How to run payroll for a small service business, from first paycheck to W-2

Payroll has two parts. The first is arithmetic: hours times rate, plus overtime, minus withholding. The second is a calendar: deposits, quarterly returns, year-end forms. Owners rarely get the math badly wrong. They get in trouble by missing the calendar, or by mixing payroll tax money with operating cash during a slow month.

This guide covers the federal side from IRS Publication 15 (2026) and Department of Labor rules, as read in October 2026. States add income tax withholding, unemployment insurance and their own pay-timing rules, and those differ widely. Use our state start pages to find your state's official agencies. This is general information, not tax advice; an accountant can confirm your setup.

What do you need before the first payroll?

• An EIN. Free from the IRS; see our EIN guide.
• State accounts. Typically a withholding account with the revenue agency and an unemployment account with the workforce agency, where your state has them.
• Each employee's Form W-4, name and Social Security number. If an employee does not give you a W-4, Publication 15 says to withhold as if they are single with no other adjustments.
• An EFTPS enrollment or another IRS electronic payment method. The IRS requires federal tax deposits by electronic funds transfer.
• A pay schedule and workweek. Weekly or biweekly is common for field crews. Your state may set a minimum pay frequency.
• A time record you trust. The FLSA requires daily and weekly hours for every nonexempt employee.

If this is your first hire, start with how to hire your first employee, which covers the onboarding forms.

How do you calculate a paycheck?

1. Total the hours for the workweek, including drive time between jobs and short breaks, which the Department of Labor counts as work time.
2. Figure gross pay. Straight time, plus overtime for hours over 40 in the workweek, paid at 1.5 times the regular rate. If the employee earned a nondiscretionary bonus or commission, it raises the regular rate. Our overtime guide shows the math.
3. Subtract pre-tax deductions, such as qualifying retirement or health contributions, if you offer them.
4. Withhold federal income tax using the employee's W-4 and the tables in IRS Publication 15-T.
5. Withhold Social Security and Medicare (the employee's share).
6. Withhold state and local income tax where they apply.
7. Subtract other deductions, such as a court-ordered garnishment, within legal limits.
8. Pay net wages on the regular payday, and record everything.

For bonuses and commissions paid separately from regular wages, Publication 15 allows an optional flat federal withholding rate of 22% on supplemental wages up to $1 million a year, as long as they are identified separately from regular wages.

What are the federal payroll tax rates for 2026?

On FUTA, the IRS says employers who pay state unemployment tax can generally take a state unemployment credit worth up to 5.4%. That brings the effective rate to 0.6%. In "credit reduction" states that have not repaid federal unemployment loans, the credit is smaller and the federal tax higher. The IRS publishes the list each year.

When are payroll taxes deposited and filed?

Withheld income tax plus both halves of Social Security and Medicare are deposited together. Publication 15 sets the schedule:

• Monthly depositors deposit by the 15th of the following month. New employers are monthly depositors for their first calendar year.
• Semiweekly depositors are employers that reported more than $50,000 of these taxes in their lookback period. Check which schedule applies to you before each calendar year starts.
• The $100,000 next-day rule: if you accumulate $100,000 or more of tax liability on any day, it is due the next business day.
• FUTA is deposited quarterly once the amount owed passes $500; otherwise it can carry forward or be paid with Form 940.

One change for 2026 W-2s: employers must separately report qualified overtime compensation, the premium part of FLSA-required overtime, in box 12 with code TT, according to the 2026 W-2 instructions. Your payroll software or provider should handle this, but your overtime records must be accurate for it to work.

Which payroll mistakes cost small crews the most?

• Leaving drive time off the timesheet. Travel between jobs during the day is work time, and it often pushes a week past 40 hours.
• Paying overtime on the base rate only when a bonus or commission was earned the same week.
• Paying a helper "as a contractor" who is really an employee. See employee vs independent contractor.
• Depositing late because the deposit date was not on anyone's calendar.
• Forgetting the state side: unemployment reports and state withholding returns run on their own schedules.
• No year-end check. Compare your four 941s to the W-3 totals before you file. Mismatches trigger letters.

Should you run payroll yourself or use a service?

You can run payroll yourself with a spreadsheet and the IRS tables. For one or two employees, some owners do. The risk is not the math, it is the calendar and the state filings. Most small service businesses end up choosing between three setups:

Even with a service, you remain responsible for the taxes. Log in to your IRS business account or EFTPS now and then to confirm deposits arrived.

How do hours get from the field to payroll?

For field crews, the hard part of payroll is not the payroll software. It is getting accurate hours out of the trucks every week. Paper timesheets go missing, texts get forgotten, and "about 8 hours" turns into a dispute three weeks later. The FLSA requires you to keep payroll records for at least three years and time cards for two, per the Department of Labor's recordkeeping fact sheet, and Publication 15 sets a four-year minimum for employment tax records.

The cleanest flow is clock-in and clock-out on the same app the crew uses for jobs, a weekly review by the owner or office, then an export to the payroll provider. We do it this way in our own service companies: approved hours leave the CRM as a plain file the payroll provider imports, with no integration to maintain. A custom CRM can produce that file in whatever format your provider accepts, and can put labor hours next to job revenue so you see which jobs pay. To find where your systems leak time or money, request a free system quote.

Frequently asked questions