What Payroll Actually Requires Before You Hire the First Person

We hired our first employee on a Tuesday. By Thursday we had confirmed that we were not ready to have hired anyone on Tuesday.

The payroll processor account was set up. The bank account was linked. We could run a payroll. We could not legally run a payroll, because we had not registered for state withholding in the employee's state, had not set up workers' compensation coverage, and had not filed the new hire report with the state within the required window.

None of this had been explained to us. The payroll processor's onboarding flow did not ask about state withholding registration. It assumed we had handled that. We had not known it was a requirement.

The federal requirements

A federal Employer Identification Number (EIN) is the starting point. You cannot run payroll or file employment tax returns without one. If you formed the company correctly you probably already have an EIN from the formation process or from opening the business bank account. If you do not, the IRS issues them online and the process is fast.

Federal withholding requires you to have each employee complete a Form W-4 on or before their first day of employment. The W-4 tells you how much federal income tax to withhold. You do not file the W-4 with the IRS. You keep it and use it to calculate withholding.

Form I-9 is the employment eligibility verification. The employee completes Section 1 on or before their first day. You complete Section 2 within three business days of the start date by examining original identity documents. You do not file the I-9. You retain it for a specific period (three years after hire or one year after termination, whichever is later) and produce it if audited.

Federal payroll taxes, the employer's share of Social Security and Medicare, are remitted to the IRS on a deposit schedule that depends on your payroll size. A new employer starts on a monthly deposit schedule. The payroll processor handles the calculation and the deposit. You are responsible for making sure the funds are in the account when the deposit is due.

The state requirements

State income tax withholding requires registration with the state agency before you can legally withhold and remit. In most states this is a separate registration from your business entity registration, done with the department of revenue or department of taxation. The registration process and timeline vary by state. Some states process registrations in days. Others take weeks.

If your employee works in a state where your business is not already registered, you may need to register the business as a foreign entity in that state before you can establish an employment relationship there. The requirement varies, but hiring an employee in a state is typically treated as creating a tax nexus in that state.

State unemployment insurance registration is separate from income tax withholding registration in most states. You register as an employer with the state's unemployment insurance agency and begin remitting contributions based on your employees' wages. The rate for new employers is set by the state and changes over time as you build a claims history.

New hire reporting is a federal requirement administered at the state level. You must report each new hire to the state's new hire directory within 20 days of the hire date, or within the state's specific deadline if it is shorter. The purpose is child support enforcement. The penalty for noncompliance varies but is real in states that enforce it.

Workers' compensation

Workers' compensation coverage is required by law in almost every state for any business with employees. The requirement applies as of the first employee's first day, not after some threshold is reached. A business that operates without required workers' compensation coverage is exposed to both penalties and personal liability if an employee is injured.

Coverage is typically purchased through a commercial insurer or, in some states, through a state fund. The premium is based on your industry classification and your payroll. The payroll processor does not arrange this. You arrange this before the hire.

The sequence to run before the first paycheck

The order matters. Register for state withholding first because the processing time may be the long pole. Then arrange workers' compensation coverage, which typically requires a premium payment and a policy number before coverage begins. Confirm your new hire reporting process. Set up the payroll processor account with the EIN and bank account information. Then hire.

On day one: collect the W-4 and I-9 documentation. File the new hire report within the state deadline. Add the employee to the payroll processor.

What the payroll processor handles after that: calculation of withholding, employer tax contributions, direct deposit, W-2s at year end, and federal deposit obligations. What it does not handle: state registration, workers' compensation, I-9 compliance, or new hire reporting. Those are yours before and after the processor is involved.

We got there. The first payroll ran correctly, a week late and with a small penalty for the missed withholding registration deadline. Nobody told us. Now we tell you.