Hiring your first employee is an incredible milestone, but the excitement can quickly turn to anxiety when you think about payroll. The idea of complex legal requirements, confusing tax filings, and intricate processes for just one person can feel overwhelming. Many small business owners wonder: Is setting up payroll for a single employee really that complicated?
At Lift HCM, we understand these concerns. We've guided countless entrepreneurs, just like you, through every step of payroll setup from day one. Our expertise ensures compliance, accuracy, and, most importantly, gives you the peace of mind to focus on building your business.
This guide will break down the entire process. We'll walk you through setting up and running payroll for a single employee, helping you avoid common pitfalls, understand your obligations, and build a strong, compliant foundation that scales seamlessly as your business grows.
Table of Contents
- Why Setting Up Payroll for One Employee Matters
- Legal & Compliance Considerations When Paying Your First Employee
- Step-by-Step: How to Set Up Payroll for One Employee
- What Payroll Costs to Expect
- Pros and Cons of Using Payroll Services for One Employee
- Potential Pitfalls to Watch For
- Simplify Small Business Payroll with Lift HCM
Why Setting Up Payroll for One Employee Matters
You might think payroll for one employee would be simple. Unfortunately, that's often not the case. The moment you hire your first team member, you take on significant legal and financial responsibilities that apply regardless of your company's size. Ignoring these obligations can lead to severe consequences, including hefty fines, legal challenges, and damage to your reputation.
Here's why a structured payroll system is crucial from the start:
- Accurate Tax Withholding: You're responsible for collecting and remitting various taxes. Errors can lead to significant penalties from the IRS or state tax authorities.
- Timely Paycheck Delivery: Employees must receive their wages on time and according to a set schedule. Delays can lead to dissatisfaction and even legal penalties.
- Compliance with Wage Laws: Beyond minimum wage, you must adhere to complex rules around overtime, breaks, and other compensation elements, which vary by federal, state, and local jurisdictions.
- Secure Recordkeeping: You're legally obligated to maintain detailed and accurate payroll records for a specific period (often three years or more) for tax reporting and potential audits.
A structured payroll system protects your business and saves you valuable time by reducing errors and streamlining processes. It's about building a robust financial backbone for your business.
Legal & Compliance Considerations When Paying Your First Employee
When running payroll for one employee, you're subject to many of the same labor laws and tax requirements as a large corporation. Understanding these key areas is fundamental to compliant payroll:
Key Regulations & Classifications
- Fair Labor Standards Act (FLSA): This federal law dictates minimum wage, overtime pay, recordkeeping, and child labor standards. Employers must keep payroll records for at least three years.
- Employee Classification (W-2 vs. 1099): This is critical. Misclassifying a W-2 employee as a 1099 independent contractor, even unintentionally, can lead to severe penalties from the IRS and state labor departments. When in doubt, lean towards W-2.
Essential Forms
Before you can issue a paycheck, you'll need:
- Employer Identification Number (EIN): Your business's federal tax ID, obtained free from the IRS website.
- Form W-4 (Employee's Withholding Certificate): Completed by your employee to determine federal income tax withholding.
- Form I-9 (Employment Eligibility Verification): Verifies an employee’s identity and authorization to work in the U.S. Must be completed within three days of hire.
- State Tax Forms: You'll likely need to register with state labor and tax agencies and collect additional state-specific withholding forms.
Wage & Overtime Laws
- Minimum Wage: You must pay at least the higher of federal, state, or local minimum wage. Stay updated on current rates.
- Overtime Rules: For non-exempt employees, the FLSA generally requires overtime pay at 1.5 times their regular rate for hours worked over 40 in a workweek. Be aware that some states also have daily overtime rules.
Pro Tip: Proactive organization is your best friend. Keep all timecards, schedules, payroll records, and compliance documentation meticulously organized and secure from day one.
Step-by-Step: How to Set Up Payroll for One Employee
Breaking down payroll setup into manageable steps makes it less daunting. Here's your roadmap:
Now let's dive into each step in detail:
1. Get Registered
Formally register your business as an employer:
- Apply for an EIN: Your essential first step for federal tax filings. Get it quickly and free from the IRS website.
- Register with State Tax and Labor Agencies: This varies by state. You'll generally register for state income tax withholding (if applicable) and state unemployment insurance (UI). Search your state government's official website.
- Collect Required Employee Forms:
- Form W-4: For federal income tax withholding.
- Form I-9: To verify identity and work authorization.
- Direct Deposit Authorization Form: If paying electronically.
2. Choose a Pay Schedule
Decide how often you'll pay your employee. Common schedules:
- Weekly: Payments every week. More frequent processing for you.
- Biweekly: Every other week (26 pay periods/year). Very common.
- Semimonthly: Twice a month on fixed dates (24 pay periods/year).
- Monthly: Once a month. Simplest but may not be allowed in all states.
Important: Ensure your chosen frequency complies with your state’s specific pay frequency laws.
3. Calculate Gross-to-Net Pay
This is the core of payroll: determining what your employee earns before and after deductions.
- Start with Gross Wages: Total earnings before taxes/deductions (e.g., hours worked × hourly rate, or salary divided by pay periods). Include overtime, bonuses, commissions.
- Subtract Required Withholdings:
- Federal Income Tax: Based on W-4 and IRS tax tables.
- Social Security (6.2%) & Medicare (1.45%): Combined as FICA taxes. You withhold these from the employee's pay AND you, as the employer, must match these amounts.
- State Income Tax: If applicable, based on state tax tables.
- Local Income Tax: If applicable in your city/county.
- Federal Unemployment Tax (FUTA) & State Unemployment Tax (SUTA): These are employer-paid taxes, not withheld from the employee's paycheck.
- Factor in Any Voluntary Deductions: (e.g., health insurance, 401(k) contributions, union dues, or legally mandated wage garnishments).
The amount remaining after all these deductions is your employee's net pay.
Now that you understand how to calculate payroll, let's look at the execution and ongoing management phase:
4. Pay Your Employee
Once net pay is calculated:
- Direct Deposit: Most efficient and secure. Funds transfer directly to their bank.
- Paper Checks: If preferred, ensure consistency and timely delivery.
Always provide a detailed pay stub showing gross wages, itemized deductions, and net pay. This is legally required in most jurisdictions.
5. Submit Payroll Taxes
This is where many small businesses face compliance challenges. You must remit withheld employee taxes and your employer-matched taxes to the appropriate government agencies.
- Federal Taxes:
- Deposit federal income tax, Social Security, and Medicare taxes (both employee and employer portions) to the IRS. Your schedule (monthly or semi-weekly) depends on your total tax liability.
- File IRS Form 941 (Employer’s Quarterly Federal Tax Return) quarterly.
- File IRS Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax Return) annually, with potential quarterly deposits.
- State and Local Taxes: Submit withheld state income taxes and SUTA to your state's tax and labor agencies according to their specific schedules.
Record Retention: The IRS recommends keeping all payroll records for at least four years.
6. Choose Your Payroll Method
How you manage these steps significantly impacts your time, accuracy, and peace of mind.
| Method | Pros | Cons |
| Manual (Spreadsheets) | "Free" in terms of direct software costs; complete control. |
Extremely time-consuming and highly error-prone. You're responsible for all tracking, calculations, forms, and deposits. High risk of penalties. Significant security risks for sensitive data.
|
| Payroll Software | Automates many calculations, tax forms, and direct deposits; reduces human error; provides digital pay stubs and basic reporting. |
Requires you to input hours and manage some setup; still need basic tax understanding. You're ultimately responsible for correct data entry and configuration. Support levels vary.
|
| Full-Service Provider | Most hands-off. Handles virtually everything: calculations, all tax withholdings and deposits, all federal and state tax forms (including W-2s). Ensures compliance with changing laws; frees up immense time. Offers HR support. |
Typically the highest monthly cost. Less direct control over daily processing. Ensure secure, reputable providers with robust data security protocols (e.g., SOC 2).
|
The best method depends on your comfort level with complexity, your budget, and how much time you're willing to dedicate to administration versus growing your business.
What Payroll Costs to Expect
Even for one employee, payroll comes with costs. View this as an investment in compliance, accuracy, and your valuable time.
Here's a general breakdown of estimated monthly costs:
| Service Type | Estimated Monthly Cost |
Hidden Costs/Time Investment
|
| Manual (DIY) | Free |
Significant time (5-10+ hours/month), high risk of errors, penalties, stress
|
| Payroll Software | $30–$60/month |
Some time for data entry and oversight, moderate error risk
|
| Full-Service Provider | $60–$100+/month |
Minimal time, lowest error risk, maximum peace of mind
|
Additional fees may apply for: direct deposit, quarterly tax filings, W-2 preparation, new hire reporting, or 1099-NEC for contractors.
How Payroll Taxes & Deductions Work
Understanding the various taxes and deductions is often the most confusing aspect of payroll. They fund critical government programs and employee benefits.
Federal Withholding
- Employee Income Tax: Based on the employee's W-4 form and current IRS tax tables.
- FICA (Federal Insurance Contributions Act) – Social Security & Medicare:
- Employee Portion: You withhold 6.2% for Social Security (up to an annual wage base limit) and 1.45% for Medicare.
- Employer Match: As the employer, you must match these exact amounts (6.2% Social Security + 1.45% Medicare). This is a separate tax liability.
State and Local Taxes
These vary dramatically by location:
- State Income Tax: Some states have none; others have significant taxes to withhold.
- State Unemployment Insurance (SUTA): An employer-paid tax funding unemployment benefits. Your initial rate is set by the state.
- Other State-Specific Taxes: Some states have additional employer-paid taxes or employee-withheld deductions (e.g., state disability insurance).
- Local Taxes: Additional income or occupational taxes may apply depending on your city or county.
Additional Deductions (If Applicable)
- Health Benefits: Employee premium contributions are often deducted pre-tax.
- 401(k) Contributions: Usually pre-tax, lowering taxable income.
- Wage Garnishments: Legally mandated deductions (e.g., child support, student loans).
- Union Dues: If the employee is part of a union.
To put this all in perspective, let's look at a real example. Here's exactly where every dollar goes when you pay an employee $800 in gross wages:
As you can see, your employee receives $602.80 (67.5% of the total cost), while taxes and employer obligations make up the remaining 32.5%. This means your true cost of employment is $893.20 - not just the $800 gross wage.
The tax landscape of payroll is intricate. Staying informed and utilizing reliable resources or services is essential to avoid costly errors.
Pros and Cons of Using Payroll Services for One Employee
For a single employee, the decision to use a payroll service balances cost with complexity, time, and risk.
Benefits
- Saves Time: Frees up hours each month you could spend on sales, marketing, or product development.
- Reduces Errors: Automates complex calculations, minimizing mistakes that lead to penalties.
- Improves Compliance: Stays updated on constantly changing federal, state, and local tax and labor laws, reducing your risk of fines or audits.
- Simplifies Tax Season: Handles preparing and filing quarterly and year-end tax forms (like W-2s).
- Provides Peace of Mind: Experts accurately and compliantly handle your payroll, reducing worry.
Potential Drawbacks
- Monthly Cost May Feel High: This is the primary concern. However, weigh it against the hidden costs of your time, potential penalties, and stress of DIY.
- Data Privacy is Crucial: You're entrusting sensitive data. Work only with secure, reputable providers with robust data security (e.g., SOC 2, ISO 27001).
- Vendor Selection Can Be Overwhelming: Vet providers carefully for needs, customer service, and transparent pricing. Look for scalability.
For most small business owners, the time savings, reduced risk, and peace of mind offered by a payroll service typically make the investment worthwhile, even for a single employee.
Potential Pitfalls to Watch For
Even with just one employee, common payroll errors can lead to significant problems.
1. Tax Mistakes
- Miscalculated Withholdings: Leads to employee frustration and potential penalties for you.
- Missed Deposit Deadlines: Even a day late can trigger costly penalties and interest charges from the IRS.
- Incorrect Employer Contributions: Failing to calculate and deposit your matching FICA taxes or unemployment taxes correctly can lead to back taxes, fines, and increased scrutiny.
2. Compliance Gaps
- Ignoring State-Specific Laws: Wage and hour rules, paid sick leave, and documentation vary widely by location.
- Misclassification of Employees: Incorrectly classifying a W-2 employee as a 1099 contractor is a major red flag for tax agencies and can result in severe penalties.
- Inadequate Recordkeeping: Not keeping accurate, detailed payroll records for the required duration can hinder your ability to defend yourself during an audit.
3. Time Drain
- Underestimating Complexity: Payroll's ongoing requirements (calculations, law changes, forms) can quickly consume valuable time.
- Troubleshooting & Research: Without expertise, you can spend hours researching tax codes or troubleshooting discrepancies.
4. Security Risks
- Unsecured Data Storage: Storing sensitive personal information (SSNs, bank details) on unencrypted spreadsheets exposes your business and employee to data breaches and identity theft.
- Phishing and Scams: Small businesses are targets for scams designed to reveal sensitive payroll information.
Mitigating these pitfalls requires vigilance, continuous education, or, most effectively, partnering with a reliable payroll expert.
Simplify Small Business Payroll with Lift HCM
Setting up payroll for one employee is a serious and ongoing responsibility. Getting it right from the beginning ensures a solid foundation, protecting your business and providing peace of mind. You now have a clear roadmap to confidently manage payroll for your first employee. Remember, compliance is paramount, accurate calculations are key, and choosing the right method can save you significant time and money.
While this guide provides a solid foundation, the nuances of payroll can still be overwhelming, especially as your business grows and regulations evolve. That's where a trusted partner like Lift HCM comes in. We understand the unique challenges small business owners face.
At Lift HCM, we help small businesses build smart, compliant payroll systems—whether you have one employee or one hundred. Our tailored payroll solutions alleviate the administrative burden, ensure accuracy, and keep you compliant, so you can dedicate your energy to your core business.
Ready to offload the complexities of payroll and focus on what you do best? Contact Lift HCM today for a personalized consultation and discover how our tailored payroll solutions can provide peace of mind and propel your business forward!
