How to run payroll for a small business in the US

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To run payroll for a small business in the US, you get an employer identification number, register with your state, collect forms from each employee, calculate federal, state and sometimes local taxes on every paycheck, deposit those taxes on schedule, and file quarterly and annual returns. Most small businesses use full-service payroll software that handles the calculations and filings. This guide explains every step so you understand what the software does, what you are responsible for, and how to avoid the penalties that catch new employers.

Before your first hire

Before paying anyone, set up these basics:

• An Employer Identification Number (EIN) from the IRS. If you are a non-US founder, see how to get an EIN without an SSN.
• State registrations for state income tax withholding (in states that have it) and state unemployment insurance (SUI).
• Workers' compensation insurance, required in most states once you have employees.
• A business bank account for payroll; see opening a US business bank account from abroad.
• A payroll system, ideally full-service payroll software.

If you have not formed a company yet, see how to form a US LLC from abroad and the LLC cost by state table.

Employee or contractor?

Payroll applies to employees. Independent contractors are paid against invoices without tax withholding and receive Form 1099-NEC at year end if they meet the reporting threshold. The IRS and states use tests of control and independence to decide status, and some states, such as California, apply stricter tests. Misclassifying employees as contractors can lead to back taxes and penalties. See contractor misclassification.

Paperwork for each new employee

• Form W-4: the employee's federal withholding certificate, used to calculate federal income tax.
• State withholding form, where the state requires its own.
• Form I-9: employment eligibility verification, completed within three business days of the start date. Some employers also use E-Verify, which is mandatory in certain states and for some federal contractors.
• New hire report: report each new employee to your state's new hire registry, generally within 20 days.
• Direct deposit details and any benefit enrolment forms.

Keep I-9s separately from personnel files, and retain them for the required period after employment ends.

Choose a pay schedule

Common schedules are weekly, every two weeks (biweekly), twice a month (semimonthly) and monthly. Many states set minimum pay frequency rules, for example requiring at least semimonthly pay for certain workers. Biweekly gives 26 pay periods a year and is popular with hourly workers; semimonthly gives 24 and suits salaried staff. Choose one that meets your state's rules and your cash flow.

Federal taxes on each paycheck

For each paycheck, the employer withholds from the employee:

• Federal income tax, based on the W-4 and the IRS withholding tables in Publication 15-T.
• Social Security tax of 6.2% of wages up to the annual wage base.
• Medicare tax of 1.45% of all wages, plus an additional 0.9% on wages above $200,000 in a year.

The employer also pays its own matching 6.2% Social Security (up to the wage base) and 1.45% Medicare. Together, Social Security and Medicare are called FICA.

Federal unemployment tax (FUTA)

Employers pay FUTA on the first $7,000 of each employee's wages each year. The gross rate is 6%, but employers who pay state unemployment taxes on time usually receive a credit of up to 5.4%, making the effective rate 0.6%, or up to $42 per employee per year. In a few "credit reduction" states with outstanding federal loans, the credit is lower. FUTA is paid only by the employer, not withheld from employees.

State and local taxes

Most states have income tax that employers withhold, with their own forms and tables; a handful have no state income tax on wages, such as Texas, Florida and Wyoming. Every state has unemployment insurance, usually paid by the employer at a rate assigned by the state, often with a new employer rate in the first years. Some states also have disability insurance, paid family leave contributions or workforce training taxes, and some cities and counties levy local income taxes.

State rules differ widely, which is the strongest reason to use payroll software that handles every state you employ in. Our US state pages, such as California, New York, Texas and Wyoming, summarise company formation costs by state.

Running a pay run

1. Collect hours for hourly employees and any changes to pay, bonuses or deductions.
2. Calculate gross pay, including overtime at one and a half times the regular rate for non-exempt employees working over 40 hours a week under federal law, and any state daily overtime rules.
3. Subtract pre-tax deductions, such as 401(k) contributions and health premiums under a cafeteria plan.
4. Calculate and withhold federal, state and local taxes.
5. Subtract post-tax deductions, such as wage garnishments.
6. Pay net wages by direct deposit or cheque and provide pay stubs.
7. Record employer taxes and set aside money for deposits.

Full-service payroll software does steps 2 to 7 automatically once you approve the run.

Depositing federal payroll taxes

Federal income tax withheld and both shares of FICA must be deposited with the IRS electronically through EFTPS or your payroll provider. Your deposit schedule is either monthly or semiweekly, based on the total taxes you reported in a lookback period. New employers usually start as monthly depositors, paying by the 15th of the following month. Semiweekly depositors pay within a few days of each payday. Very small employers with low liabilities may pay with their quarterly return.

Late deposits attract penalties that rise with the delay, so deposits are one of the most important things your payroll provider handles.

Quarterly and annual filings

• Form 941: quarterly federal return of income tax withheld and FICA, due by the last day of the month after each quarter.
• Form 940: annual FUTA return, due by 31 January.
• Forms W-2 and W-3: give W-2s to employees and file them with the Social Security Administration by 31 January.
• Forms 1099-NEC: for contractors, by 31 January.
• State returns: quarterly withholding and unemployment returns, and annual reconciliations.

Some very small employers file Form 944 annually instead of Form 941 if the IRS notifies them.

Minimum wage and overtime

Pay at least the federal minimum wage, or your state or city minimum if higher; many states and cities have minimums well above the federal level. The Fair Labor Standards Act requires overtime for non-exempt employees over 40 hours a week, and some states, such as California, require daily overtime. Classify employees correctly as exempt or non-exempt based on their duties and salary, not just their job title.

Benefits and retirement plans

Benefits affect payroll through pre-tax and post-tax deductions. Common ones are health insurance premiums, 401(k) or SIMPLE IRA contributions, health savings accounts and commuter benefits. Several states require employers above a certain size to offer a retirement plan or enrol employees in a state-run program. Full-service payroll providers integrate with benefit providers so deductions are automatic.

Choosing payroll software

For most small businesses, full-service payroll software is worth it. It calculates taxes in every state, makes deposits, files returns, issues W-2s and 1099s, and often guarantees accurate filings. Compare options in the US payroll ranking and best US payroll for small business. Current entry prices: Gusto From USD 49 per month + USD 6 per person, OnPay From USD 49 per month + USD 6 per worker, Justworks From USD 50 per month + USD 8 per employee.

See Gusto vs OnPay and OnPay vs Justworks for direct comparisons, and payroll software cost for how to estimate the total bill.

Paying yourself as an owner

How you pay yourself depends on your business structure. Sole proprietors and single-member LLC owners taxed as disregarded entities take owner's draws, not payroll, and pay self-employment tax on their own returns. S corporation owners who work in the business must pay themselves a reasonable salary through payroll. C corporation owners who work in the business are employees. If your LLC is foreign-owned, other filings apply; see Form 5472 for foreign-owned LLCs.

Records to keep

Keep payroll records, including W-4s, timesheets, pay rates, payroll registers, tax deposits and returns, for at least four years for federal purposes, and longer if your state requires it. I-9s have their own retention rule. Payroll software keeps most of this, but make sure you can export it if you change providers.

Common mistakes

• Late tax deposits, which trigger penalties quickly.
• Misclassifying employees as contractors or as exempt from overtime.
• Forgetting to register in a new state when a remote employee moves.
• Missing new hire reporting or I-9 deadlines.
• Not issuing W-2s and 1099s by 31 January.
• Mixing payroll funds with other spending and coming up short on deposit day.

Example: a biweekly paycheck

An employee in a state with no income tax earns $52,000 a year, paid biweekly, so gross pay is $2,000 per paycheck. They contribute 5% to a 401(k) pre-tax, which is $100. Social Security is 6.2% of $2,000, or $124, and Medicare is 1.45%, or $29; note that 401(k) contributions do not reduce wages for FICA. Federal income tax is calculated on $1,900 using the W-4 and the IRS tables. Net pay is gross pay minus the 401(k), FICA and federal income tax.

The employer pays its matching $124 Social Security and $29 Medicare, plus FUTA on the first $7,000 of wages in the year and state unemployment tax at its assigned rate. Payroll software produces this breakdown automatically on every pay stub.

Hiring remote employees in other states

When you hire someone who works in a different state, you generally need to register with that state for withholding and unemployment insurance, follow its minimum wage, pay frequency and final pay rules, and in some cases local tax rules. Some neighbouring states have reciprocal agreements that simplify withholding for people who live in one state and work in another.

Before making an offer to someone in a new state, check registration requirements and costs, and confirm your payroll provider supports that state, since some charge extra per state. Keep a list of where each employee works, and update it when people move.

Final paychecks

When an employee leaves, state law sets the deadline for their final paycheck, which in some states is the last day of work for terminations, and within a few days or the next regular payday in others. Some states require payout of accrued but unused vacation. Missing these rules can lead to waiting-time penalties. Check your state's rules each time and run an off-cycle payroll if needed. Payroll software usually flags state-specific requirements.

Payroll tax mistakes and the trust fund penalty

Taxes withheld from employees' pay, federal income tax and the employee share of FICA, are held "in trust" for the government. If a business fails to pay them, the IRS can assess the Trust Fund Recovery Penalty personally against the owners or officers responsible, even if the business is an LLC or corporation. This is one reason never to use payroll tax money for other expenses when cash is tight. If you fall behind, contact the IRS early and use a full-service provider that makes deposits automatically.

Payroll for a foreign-owned US company

Non-US founders with a US company can run US payroll for US-based employees in the same way as any employer, once they have an EIN and state registrations. Many full-service providers accept foreign owners, though some require a US address or bank account. Paying employees abroad is different: US payroll covers people working in the US, while staff abroad are paid under their own country's rules, through an employer of record or local entity. See global payroll explained.

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