Running a pay review in the United States
Reviewed by Mellow Editorial Team, HR & payroll content team
A pay review is a structured process for evaluating and adjusting employee compensation — typically done annually, though some companies run them twice a year or after a probationary period ends. Done well, it keeps pay competitive, defensible, and internally fair.
Decide the scope and timing before you start
Before you touch a single salary, answer three questions:
- Who is included? New hires in their first six months are often excluded. Contractors paid on 1099-NEC are not employees and sit outside a standard pay review entirely.
- What budget are you working with? Most companies set a percentage of total payroll as the merit pool before managers make individual decisions. Without a defined pool, reviews drift over budget.
- What cycle are you on? Calendar-year reviews are common because they align with financial planning. Fiscal-year or anniversary-date reviews are also valid — pick one and stick to it.
Getting these decisions in writing before the review starts prevents disputes later and gives managers clear guardrails.
Gather market data you can actually use
A pay review without external benchmarks is just a guess. Reliable sources include:
- Published salary surveys from industry associations or compensation research firms
- Government data from the Bureau of Labor Statistics Occupational Employment and Wage Statistics program (publicly available, updated annually)
- Job postings for comparable roles in your metro area — crude, but useful for a directional check
When you pull data, match on job function, company size, and geography. A software engineer salary in Austin and one in San Francisco are not comparable. If you operate across multiple states, run separate benchmarks for each location.
Define your target position in the market — at the 50th percentile (median), the 75th, or somewhere else — and apply that consistently. Changing the target each year makes it impossible to track progress.
Assess individual pay against the range
Once you have market ranges, map each employee's current salary to the midpoint. This produces a compa-ratio (current pay divided by midpoint). A compa-ratio below 1.0 means the person is paid below market; above 1.0, above market.
Use compa-ratio alongside performance to drive decisions:
- High performer, low compa-ratio: priority for a meaningful increase
- High performer, at or above midpoint: smaller increase; recognize through other means
- Lower performer, above midpoint: hold or minimal adjustment; address the performance issue separately
This approach keeps pay decisions explainable. If an employee asks why their increase was 2% while a colleague received 6%, you can show the methodology — not just a manager's judgment call.
Also check for internal equity issues: two people doing the same job at materially different pay levels without a clear justification (seniority, scope, location differential) is a legal and morale risk. Title VII of the Civil Rights Act and state equivalents prohibit pay discrimination based on protected characteristics. If your data surfaces a pattern — even an unintentional one — fix it proactively.
Understand the payroll and tax mechanics of a change
A salary increase takes effect on the payroll run for the pay period it applies to. The mechanics flow through federal income tax withholding (progressive brackets from 10% to 37%, based on the employee's Form W-4), FICA contributions (Social Security at 6.2% on both sides up to the annual wage base, Medicare at 1.45% with no cap, and a 0.9% Additional Medicare surcharge for high earners), and any applicable state income tax.
A few practical points:
- If an increase is backdated, the catch-up payment will appear as a lump sum in one payroll run, which can push the employee into a higher withholding bracket temporarily. This does not change their annual tax liability — it just affects the paycheck math.
- Mid-year increases shift your annual payroll cost. Update your payroll system on the effective date, not the announcement date.
- Employees in states with no income tax (Texas, Florida, and Washington among them) will see the full federal picture with no state withholding layer; employees in high-tax states like California or New York will see a noticeably different net figure.
- Reclassifying a worker from contractor to employee as part of a pay review triggers full payroll tax obligations and requires a W-4 and enrollment in benefits. That is a separate process with compliance implications; do not treat it as a routine pay adjustment.
Communicate clearly and document everything
Tell employees their new salary, the effective date, and — if your culture supports it — the rationale. You are not required to share other employees' pay, but explaining the process builds trust in the outcome.
Document each decision: the market data used, the performance rating applied, the prior salary, and the new salary. Keep records for at least three years, which covers most federal and state wage claim statutes of limitations. If a decision is challenged, documentation is your defense.
Employment in the US is generally at-will, which means compensation can be adjusted prospectively with notice — but changes cannot be applied retroactively in a way that reduces pay for work already performed, and some states have additional requirements around advance notice of pay changes.
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