LLC Payroll Guide: Setup, Taxes, and Software

You need payroll when your LLC has employees or when you have elected S-Corp tax status (which requires paying yourself a salary). Payroll costs typically run $40-150/month through services like Gusto or ADP.

When LLCs Need Payroll

Payroll is the system for paying employees and handling the taxes associated with those payments. Not every LLC needs payroll. Whether you need it depends on your LLC's structure, tax election, and whether you have hired employees.

There are two main situations where payroll becomes necessary:

• You have W-2 employees: If your LLC has hired employees (part-time or full-time), you are required by law to run payroll. This means withholding income taxes, paying employer taxes, and filing payroll tax returns.
• You elected S-Corp taxation: If your LLC has elected to be taxed as an S-Corporation (by filing IRS Form 2553), you must pay yourself a "reasonable salary" through payroll before taking any distributions. This is an IRS requirement, not optional.

If your LLC is a single-member LLC with default tax treatment and no employees, you do not need payroll. You pay yourself through "owner draws" (taking money from the business account) and pay self-employment tax on your profits when you file your annual tax return.

Do You Need Payroll?

Here is a quick breakdown to determine whether your LLC needs a payroll system:

You DO Need Payroll If:

• Your LLC has hired one or more W-2 employees
• Your LLC has elected S-Corp taxation (you must pay yourself a salary)
• You pay yourself wages from a multi-member LLC taxed as a partnership (in certain situations)

You DO NOT Need Payroll If:

• You are a single-member LLC with default (disregarded entity) tax treatment and no employees
• You only work with independent contractors (1099 workers)
• You are a multi-member LLC where members receive profit distributions only (no guaranteed payments treated as wages)

The most common trigger for payroll is the S-Corp election. Many LLC owners elect S-Corp status to save on self-employment taxes. The trade-off is that you must now run payroll for yourself, which adds complexity and cost. The tax savings usually outweigh the payroll costs once profits exceed $40,000-70,000 per year.

Payroll Setup Process

Setting up payroll for the first time involves several steps. Plan to spend 1-2 weeks getting everything in place before your first pay date.

Step 1: Get Your EIN

You need an Employer Identification Number (EIN) from the IRS before you can run payroll. If you already have an EIN for your LLC (which you should), you can use the same one. If you formed your LLC without getting an EIN, apply for one at IRS.gov. It is free and issued immediately online if you have an SSN.

Step 2: Register With State Tax Agencies

Most states require you to register for state income tax withholding and state unemployment insurance before processing payroll. This is separate from your LLC's state formation filing. Visit your state's department of revenue or taxation website to register. You will receive a state employer identification number and instructions for filing.

If you have employees in multiple states, you need to register in each state where an employee works.

Step 3: Choose a Payroll Provider

Unless you are an accountant yourself, use a payroll service. Payroll involves calculating withholdings from multiple tax tables, filing quarterly and annual reports with the IRS and state agencies, issuing W-2 forms, and making tax deposits on time. The penalties for payroll errors are steep, so this is not an area to cut corners.

Popular payroll providers include Gusto, ADP, OnPay, and Patriot Payroll. We compare these in the software section below.

Step 4: Set Your Pay Schedule

Decide how often you will pay employees. State laws may limit your options. Most states require at least semi-monthly or biweekly pay for employees. Check your state's requirements before setting a schedule.

Step 5: Collect Employee Information

For each employee, you need:

• Form W-4: Employee's Withholding Certificate (determines federal income tax withholding)
• Form I-9: Employment Eligibility Verification (confirms the employee is authorized to work in the US)
• State withholding form: Some states have their own version of the W-4
• Direct deposit information: Bank account and routing numbers for electronic payment

Payroll Tax Withholding

When you run payroll, you must withhold certain taxes from each employee's paycheck and pay additional employer taxes. Here is a breakdown of each tax:

Federal Income Tax

Withheld from the employee's pay based on the information they provided on Form W-4 (filing status, number of dependents, additional withholding). The amount varies by employee. Your payroll software calculates this automatically based on IRS tax tables.

Social Security Tax (FICA)

The Social Security tax rate is 12.4% total, split evenly between employer and employee. You withhold 6.2% from the employee's pay and pay 6.2% as the employer. This applies to wages up to the Social Security wage base ($168,600 in 2024). Wages above this amount are not subject to Social Security tax.

Medicare Tax (FICA)

The Medicare tax rate is 2.9% total, split evenly at 1.45% each for the employer and employee. There is no wage base limit for Medicare. An additional 0.9% Medicare tax applies to employee wages exceeding $200,000 in a calendar year (this is employee-only, with no employer match).

State Income Tax

Most states require you to withhold state income tax from employee wages. The rate and calculation method varies by state. Nine states have no state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you operate in one of these states, you do not withhold state income tax.

Federal Unemployment Tax (FUTA)

FUTA is an employer-only tax (not withheld from employees). The rate is 6.0% on the first $7,000 of each employee's wages per year. You receive a credit of up to 5.4% for state unemployment taxes paid, reducing the effective FUTA rate to 0.6% in most cases.

State Unemployment Tax (SUTA)

Also an employer-only tax in most states. The rate varies by state and by your LLC's experience rating (how many former employees have filed unemployment claims). New employers typically start at a default rate, which adjusts over time based on your claims history.

Pay Schedule Options

There are four common pay schedules. Your choice may be limited by state law, which often sets a minimum frequency for employee pay.

For S-Corp owner-employees paying themselves a salary: Semi-monthly or monthly is the most common choice. It is simpler to manage and reduces the number of payroll runs per year. If you are the only employee (paying yourself through S-Corp payroll), monthly payroll keeps things straightforward.

For LLCs with hourly employees: Weekly or biweekly is standard. Hourly workers expect more frequent pay, and some states require it.

Payroll Software Comparison

Payroll software handles tax calculations, direct deposits, tax filings, and year-end forms (W-2s). Here are the most popular options for small LLCs:

Gusto is the most popular choice for small LLCs. It handles payroll, benefits, and HR in one platform. The interface is clean and easy for non-accountants to use. It automatically files your federal and state payroll taxes, generates W-2s, and handles direct deposits. Gusto also offers health insurance, 401(k), and workers' compensation integration.

ADP Run is part of ADP's larger payroll ecosystem. It is a good fit if you plan to grow beyond 10-20 employees, as ADP scales well to larger teams. It offers more HR features than Gusto, including background checks, time tracking, and retirement plans. Pricing is quote-based and not always transparent.

OnPay offers straightforward pricing with all features included at one price point. There are no tiers or hidden fees. It handles multi-state payroll, contractor payments, and benefits administration. It is a strong option if you want a simple, all-in-one solution.

Patriot Payroll is the most budget-friendly option. At $17/month base, it is ideal for LLCs with just one or two employees (or S-Corp owners paying themselves). Patriot offers a "Basic" plan (you handle tax filings yourself) and a "Full Service" plan (Patriot files for you). The Full Service plan costs $37/month plus $4/person.

Common Payroll Mistakes

Payroll errors are expensive. The IRS assessed $6 billion in payroll penalties in a recent year. Here are the most common mistakes and how to avoid them:

1. Misclassifying Employees as Independent Contractors

This is the most common and most expensive payroll mistake. If you treat someone as a 1099 contractor when they should be a W-2 employee, you owe back taxes, penalties, and interest. The IRS and state agencies look at factors like how much control you have over the worker's schedule, tools, and methods. If you set their hours, provide their equipment, and direct how they do the work, they are likely an employee.

Penalties for misclassification can include:

• Payment of all back employment taxes (employer and employee portions)
• Penalties of 1.5% of wages for income tax withholding failures
• 40% of the employee's share of FICA taxes you should have withheld
• State-level fines and penalties
• Potential lawsuits from misclassified workers

2. Missing Tax Deposit Deadlines

Federal payroll tax deposits are due on a schedule determined by your total tax liability. Most small employers deposit monthly (by the 15th of the following month). Larger employers deposit semi-weekly. Missing a deposit triggers penalties starting at 2% and increasing to 15% based on how late you are. Using a payroll service eliminates this risk because the service makes deposits on your behalf.

3. Paying the Wrong Tax Rates

Tax rates change every year. The Social Security wage base increases annually. State tax rates and brackets change. SUTA rates adjust based on your experience rating. Using outdated tax tables results in under-withholding or over-withholding, both of which create problems. Payroll software updates tax tables automatically, which is another reason to use it.

4. Not Filing Quarterly and Annual Returns

In addition to making tax deposits, you must file payroll tax returns:

• Form 941: Quarterly federal payroll tax return (due April 30, July 31, October 31, January 31)
• Form 940: Annual federal unemployment tax return (due January 31)
• W-2 forms: Annual wage statements for each employee (due January 31 to employees and the SSA)
• State returns: Quarterly and annual state payroll tax returns (dates vary by state)

Missing these filings results in failure-to-file penalties on top of any unpaid tax penalties. Full-service payroll providers file these returns for you.

5. Forgetting State Registration Requirements

Every state where you have employees requires you to register for state income tax withholding and state unemployment insurance. If you hire a remote employee in a new state, you must register in that state before processing their first paycheck. Forgetting this step can result in penalties and delayed filings.

Frequently Asked Questions