Setting Up Small Business Payroll in California: 2025

Introduction

Navigating the complexities of payroll is a crucial responsibility for any small business owner. However, managing payroll in California brings unique challenges due to the state's extensive regulations that go beyond federal requirements. These include specific registration processes, intricate tax calculations, mandatory reporting, and robust employee protections. Non-compliance can result in hefty penalties, legal troubles, and significant disruptions to your business operations.

For small businesses looking to establish or refine their payroll systems in 2025, understanding the overlapping federal and state obligations is essential. This guide provides a comprehensive walkthrough of the necessary steps for setting up and managing payroll in California for the 2025 tax year. We'll cover federal and state registrations, required employee documents, payroll tax calculations and remittances, California-specific rules like workers' compensation and CalSavers, payroll processing options, and vital record-keeping practices. Following these guidelines will help you stay compliant, reduce risks, and free up time to focus on growing your business.

Step 1: Federal Registration - Getting Your Employer Identification Number (EIN)

The first step in setting up a federal payroll system is obtaining an Employer Identification Number (EIN) from the Internal Revenue Service (IRS). This unique nine-digit number functions like a Social Security Number for your business, identifying it for tax filing and reporting purposes.

Why is an EIN Necessary?

If your business plans to hire employees, an EIN is mandatory. You'll need it to report employment taxes (federal income tax withholding, Social Security, and Medicare) and file employer tax returns, such as Form 941. Even if not required for federal taxes (like a sole proprietor with no employees), an EIN may still be needed to open a business bank account or meet state registration requirements.

Prerequisite: Form Your Entity First

Crucially, your business must be legally formed under California law *before* you apply for an EIN. This applies to corporations, partnerships, and LLCs. Applying before your entity is officially registered with the state can cause delays or complications.

How to Apply for an EIN

The IRS offers several ways to get an EIN, with the online application being the fastest and preferred method:

Responsible Party Information

The EIN application requires designating a "responsible party"—the individual who ultimately owns or controls the entity. You must provide their name and Taxpayer Identification Number (SSN, ITIN, or an existing EIN). Only one EIN application can be submitted per responsible party per day.

Post-Application Considerations

While you can often use the EIN immediately for tasks like opening a bank account, allow up to two weeks for it to fully integrate into all IRS systems before e-filing returns or making electronic payments via the Electronic Federal Tax Payment System (EFTPS). If you apply online, you're automatically enrolled in EFTPS and will receive a PIN by mail. Keep your EIN information current by reporting changes (address, responsible party) using Form 8822-B. If you lose your EIN, check previous tax returns, bank records, or call the IRS Business & Specialty Tax Line.

Step 2: California State Registration - EDD Employer Payroll Tax Account Number

After securing your federal EIN, the next vital step is registering with California's Employment Development Department (EDD). This establishes your state payroll tax account and assigns a unique eight-digit employer account number (EDD number or State Employer ID Number).

When is Registration Required?

California law requires you to register with the EDD within 15 days of paying more than $100 in total wages to one or more employees in a calendar quarter. For household employers, the threshold is $750 in cash wages per quarter. This low threshold means registration is needed very early on.

Taxes Administered by EDD

The EDD handles California's main payroll taxes:

How to Register with EDD

Registration and ongoing account management *must* be done through the EDD's online portal, e-Services for Business. This system is available 24/7.

The process involves two stages:

1. Enroll in e-Services for Business: Visit the portal, select "Enroll," enter required info (username, password, security questions), and verify your email address via a link sent by EDD within 24 hours.
2. Register for an Employer Payroll Tax Account Number: Log in, select "New Employer," choose "Register for Employer Payroll Tax Account Number," complete the online application with your business details (name, DBA, address, type, EIN, responsible party), and submit. In most cases, your eight-digit EDD account number is issued online within minutes.

If you already have an EDD number but haven't used e-Services, you'll need extra info (like recent wage report data or a Letter ID) to link your account online.

2025 New Employer Tax Rates and Wage Bases

When you register, new employers are assigned standard rates for 2025 (subject to final confirmation by EDD):

After the initial period, your UI rate will be recalculated annually based on your "experience rating" (related to unemployment claims). You'll receive an annual notice (DE 2088) with your specific rate.

Mandatory Electronic Filing and Payment

California requires all employers to electronically submit employment tax returns (DE 9, DE 9C), wage reports, and payroll tax deposits (DE 88) to the EDD. e-Services for Business is the platform for this. Mail-in filings are generally not accepted. Setting up and using the e-Services portal from the start is crucial.

Step 3: Gathering Essential Employee Information & Forms

Once registered federally and with the state, you need to collect specific information and legally required forms from each new employee *before* their first paycheck. Accurate completion and retention are vital for compliance.

Key Required Forms:

• Form I-9 (Employment Eligibility Verification): A mandatory federal form (USCIS I-9 Central) verifying identity and work authorization.
  • Employee completes Section 1 on/before day one.
  • Employer physically examines original documents and completes Section 2 within three business days of the start date (alternative remote options exist).
  • Retain for 3 years after hire or 1 year after termination, whichever is later. Store separately from personnel files. Penalties for non-compliance are significant.
• Form W-4 (Employee's Withholding Certificate): A required federal IRS form (IRS Form W-4) telling you how much federal income tax (FIT) to withhold. Collects filing status, dependents, other income/deductions. Employees can claim exemption under specific conditions (expires annually). Retain on file.
• Form DE 4 (Employee's Withholding Allowance Certificate): A required California state form (EDD Form DE 4) for state income tax (PIT) withholding. Separate from the W-4. Specifies state filing status and allowances. If not submitted, withhold as "Single" with zero allowances. Exemption claims follow federal rules. Retain on file.

Other Required California Notices and Pamphlets:

California mandates providing several notices/pamphlets to new hires, often at the time of hiring:

• Notice to Employee (Labor Code Section 2810.5)
• Workers' Compensation Pamphlet
• Paid Family Leave (PFL) Pamphlet
• State Disability Insurance (SDI) Pamphlet (DE 2515 - within 5 days)
• Sexual Harassment Pamphlet (DFEH-185P)
• Unemployment Insurance Benefits Notice (DE 2320)
• California Earned Income Tax Credit (CalEITC) Notice
• Health Insurance Marketplace Coverage Options Notice (Federal)
• General Notice of COBRA Rights (if applicable)
• Harassment, Discrimination, and Retaliation Policy Acknowledgment

Many forms must be provided in the employee's primary language if certain workforce thresholds are met.

Recommended Additional Documents:

• Offer Letter
• Direct Deposit Authorization Form
• Emergency Contact Form
• Employee Handbook Acknowledgment
• Meal and Rest Break Acknowledgment/Waiver Forms
• Optional: Arbitration Agreement, Confidentiality Agreement

Diligently managing this paperwork from day one is essential.

Step 4: Understanding and Calculating Payroll Taxes (Federal & CA)

Accurate tax calculation is critical. This involves determining gross pay, calculating federal and state withholdings based on employee forms and rates, and identifying the employer's own tax liabilities for 2025.

Federal Payroll Taxes (2025):

• Federal Income Tax (FIT): Employee-paid. Amount based on W-4, wages, and IRS Pub 15-T methods.
• FICA (Social Security & Medicare): Split employer/employee.
  • Social Security: 6.2% employer + 6.2% employee (12.4% total) on wages up to $176,100 (anticipated 2025 limit, confirm with SSA/IRS).
  • Medicare: 1.45% employer + 1.45% employee (2.9% total) on all covered wages (no limit).
• Additional Medicare Tax: Employee-only 0.9% tax on employee wages over $200,000/year.
• FUTA (Federal Unemployment Tax Act): Employer-paid. Nominal rate 6.0% on first $7,000 wages/employee/year. Typically reduced to 0.6% ($42 max/employee) due to credit for state UI payments. *Note: California's past federal loan status might affect this credit; check IRS updates late in the year.*

California State Payroll Taxes (2025):

• Personal Income Tax (PIT): Employee-paid. Withheld based on DE 4 and EDD schedules (Method A or B).
• State Disability Insurance (SDI): Employee-paid. Withheld at 1.2% (anticipated 2025 rate) on all employee wages (no wage limit since 2024). Funds DI and PFL.
• Unemployment Insurance (UI): Employer-paid. New employers: 3.4% (anticipated 2025 rate) on first $7,000 wages/employee/year. Rate adjusts annually based on experience.
• Employment Training Tax (ETT): Employer-paid. 0.1% (anticipated 2025 rate) on first $7,000 wages/employee/year (max $7/employee). Applies if notified on DE 2088.

Defining Taxable Wages:

Generally includes salaries, hourly pay, commissions, bonuses, and the value of non-cash compensation (fringe benefits), unless excluded by law. Refer to IRS Publication 15-B for fringe benefit details.

Supplemental Wage Withholding:

Payments like bonuses have special withholding rates. Federal: 22% flat rate (up to $1M), 37% (over $1M). California: 10.23% (bonuses/stock options), 6.6% (other supplemental wages). Confirm rates annually.

Accurate calculation requires tracking earnings, applying correct rates/bases, and handling pre-tax deductions. Payroll software or services greatly reduce error risk.

Step 5: Depositing and Reporting Taxes

After calculation, you must deposit withheld and employer taxes with the IRS and EDD and file regular reports. Timeliness and accuracy are crucial to avoid penalties. Electronic methods are often mandatory.

Federal Tax Deposits (FIT, FICA):

• Method: Must use Electronic Federal Tax Payment System (EFTPS).
• Schedules: Based on Form 941 "lookback period" liability.
  • Monthly: If lookback liability ≤$50,000. Deposit by 15th of the following month.
  • Semi-weekly: If lookback liability >$50,000. Wed/Thu/Fri payday taxes due next Wed; Sat/Sun/Mon/Tue payday taxes due next Fri.
• $100,000 Next-Day Rule: If $100k+ accumulates on any day, deposit by the next business day.

Federal Tax Reporting:

• Form 941 (Employer's QUARTERLY Federal Tax Return): Reconciles FIT/FICA liability with deposits. Filed quarterly (due Apr 30, Jul 31, Oct 31, Jan 31). Use the current revision.
• Form 940 (Employer's Annual FUTA Tax Return): Reports annual FUTA liability. Filed annually (due Jan 31). Deposit FUTA quarterly if liability >$500.
• Form W-2 (Wage and Tax Statement) & W-3 (Transmittal): Reports annual employee wages/taxes. Furnish to employees by Jan 31. File with SSA (along with W-3) by Jan 31. E-filing required for 10+ forms via SSA's BSO portal.

California Tax Deposits (PIT, SDI, UI, ETT):

• Method: Mandatory electronic deposit via EDD's e-Services for Business (associated with Form DE 88).
• Deadlines:
  • UI & ETT: Due quarterly with DE 9/DE 9C filing.
  • SDI & PIT: Generally follow federal schedule (Next-Day, Semi-weekly, Monthly). *Exception: Even quarterly federal depositors must deposit CA PIT/SDI monthly if accumulated PIT withholding ≥ $350 in any pay period.* Consult DE 44 for details.

California Tax Reporting:

• DE 9 / DE 9C (Quarterly Contribution Return and Report of Wages): Reports total wages, calculates UI/ETT/SDI, details employee wages/PIT/SDI withheld. Filed quarterly (due Apr 30, Jul 31, Oct 31, Jan 31). Mandatory e-filing via e-Services. File even if no payroll.
• DE 34 (Report of New Employee(s)): Reports new/rehired employees to New Employee Registry (NER). Due within 20 calendar days of start date. E-file via e-Services preferred. Penalties apply for failure.
• DE 542 (Report of Independent Contractor(s)): Reports contractors paid ≥$600. Due within 20 days of paying ≥$600 OR entering into a contract for ≥$600 in a calendar year, whichever is first. File Form DE 542 with EDD. Requires near real-time tracking.

Summary of 2025 Federal & California Payroll Tax Deposit and Reporting Deadlines

Note: Deadlines falling on weekends/holidays shift. Always check official calendars.

Managing these deadlines requires a robust system, often provided by payroll software or services.

Step 6: California-Specific Payroll Mandates

Beyond taxes, California has several other payroll-related mandates.

Workers' Compensation Insurance:

• Requirement: Mandatory for ALL employers (even with one employee). Covers work-related injuries/illnesses.
• Obtaining Coverage: Buy from a licensed insurer, through the State Compensation Insurance Fund (State Fund), or self-insure (requires state approval, typically for large employers).
• Penalties: Severe penalties for non-compliance (fines up to $10k, imprisonment, stop orders, personal liability for injury costs).
• Posting: Must post "Notice to Employees—Injuries Caused By Work" (DWC 7) with carrier info.
• Payroll Impact: Premiums based on payroll, industry code, and claims history. Accurate payroll is key. Pay-as-you-go plans integrate payments with payroll runs.

CalSavers Retirement Savings Program:

• Requirement: Employers with 1+ CA employees who *do not* offer a qualified retirement plan must participate. Deadline for employers with 1-4 employees to register is Dec 31, 2025.
• Purpose: State-run Roth IRA program funded by automatic employee payroll deductions.
• Employer Role: Register with CalSavers, submit employee roster, facilitate payroll deductions, remit funds, distribute program info. No employer contributions allowed/required.
• Employee Participation: Auto-enrolled after 30 days unless they opt out. Default contribution 5% (escalating to 8%), but employees can change rate or opt out.
• Exemption: Available if offering a qualified plan (401k, SEP-IRA, etc.). Must certify exemption with CalSavers.
• Penalties: $250/employee after 90 days non-compliance notice, plus $500/employee after 180 days.
• Payroll Integration: Requires setting up deductions and remittance within the payroll process.

California Paid Sick Leave (PSL):

• Requirement: Mandated by Healthy Workplaces, Healthy Families Act (as amended by SB 616) for nearly all employees working 30+ days/year in CA.
• Accrual/Provision Options:
  • Accrual: Earn 1 hour PSL per 30 hours worked (can cap annual accrual at 40hrs/5days, total bank at 80hrs/10days).
  • Upfront/Lump Sum: Provide at least 40 hours or 5 days at the start of each year/12-month period (no carryover required if full amount granted annually).
• Usage: After 90 days employment, for self/family member health needs or preventive care. Must allow use of at least 40hrs/5days per year. Cannot require documentation for <3 days leave. Min usage increment rules apply.
• Payroll Impact: Must track accrual/usage/balance. Available balance must be on pay stub (or separate notice). Pay at regular rate (specific rules for non-exempt/variable pay).
• Local Ordinances: Be aware of potentially more generous local PSL laws (SF, LA, Oakland, etc.). Comply with the most favorable provision (state or local).

Step 7: Choosing a Payroll System or Service

Managing payroll involves many tasks. Small businesses have several options:

Factors to Consider When Choosing:

• Number of Employees
• Budget (setup, per-payroll fees)
• Time Availability
• Complexity (pay types, deductions, multi-state, CA specifics)
• Compliance Confidence
• Desired Features (direct deposit, self-service, integrations)

Given California's complexity, mandatory e-filing, and specific mandates, using payroll software or a full-service provider is highly recommended over manual processing for most small businesses in 2025.

Step 8: Establishing Pay Periods and Paydays

California law dictates pay frequency. Failure to comply leads to wage claims and penalties.

Defining Pay Periods:

A pay period is the recurring timeframe for work/earnings (weekly, bi-weekly, semi-monthly). California Labor Code sets limits.

California Pay Frequency Requirements:

• General Rule (Non-Exempt): Must be paid at least semi-monthly. Wages earned 1st-15th due by 26th of same month. Wages earned 16th-end of month due by 10th of next month.
• Overtime: Can be paid on the payday for the *next* regular pay period.
• Exempt Employees: Can be paid once monthly, on or before the 26th, including the entire month's salary.
• Other Schedules: Weekly (pay within 7 days of period end) or bi-weekly (pay within 7 days of period end) are common and compliant for non-exempt workers. Semi-monthly (twice per month) also common.
• Exceptions: Some industries have specific rules.

Establishing the Payday:

The specific day employees receive wages.

• Timeliness: Payment due on the established payday. If holiday/weekend, pay on preceding business day.
• Consistency: Paydays should be regular and predictable.
• Notice: Regular payday must be on the Notice to Employee at hire. Changes require prior written notice.

Choosing a Pay Schedule:

Consider compliance (at least semi-monthly for non-exempt), employee preference, administrative burden (weekly=52 runs, bi-weekly=26, semi-monthly=24), cash flow, and benefit deduction ease. Clearly communicate the schedule.

Step 9: Record Keeping Requirements

Maintaining accurate payroll records is legally required by federal (FLSA, IRS) and California (Labor Code, EDD) laws. Essential for audits, tax calculation, and defending against claims.

Federal Requirements (FLSA & IRS):

Keep records for each non-exempt worker including personal details, workweek start, hours worked daily/weekly, pay basis, rates, earnings (straight & overtime), additions/deductions, total pay, payment date/period. IRS requires employment tax records kept for at least 4 years (EIN, wage details, W-4s, deposits, returns, benefits).

California Requirements (Labor Code & EDD):

Often more detailed/longer retention. Must include:

• Employee details (name, address, SSN, occupation, birthdate if <18).
• Total hours worked daily/weekly (non-exempt), *including exact start/end times for work and meal periods*.
• Earnings (straight, overtime), all applicable rates.
• Gross wages, itemized deductions, net wages per pay period.
• Pay period dates.
• Copies of itemized wage statements (pay stubs).
• Paid Sick Leave accrual and usage records.

Retention Period (California):

• Basic payroll records (hours, wages, deductions): At least 3 years.
• Pay Stub Copies: At least 3 years.
• EDD Tax Records: At least 4 years (aligns with IRS).
• Other Records: New Hire Reports, CalSavers, Workers' Comp (injury logs 5 years).

Best Practice: Retain all payroll-related records for at least 4 years.

Itemized Wage Statement (Pay Stub) Requirements (Labor Code § 226):

California pay stubs must include specific details. Failure leads to penalties.

Storage and Accessibility:

Keep records safe, accessible for inspection (DLSE, EDD, DOL, IRS). Must be available in CA within 72 hours of Labor Commissioner request. Employees have right to inspect/copy records within 21 days of request. Electronic records are permissible if compliant. Payroll software/services facilitate this.

Step 10: Handling Final Paychecks (Termination & Resignation)

California has very strict, time-sensitive rules for final paychecks, more protective than most states. Failure leads to "waiting time penalties."

Timing of Final Pay:

What Must Be Included in Final Pay:

• All earned wages (including overtime).
• Accrued, unused vacation/PTO (considered vested wages, cannot be forfeited). Paid at final rate.
• Exception: Mandatory Paid Sick Leave generally *not* paid out unless lumped into a general PTO bank.
• Earned bonuses/commissions per agreement/policy terms.

Waiting Time Penalties (Labor Code § 203):

If final wages are willfully unpaid on time, penalties apply: Employee's average daily rate of pay for each day late, up to 30 calendar days. "Willful" generally means knowing wages were due but intentionally not paying on time. Ignorance of the law is usually not a defense. Penalties can be substantial.

Best Practices for Final Pay:

• Know the timing rules for termination vs. resignation.
• Calculate accurately (wages, OT, vacation/PTO payout).
• Prepare checks in advance when possible (especially for terminations).
• Follow rules for delivery location/mailing (use certified mail if mailing).
• Keep detailed records of final pay calculation and delivery.
• Avoid unlawful deductions (only required taxes or specifically authorized deductions).
• Consult legal counsel if unsure, especially with complex pay structures or disputes.

Conclusion

Setting up and managing small business payroll in California for 2025 requires meticulous attention to a complex web of federal and state rules. From initial EIN and EDD registration, through careful employee form collection (I-9, W-4, DE 4) and notice distribution, the setup demands diligence.

Ongoing tasks are equally challenging: accurate calculation of federal (FIT, FICA, FUTA) and state (PIT, SDI, UI, ETT) taxes, timely electronic deposits, and punctual filing of quarterly (941, DE 9/DE 9C) and annual (940, W-2/W-3) reports are essential.

California adds further complexity with mandates for workers' compensation, CalSavers participation (for employers without retirement plans), and compliant Paid Sick Leave administration. Establishing proper pay periods/paydays, maintaining detailed records (for at least four years), providing compliant pay stubs, and adhering to strict final pay rules are all critical.

Given the intricacies and high cost of errors (penalties, legal fees), most California small businesses benefit immensely from using reliable payroll software or a full-service provider. These solutions automate tasks, manage compliance, and help navigate changing regulations, reducing risk and freeing up business owners to focus on growth. Investing in a robust payroll system is a vital step for success in California.