A Step-by-Step Guide to Setting Up a Payroll System

Any small business owner can tell you that paying employees involves a lot more than writing a check every two weeks.

There are dozens of laws governing employee compensation. If you don't want to run afoul of various government agencies, you have to be well organized and stay up-to-date on federal and state guidelines.

The key to staying on top of things is setting up a good system that complies with all the applicable state and federal laws. To get started, try this step-by-step approach to setting up a simple payroll system:

Step one: Get an Employer Identification Number (EIN). You can apply for a number by filling out IRS Form SS-4. To determine if an EIN is really necessary for your business, consult the helpful chart found in Do You Need an EIN?

Step two: Get state and local identification numbers if they are required in the area or areas where your business operates.

Step three: Separate your independent contractors and full-time employees. You don't have to withhold taxes from an independent contractor's pay. Don't think that you can save time by classifying all of your employees as independent contractors, however: The IRS may penalize your business heavily if you designate regular workers as independent contractors. For details, see the IRS Publication 15 Circular E, The Employer's Tax Guide.