keep more accurate records of payroll transactions and avoid mistakes.

Creating separate accounts also enhances security. If there was ever a breach in the payroll account, the rest of the business finances would be out of reach and safe. Likewise, if the business account became compromised, employers wouldn’t have to worry about paying their people.

9. Set up retirement services

Setting up a retirement plan might seem unrelated to payroll for startups, but states continue to pass laws requiring employers to provide their employees with retirement savings opportunities. Such legislation is commonly referred to as state-mandated retirement. Businesses generally have two ways to comply – enroll their employees into a state-sponsored retirement program or sponsor a plan through the private market.

Owners of small businesses who are concerned about the cost of offering retirement plans may find relief in the new and enhanced startup tax credit provisions of the SECURE 2.0 Act of 2022.

Why should employers use startup payroll services?

Many challenges come with managing payroll independently, which is why startup businesses often seek professional, third-party support. Those who do so may be able to:

  • Process payroll online from anywhere, at any time
    Online payroll and mobile apps make it easier and faster to pay employees than ever before.
  • Be at ease about depositing payroll taxes and filing tax returns
    Some of the best payroll software for startups will calculate, deduct and deposit taxes on employers’ behalf and help them anticipate and manage compliance challenges.
  • Take advantage of intelligent tech
    Intelligent technology flags possible errors before they happen, helping startups avoid costly mistakes that can impact the accuracy of their payroll.
  • Get support from certified payroll experts
    Some providers offer 24/7 support so employers always have the help they need to manage their payroll processes.
  • Offer employees convenient digital tools and meaningful perks
    Employees today appreciate flexible pay options and access to self-service tools that save time and help improve accuracy.

How to choose the best payroll services for startups

Paying employees on time and accurately is required. If mistakes occur, it can affect employee morale and potentially lead to penalties for the employer. That’s why choosing a high-quality payroll system is so crucial for startups. When evaluating potential providers, employers should look for:

  • A provider who offers the right solutions and advice to help manage a growing workforce
  • A provider who can help with compliance challenges presented by changing laws and trends
  • 24/7 customer support, digital tools and meaningful perks, like flexible pay options and an easy-to-use app

Frequently asked questions about startup payroll software

As a startup with only one full-time employee (me), do I still need to run payroll?

The method by which owners of startup businesses pay themselves generally depends on how the company is structured. Sole proprietorships and limited liability corporations (LLCs) may pay owners by drawing directly from business equity. Owners of S corporations, on the other hand, must pay themselves a reasonable salary, which means they may have to process payroll.

Are startups required to pay payroll taxes?

Startup business owners who have employees must pay the employer portion of Medicare tax and Social Security tax and deduct an equal portion of the taxes from their employees’ pay. If the startup is a sole proprietorship or single-member LLC, the owner pays self-employment tax. This tax is equal to the combined total that an employer and an employee contribute to Medicare and Social Security taxes.

How much does it cost for me to run payroll for my startup company?

Payroll pricing structures vary by provider. In most cases, the cost depends on how frequently payroll is processed, how many people are being paid, how often payees are added or removed, and which features or services are needed.

What if I have a combination of employees and independent contractors I need to pay?

Employers must deduct all required employment taxes, including income taxes and Medicare and Social Security taxes, from their employees’ pay. They must also pay their own share of applicable employment taxes. They do not do the same for independent contractors because these workers pay self-employment taxes. However, employers must report how much they paid independent contractors during the year by filing Form 1099-NEC, Nonemployee Compensation.

This guide is intended to be used as a starting point in analyzing payroll for startups and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.